New rules on how research is paid for and used will have a big impact on companies – including retailers – that publicly report their results.
This month the second Markets in Financial Instruments Directive (MiFID II) came into effect. The purpose of this European-wide regulation is to improve transparency and standardise disclosure across European financial markets.
One consequence is investment banks will now need to price research separately from sales and trading execution.
Going forward, research will need to be paid for by institutions directly rather than bundled as part of their trading commissions, and only those institutions that pay for the research can receive it.
Research may also be paid for by the companies being covered, and in that case anyone will be able to receive it.
With regard to this type of research, it is unlikely to be impartial, and will therefore be seen as having less value in the decision-making process of investors.
The media has discussed at length the impact on banks and financial institutions. Few have written about the potentially negative impact on listed companies – specifically the potential for a material reduction of independent research coverage.
“Research matters; it provides a third-party assessment of a company’s performance and the investment opportunity that might exist”
Research matters; it provides a third-party assessment of a company’s performance and the investment opportunity that might exist.
By outlining this potential, this in turn can help drive a company’s valuation, and clearly the more widely the research can be spread, the greater the impact.
Also at times of more challenging trading conditions, a good analyst can help maintain investor support in a company, highlighting the reasons for any short-term underperformance and take a longer-term perspective on the investment story, potentially reducing the number of sellers, and consequently supporting a price.
Reduced analyst presence
The visible impact of MiFID II will be reduced analyst presence in results presentations.
This will result in less coverage, which may well lead to less trading in shares. Lower liquidity tends to result in lower valuations, and this is as true for the listed retail sector as any other.
For the larger retailers with market caps above, say, £700m, they may be less impacted by these changes. They will likely continue to receive coverage from the larger investment banks, given they provide sufficient liquidity to justify that coverage.
This research will be funded by the wide number of institutions that desire the coverage. But the consequence of this funding route is that only those fund managers who pay for research will be able to receive research.
Notes will not be widely distributed and this may well have an impact on wider investor knowledge of companies and, subsequently, liquidity and valuations.
The greater issue lies with companies with a market cap below £700m that face a much bleaker coverage outlook.
“Company paid-for research is rarely viewed as independent and, as a consequence, is less valuable as an investment tool. Similarly the reduction in the depth of coverage is unlikely to be positive”
Investor paid-for research is likely to be far more limited. In an extreme case, research coverage may fall to a couple of analysts who are paid by the company to publish research.
While this is the norm for many micro-cap companies, the effect is likely to creep up the market capitalisation scale.
Company paid-for research is rarely viewed as independent and, as a consequence, is less valuable as an investment tool. Similarly, the reduction in the depth of coverage is unlikely to be positive.
The outcome is that certain companies are likely to fall off investors’ radars with the implied negative outcome on valuations as liquidity dries up.
What should companies do? Identifying good research houses that are focused on delivering a high-quality product will be essential. Corporate brokers may also be required to work much harder on a company’s behalf to deliver the story to the wider investment community.
That said, the longer-term strategic question for smaller-cap companies is likely to be: is the public market the right place to be at all?
- Mervyn Metcalf is managing director at Dean Street Advisers