One year on from the introduction of MiFID II, asset and wealth managers continue to struggle with much of the pan-European regulation's requirements as well as its unintended market consequences.
MiFID II, which came into force in January 2018, placed an additional raft of onerous new requirements on firms with regard to fee and performance disclosures, while placing strict restrictions on how they go about acquiring research.
It was born in the wake of the financial crisis and, like other regulations that were introduced at the time, it sought to achieve greater transparency in financial markets and improve investor protection standards.
Partner at law firm Dechert, Richard Frase, explained the regulation has represented both a large operational challenge and monetary cost for the asset management industry.
He said: "There is more transparency, but whether that transparency is actually capable of alleviating the ills you are concerned about is difficult to say.
"Whether the cost has been worth it, it is too early to tell."
The requirement to ‘unbundle' research costs from the rest of sell-side services is thought to have taken a toll on research coverage and therefore liquidity as a result of reduced trading volumes.
Analysis from research provider Hardman & Co in December revealed that since the introduction of MIFID II liquidity levels across the market have declined, with London Stock Exchange main market liquidity falling by an average of 15.5% per stock in 2018.
Meanwhile, as asset managers have reduced the amount of research and number of brokers they are using, and analysts have left brokers in their droves, the average stock on the main market saw a reduction in research coverage of 6.2% in 2018.
However, according to head of UK banking at pricing strategists Simon-Kucherone Gianluca Corradi, one positive for asset managers that appears to have emerged as a result of the research requirements is a "price war" between brokers, which has forced research costs down.
He said: "Large investment banks are currently pricing their research low in order to push smaller research providers out of the market.
"They expect a consolidation of the industry and want as much market share as possible now in order to be one of the eventual winners.
"Currently, this price-war is good news for buy-side funds and asset managers, especially as they are themselves experiencing strong price pressure from their own customers particularly through a shift towards lower margin passive funds.
"This too is translating into hard negotiations with investment banks over the cost of their research."
Acting 'in the spirit' of MiFID II
While research unbundling has represented a large operational and administrative cost for asset managers, firms are also failing to change pre-MiFID II behaviours, such as deciding on the value of research after consuming it, according to co-founder of Electronic Research Interchange Chris Turnbull.
He said: "In hindsight, it may have been naïve to expect quick-fire change from an industry that has operated in a certain way for decades.
"A mitigating factor has been that the FCA has not been active enough in enforcing penalties and facilitating the transition."
Turnbull explained that firms have been given "free reign" by regulators and have not "acted in the spirit of the regulation".
He added: "We must now accept that achieving an effective research market will be a slow process, as we are very much in the infancy stage at this point."
This more relaxed approach by the FCA in the first year of MiFID II was outlined by the regulator in the early months of its implementation in efforts to allow market participants to get to grip with the new requirements. However, this is expected to change as the FCA and other European authorities are armed with more data, and are better placed to enforce the directive.
Technical policy director at trade body TISA Jeffrey Mushens acknowledged the sector has "obstacles to overcome" in this respect, particularly with regard to pre-sale reporting requirements, which many firms "failed to grapple with early on in ".
He added: "The industry is still struggling with having to report annually in both pounds and percentages after a sale has gone through.
"Central to these concerns is the requirement to effectively link information about changes - typically reported as a percentage to customers' actual balances - and turn that into a personalised figure.
"For those customers with more than a single investment or where they have taken income or topped up, or left, reporting in this way is proving particularly technically challenging.
Elsewhere, MiFID II has yet to achieve its goal of providing investors with the full transparency the directive was designed to create, with wealth managers struggling to provide past performance and costs and charges disclosures.
Maarten Heukshorst, BNY Mellon's Pershing chief relationship officer, explained it is likely to take five years for investors to be accurately provided with year-on-year comparative data of costs and charges.
He added: "It is only then that consumers will get full transparency of the value chain of who is looking after their money.
"While there is currently not a standardised approach on the reporting of cost and charges, such regulatory developments are focusing the mind of firms when it comes to the cost of doing business.
"We are likely to see a divergence in the market, with firms either joining the race to the bottom when it comes to fees or opting for the value for money camp."
His colleague Michael Horan, Pershing's head of trading, also explained that MiFID II transparency standards have actually had the "reverse effect" for fixed income markets as trade reporting requirements are "too ambitious".
He said: "Having to report in 15 minutes for liquid bonds and 48 hours for illiquid bonds is too short a window and means risk positions are shown to the market too early, forcing banks to widen their spread and avoid committing as much as previously.
"We knew that MiFID II was going to be a challenge for bonds as it was forcing transparency and electronification in a market already experiencing liquidity issues.
"It is not as evolved or developed as the equity market, so the unintended consequence of MiFID II has come home to roost: it was always going to be too much, too soon."
The problems associated with MiFID II - as well as some of the compromises made by law makers in its creation - are set to be assessed by forthcoming reviews from both the Financial Conduct Authority and European regulators by 2020.
Dechert's Frase, who was previously head of litigation at FCA forerunner the Personal Investment Authority, said whether these difficulties will be assessed by authorities and reduced - or simply added to - is "impossible to say".
This article was first published by Investment Week