Why MiFID II
The Markets in Financial Instruments Directive II (MiFID II) was introduced by the European Securities and Markets Authority (ESMA) in the EU in January 2018 to much fanfare. ESMA states the aim of the Directive is to “strengthen investor protection and improve the functioning of financial markets making them more efficient, resilient and transparent”.
One major consequence of MiFID II is that the amounts investors pay to brokers for research, access and execution have to be split out. Research cannot be paid for out of client fees.
While transparency is to be welcomed, so is independent, high-quality research. In the first instance MiFID II has led to the downsizing of many research functions. Some investors, particularly the larger houses, are building up in-house research but in a time of competitive pressure this is not an option for many investors.
It is true that the extensive analyst coverage of many large caps has been excessive – do investors realistically need over 40 analyst reports on a quarterly set of numbers for Siemens, HSBC or LaFargeHolcim? But what about smaller companies?
The Impact
There is clearly a very real danger that smaller companies and smaller investors are the losers in MiFID II:
- Smaller companies because they become less visible to the capital markets and potential investors;
- Smaller investors because they have reduced access to research and possibly little access to management.
Much of the focus to date has been on smaller companies and there is rightly concern that with the reduction of research coverage they will have lower access to liquidity and capital. The speed of the impact of MiFID II on research capability suggests that this is of relevance to every quoted company Board – including larger caps.
It is certainly incumbent on the Boards of listed companies to think very carefully how they can ensure that their company remains on the radar screen for research. This in turn gives access to pools of investment representing a long-term, sustainable source of capital.
Questions that public company Board Directors should be asking include:
- Is the company’s visibility with investors likely to be impaired by MiFID II?
- Is this an opportunity to articulate to the equity story more cleanly and effectively?
- Does the company have in place the Executive (CEO/CFO) and IR capability for the MiFID II era?
- What does Board-level shareholder engagement look like in the MiFID II era?
The Opportunity and the Risk
As equity research becomes more streamlined, so to do investment decisions. This will favour some companies but there is a risk that the market will miss nuance and be unwilling to think through more complex or less well (loudly) articulated investment opportunities.
There is undoubtedly an opportunity for Board and Management Teams to build better relationships with shareholders if brokers are no longer the conduit for corporate access.
Equally MiFID may prompt companies that have been sloppy about articulating their equity story to significantly up their game.
It is no coincidence that the introduction of MiFID II comes at a time when regulators and governments are insisting on greater levels of shareholder engagement by public company Boards. Indeed, the latest revisions to the UK Corporate Governance Code published by the Financial Reporting Council as well as recent corporate governance trends internationally, strongly advocate a higher degree of shareholder engagement.
The risks of not stepping up to the opportunities represented by MiFID II are considerable. Companies that fail to embrace change could face diminished access to capital with a knock-on impact on valuation.
This in turn reduces strategic opportunities for the Board, as well as reward mechanisms for employees. Potentially the company becomes vulnerable to takeover and also to activism – with over $170bln of assets under management focussing on activist investment opportunities globally. Across Europe we see corporate Boards facing increasingly audacious shareholder activism and companies that are weak in the articulation of their equity story and have poor access to key investors could well fall victim.
These are very real risks for corporate Boards and hence the theme of activism and the Board level response will be included in Fidelio’s next “A Seat at the Table” Programme with its focus on Board learning.
Given these risks and challenges, practically what can Boards be doing to ensure that the value proposition is being communicated clearly?
How can Boards keep their companies firmly on the radar screen for long-term investors and thereby support the sustainable growth of the company?
Practical Considerations for Public Company Boards in the MiFID II Era
Drawing on Fidelio’s work with quoted Boards internationally, we set out some basic steps:
- Board Composition
Ensure that Board composition embraces a good understanding of the capital markets. This is not synonymous with prior public company Board experience, although this is of relevance. A broader understanding of how the markets are structured and the changes that are taking place is advantageous. This includes a network across regulators, banks and investors to provide reference points to guide the Board through changes at least partly driven by MiFID II.
- Board Engagement with Shareholders
Shareholders increasingly expect regular communication with the Chairs of companies they invest in. This level of engagement is becoming “business as usual”. The pattern typically follows the company’s financial and IR calendar with most Chairs of quoted companies making themselves available to investors in the run up to the AGM for example. Nor are shareholders restricting their attention to the Chair. For example, in the UK it is becoming more common for major listed companies to host investor days providing opportunity for shareholders to engage with Committee Chairs. We see experienced Chairmen keep a close eye on best practice and benchmarking against relevant peers.
FRC: “Committee chairs should seek engagement with shareholders on significant matters related to their areas of responsibility.”
- Board Oversight of Executive Engagement with Shareholders
The Board will be receiving regular updates from the CEO and CFO on their relationships with investors and the market. We clearly see in public company CEO and CFO appointments a preference for track record in dealing with shareholders.
On an ongoing basis the Board needs to retain comfort that the CEO and CFO have good relationships with the market and are also well regarded by investors. This is typically achieved through a number of mechanisms including:
- A good ear to the market
- Direct Board level engagement with shareholders
- Regular shareholder reviews
- A dotted line to a good IR Director with both formal and informal feedback
4. Benchmarking IR
The day-to-day front-line engagement with investors is typically conducted by the Head of IR or IR team. MiFID II will heighten the importance of this role and we increasingly see Boards and CEOs benchmarking the effectiveness of their IR team. This is typically against relevant peers but is also extended to other companies recognised for best practice and indeed valuation. Fidelio has recently undertaken benchmarking for clients to build an effective IR capability and understand this link with the valuation. It has also provided a good opportunity for the Board to conduct a broader review of the company’s ’s interface with its investors.
Yes, the above may sound daunting to Non-Executive Directors who are removed from the daily interaction with investors. Companies also frequently face significant cost pressure. As Boards review how well the company is positioned to navigate MiFID II they can take comfort from innovation from technology.
Increasingly companies will be able to bring in-house a number of tools that will greatly enhance access to the shareholders they need to grow their business including:
- Smart investor targeting
- Observation of peers – who is attracting investment and why
- Handling of roadshows and investor meetings
- Channels of direct communication with investors which will supplement the one-on-one meetings across the globe.
Conclusion
MiFID II is clearly shaking up the market for investment banks and investors.
The effects are beginning to be felt by corporates and public company Boards are taking note. The risk of reduced access to capital, weakening valuation and loss of strategic opportunity is considerable.
But there is also an opportunity for Boards to turn this around. Through a mixture of strategic thinking, relevant experience and innovative technology the winners will start to pull away. Companies that implement these steps will be better placed to drive valuation and their Boards will be having a much higher quality discussion about architecting the shareholder base.
To learn more about how Fidelio supports public company Boards that are “fit for the future” through Search, development and Evaluation, please contact Luke Main on lmain@fideliopartners.com