The debate over MiFID II has sparked intense speculation about the future of the European equity research business. Much less attention has been paid to the potentially profound impacts of the regulatory proposals on the European cash equity trading business.
A new report from Greenwich Associates, European Equity Trading and the Consequences of Regulation, reveals that European buy-side traders and portfolio managers believe MiFID II provisions could increase trade execution costs and reduce market liquidity – particularly in small cap stocks.
The report shows that the more than EUR3.4 billion in commission payments earned by brokerage firms on institutional trades of European equities in the year ending Q2 2015 was about evenly divided, with 53 per cent paying for research and advisory services and 47 per cent taking the form of payments for trade execution services.
While MiFID II will force greater clarity in how research is being valued and impose new structures on how investors pay for it, it will also bring greater clarity to the profitability of individual trading relationships between investors and brokers.
“In a more unbundled world, it will become difficult for one to subsidise the other,” says John Colon, Greenwich Associates consultant and author of the new report. “Conceivably, the cost of execution may go up to the extent the real cost of liquidity has been hidden in the bundled model.”
MiFID II includes a series of proposed rules addressing regulatory concerns about transparency and the impact of fragmentation on price discovery. By a wide margin, the buy-side traders believe MiFID II will be successful in increasing dark pool transparency. “As is often the case, the question is: ‘At what cost?’” says John Colon.
Traders do not believe MiFID II will have a material impact on market fragmentation. To the contrary, they believe that transaction costs will increase as the new rules diminish market liquidity, particularly for small/mid-cap trades and that MiFID provisions that more clearly separate payment for research from order execution may drive additional order flow to the lowest cost avenues of execution.
The proportion of European equity trading volume executed as electronic or portfolio trades by traditional European investment managers (i.e. excluding HFT’s) rose steadily from less than 40 per cent five years ago to 50 per cent today. However, year-over-year volume has essentially plateaued.
One contributor to this interruption in e-trading growth is institutions’ continued need to pay for research (which is arguably easier via high-touch than low-touch trades), and their wide use of commission sharing accounts. Looking ahead, institutions expect a further increase in electronic trading to nearly 60 per cent in the next three years.

“In the post MiFID II world, sell-side trading desks will compete for customer flows more purely on their trading prowess – trading ideas and market color, access to liquidity including the ability to provide liquidity via capital commitment, and trading technology,” John Colon says.
