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Mike Tyrrell: Fuel or fig-leaf? The impact of EU’s MIFID II on responsible investment research (Part 1)

Mike Tyrrell: Fuel or fig-leaf? The impact of EU’s MIFID II on responsible investment research (Part 1)

Part one of a two-part look at the implications of MIFID II for RI and ESG research.

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Is SRI an investment discipline for grown-ups or a fig-leaf for wannabe campaigners? Is corporate governance (CG) a value-creator or a retirement home for bureaucrats? In 2018 we’re going to find out as an unintended (but highly desirable) consequence of the MIFID II European Directive!
Most people in the SRI/CG industries will share MIFID II’s broad aims of making European markets safer, more transparent and more efficient, thus restoring investor confidence. They are also likely to applaud the expectation of transparency and the tougher standards applied to investment products through the value chain. Whether they are prepared for the implications for their own sector remains to be seen.
The impact of MIFID II on SRI/CG depends on the extent to which you agree with the following statements:

  • SRI is primarily an investment strategy
  • Research is the fuel which drives a priori investment decision-making
  • Direct engagement matters

Although these statements may sound self-evident, consideration of contrary positions indicates that many people in SRI/CG have different views, notably that:

  • SRI is primarily an ownership process, an approach to public policy engagement or a means of satisfying client expectation
  • ESG factors manifest primarily through risk exposures and are best tackled a posteriori
  • The complexity of engagement necessitates careful preparation and collaboration

If you agree with the latter set of statements, then MIFID is unlikely to affect you much as your primary driver isn’t investment-related and it follows that you won’t be (and certainly shouldn’t have been) using dealing commission to pay for SRI/CG research or access to companies.
If, by contrast, you think that SRI/CG are factors that affect asset managers’ decisions to buy, hold or sell stock, and that high-quality research is needed to inform these decisions and that direct contact with the companies in portfolios is a critical source of information, then you are likely to be significantly affected by MIFID II implementation. You are also probably well-advanced in changing the way you pay for investment research and corporate access.
MIFID II rules that asset managers should no longer pay for the research or corporate access services that they receive bundled into trading commissions. Instead, payment should either come out of the asset manager’s own pocket or, if the end client is to pay, the research/access costs should be separately identified, both at the payment stage and at the point of client reporting. In theory, this sounds simple. In practice, however, it introduces major new competitive dynamics into the SRI/CG research market, notably:

  • Usually, it causes sell-side broker research to be paid for out of the same budget pot as SRI / CG research
  • Often, it causes external research to be paid for from the same budget pot as internal research
  • Always, it forces asset managers to be more disciplined about the research and services that they receive and to report more transparently to clients about the use that they make of these.

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