Another year, another new regulation! Although we’re only a few weeks into implementation of MiFID II and it may seem like nothing has changed, I can assure you that this will have a major impact on not only the sellside, but the buyside as well. If you’re looking to get into the industry, you need to be aware of these changes, as it will not only affect demand for these types of jobs, but the economics as well.
A Summary of MiFID II
MiFID II stands for Markets in Financials Instruments Directive II. For some people, the non-I letters are most important: Mother F#cking Disaster. Unless you work in the back office. Then MiFID II means years and years of job security.
On the buyside, I use research provided by the the sellside, such as research reports, calls with analysts, conferences, and management meetings. Although these services aren’t free, I don’t pay for them directly. Instead, my firm pays for this access through soft dollars. This means that we direct trading to firms that provide us research. So even though there’s no direct cost of research, we pay for it indirectly by trading more with firms that provide quality research. This relationship between buyside firms and sellside firms has existed for many decades now. But it begs the question, how much of the trading costs comes from execution and how much is for research? This is one thing that MiFID II is trying to accomplish. Going forward in Europe, the costs for trading and research must be separated.
If It’s Only In Europe, Does It Impact US Firms?
Technically speaking, it should only impact European investment firms. However, hedge funds like mine are global, and we have operations around the world, including Europe. Some firms are trying to ring-fence the European operations, but this not only adds costs, but complexity as well. But let’s be honest here. There’s no cheap or easy way to be MiFID II compliant. Different firms are taking different approaches, because they all have drawbacks.
Another issue with MiFID II is institutional investors love the idea of increased transparency. In the previous fee structure, investors were responsible for research and trading costs because we passed those costs on to them. However, it could be argued that research is a source of alpha generation and therefore should be borne by the investment firm, and not the investor. We’re already seeing signs of this, as some large asset managers have decided to pay for research directly out of their own pockets, instead of passing it on to investors.
How Does It Impact the Sellside?
The impact to the sellside is pretty straightforward. Previously, banks viewed research as a cost center that supported trading and investment banking. Now, research needs to stand up on its own. The consensus view is that demand for sellside jobs will decrease because there are too many firms providing the same service. For many large companies that I cover, there are over 30 analysts that provide research, and most of it is undifferentiated. I didn’t care when it was all given to me for free, but I’m not paying 30 analysts to rehash earnings results and what management said on the call.
The consensus view is that the bulge brackets will be fine. They can provide full, global coverage of stocks and also prime services for hedge funds like mine. Small boutique firms should also be fine, since they can survive on $30k checks from a few clients. It’s the middle tier firms that will get squeezed. They’re too large to subsist on small checks, but not large enough to be a one-stop shop for large asset managers like mine.
Net Negative for the Sellside
Overall, MiFID II should be a net negative for sellside jobs. Bulge brackets aren’t going to be net hirers from this, while middle tier firms will get squeezed. Small boutiques will see a net positive, but there aren’t enough of them to offset the loss from the middle tiers.
How Does It Impact the Buyside?
2 and 20 is dead. Fees are coming down, and it’s not just with hedge funds. We continue to see funds shift to passive strategies, which puts pressure on all active asset managers. If more institutional investors expect asset managers to absorb the cost of research, that means firms like mine will see less revenue and higher costs. As any investor can tell you, that’s not a good combination.
I believe MiFID II will continue the trend of lower new hedge fund formation, as it gets more and more expensive to start a new hedge fund. Some sellside firms are charging $10,000 for a management meeting. That can make sense when it’s a one-on-one with the CEO and it lasts an hour. But sometimes I’m in a meeting with 20 other investors and it only lasts 30 minutes. I’m not even going to pay $100 for that. With increasing costs, only the largest hedge funds will be able to successfully compete for resources and talent, which puts smaller hedge funds at a larger disadvantage.
Net Negative for the Buyside
Overall, I believe MiFID II will be a net negative for buyside hiring as well. Fewer new hedge funds mean fewer hedge fund jobs. I’ve heard some people suggest that buyside firms will spend less on sellside research, and instead hire more internal analysts. I don’t think this is the case because the two aren’t interchangeable. Having more buyside analysts isn’t a replacement for less sellside research, just like how more sellside research can’t replace buyside analysts. I use the sellside for access to management and to get the view of other buysiders, since they talk to many people on the street. On the buyside, my job is to determine whether management is believable and what is going to get investors more positive or negative on a stock. These two types of jobs are very different things.
So MiFID II Is All Bad?
So far, I’ve painted a pretty negative picture of MiFID II on the investment industry. But remember, if you’re good at what you do, somebody will hire you. And if your strength is making money, somebody will pay you boatloads of cash to generate high returns, regardless of the regulatory environment.
Another thing to consider is that MiFID II is creating disruption. And disruption creates opportunity. It’s not yet clear who will benefit from MiFID II, other than back office and institutional investors. But some enterprising person will see an opportunity and become extremely successful.