Having yesterday taken a little stab at MiFID II, in my view one of the most ridiculous pieces of self-congratulatory but also destructive over-legislation since the 1919 Treaty of Versailles, I received a response from an old chum.
“Another daft point of MiFID II being that by forcing investors to pay for research outright without it being an “incentive to trade” - (ie. dropping margins to compensate is a no-no) makes it more difficult for the smaller asset managers to compete, thus perversely reducing competition in asset management, which surely is a worse outcome for consumers.”
The chum in question, Saro Bos of Imperial capital, a decent sized but not huge independent broker-dealer, has a stronger point that I think even he was aware of. Markets are about pluralism; the more choice a consumer has, the healthier the market will be. The more players that emerge in a market place, the more transparent the market becomes for the clustering of data points on a bell curve will tell more about the correct price of an asset than a thousand post-trade reporting systems. Practitioners of the art of trading will know that the highest bid or lowest offer, if outliers from the cluster, can often prove to be erroneous and the number of trades that are subsequently cancelled due to miscommunications or “fat finger syndrome” prove that there is no such thing as a free lunch. Best execution is, as all serious players know, a first class tool for self-delusion.
Pond life
Smaller broker dealers, the pilot fish in the shark pond, are being squeezed out of business. It’s not that they’re bent or useless; it’s because the compliance effort that has to be put into periodic KYC due diligence has become too costly for the banks to perform on smaller counterparties. My old platform, SwissInvest, which has been comfortably trading bonds with the principal market makers around the world and across the currency spectrum for over a quarter of century is suddenly finding itself being struck off the approved counterparty lists by eager compliance officers, some of whom where babes in arms when SwissInvest wrote its first ticket with their employers.
But the depth of the market and offering the end user the best price is not the regulator’s business. I was speaking to a journo last week who covers financial regulation. Although slightly surprised but offering no push-back, he took on board my contention that the regulators’ first objective is to cover their own butts. The start of the global financial crisis 10 years ago was as much the fault of sleeping regulators as it was the banks who believed they were working in permissible spaces. Don’t get me wrong; much of what the banks perpetrated in the first half of the last decade was beyond responsible and immoral but it was generally not illegal.
The great German writer Erich Kästner, known outside the German speaking world mainly for his children’s books including Emil and the Detectives in 1929, coined the phrase “In the perpetration of a mischief not only those are to blame who perpetrate it but also those who fail to prevent it”. The political hate campaign against bankers in 2008/2009 certainly kept the flies off the politicians who had gratefully and greedily garnered to fiscal avalanche emanating from the banking sector, but as a by-product also protected the sleeping regulators from public wrath.
Phantom Menace
MiFID II is an embarrassingly transparent case of “The Empire Strikes Back” although with the likes of Brian Moynihan, the chairman and CEO of Bank of America saying that he is in favour of tighter regulation, the Republic is not looking good. Only Jamie Dimon, Moynihan’s opposite number at JP Morgan, seems prepared to stand up to be counted and to don the suit of Luke Skywalker.
But back to research. What’s wrong with free research? Well, of course it’s not free but I read in this morning’s FT that Vanguard, the world’s second largest asset manager, is budgeting no more than US$5m for paid research. Assuming that the cost of a research analyst, along with the compliance officers who looks over his shoulder plus systems and what-not, is US$250,000 per year, then Vanguard reckons it will only fund the jobs of 20 external analysts. One must therefore assume that Vanguard believes that it can do all the research it needs in-house.
Isn’t the point of reading research to collect the most diverse range of views on a chosen subject and, hopefully, a few views on some un-chosen subjects too? In-house research is fine and dandy but how many young, aspiring analysts are going to risk their careers by producing controversial views that go against the position taken by their bosses? In our dreams it is the bright, imaginative graduate who will shine and rise swiftly to the top. Look at Taylor at Axe Capital in the TV series “Billions” who out-thinks everybody and who in 11 episodes rises from graduate geek to CIO. In reality it is whoever pleases the head of research and can be relied on to toe the party line that gets pulled up the greasy pole.
From beginning to end MiFID II talks of transparency and fairness while in fact it is doing little other than to reinforce the power of the sharks while slaughtering the pilot fish. For several years I sat on the Secondary Market Practices Committee of ICMA, the European bond market’s principal trade body. I know what it was like when we scrutinised legislative proposals and filed our comments and suggestions, only to be met with “save your breath and don’t confuse us with facts; our mind is made up”.
When draconian legislative straitjackets were first proposed, many of my peers reckoned it wouldn’t take long for the authorities to notice that they had got it wrong and for the process to be reversed. I was less sanguine and thought 25-30 years to get it right and not within our working lifetime. We are now 10 years in and the legislators are still fighting windmills. The financial crisis erupted not over asset quality but over the lack of liquidity. You may recall that BNP Capital Partner’s August 9 2007 statement referred to it’s not being able to value its assets because of a lack of liquidity. The money markets might have been illiquid but the bond markets weren’t. Some of the prices may have been a bit dodgy but at least they were there. Next time and with a high level of probability they won’t.
A New Hope
The wholesale slaughter of the banks’ research departments that is threatening might please the legislators but, as Saro noted, it will freeze out the smaller players on both the buyside and the sellside. The centripetal effect will concentrate more and more power in the hands of the big asset managers, the second largest of which has already said that it doesn’t want to spend more than US$5m on research. Can anybody give me a single argument of what benefit that might bring to the depth and diversity of markets and thus to Joe SixPack, the ultimate consumer? C’mon Jamie, swing that light sabre!
Oh, and by the way, the prices for bonds, stocks, commodities and currencies went up and down yesterday but of course not necessarily always in that order…