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By Simon Jessop and Dasha Afanasieva
LONDON (Reuters) - European stock exchanges expect it to be harder for smaller companies to create a buzz among investors when brokers produce fewer research notes after new rules come into force next year.
Investors often use analysis on a company to decide when to buy or sell a stock. But asset managers are expected to reduce their research budgets when the European Union's Markets in Financial Instruments Directive (MiFID) II goes live in January.
With a shrinking pot of money to pay for analysis, brokers are cutting their teams and reducing coverage of the smallest companies.
"The less research coverage you have, the less trading liquidity you get on the back of it," said Christian Edelmann, global head corporate & institutional banking and wealth & asset management at consultants Oliver Wyman.
The region's biggest exchange, Euronext, already provides free research for some companies, but said it may expand the service to others.
Borsa Italiana plans to require all small firms listing after January to pay for their own research.
Coverage of smaller companies has always been patchy and a spokesman for the EU markets regulator the European Securities and Markets Authority said there was "little evidence that the new rules would negatively impact SMEs".
The exchanges disagree.
"We looked at MiFID II and took soundings from the market. They told us that the situation for small and medium-sized companies was getting worse, regarding research," Renata Bandov, Head of Listing at Deutsche Boerse, said.
"They (the companies) need investors and investors need information... it's really important that you have transparency for investors."
This could also mean that companies turn to a growing pool of private equity and venture capital funds as an alternative to listing on a stock exchange.
Deutsche Boerse in March this year to launch a new listing segment - Scale - for small and medium-sized enterprises. It provides a basic level of research for all firms paid for out of listing fees.
Each company in Scale gets publicly available reports upon listing plus periodic reports afterwards. Listing fees are a basic fee of 20,000 euros ($23,692) plus an extra fee of 10,000-50,000 based on the company's market capitalisation.
The exchange has had four IPOs since March, to add to the 49 companies at Scale's launch. For all of the companies, which average 200 million euros in size, trading liquidity has improved, Bandov said.
The move by Deutsche Boerse follows similar action at Euronext three years ago, where the exchange decided to pay for research for smaller tech and family-owned businesses, which make up a large number of companies on the exchange.
It pays for research for 430 companies, but is considering expanding coverage to other companies in light of MiFID II, although no decision has yet been reached, Eric Forest, head of French listings at Euronext, said.
"The paying model will probably become, very, very quickly, the most-used model by small and mid-sized companies. They will have to pay to be covered by brokers in terms of equity research," Forest said.
Borsa Italiana, part of the London Stock Exchange Group, said any company listing after January would have to do just that.
Barbara Lunghi, head of Primary Markets Borsa Italiana, said the new rules would likely mean that firms employ a specialist broker for research.
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Larry Fink, chief executive of the world's biggest asset manager, BlackRock, is also worried about the ability of smaller companies to attract a following by investors.
Thomson Reuters data shows 1,119 European Union companies worth under $1 billion with a free-float of at least 25 percent have no analyst coverage. That covers 64 corporate sectors but excludes investment funds and holding companies.
Luke Ellis, chief executive at hedge fund firm Man Group, said the new rules could also punish less-experienced retail investors.
"Is the transparency about what's going on in small and mid-cap stocks going to get materially worse? Yes. Is it going to create some inherently false markets which will hurt some inexperienced investors? Yes," he said at Reuters recent Investment Summit in November
($1 = 0.8442 euros)
(Additional reporting by Helen Reid; editing by Anna Willard)
(This story has not been edited by Business Standard staff and is auto-generated from a syndicated feed.)