“A catalyst”. “Disruptive”. “Disorientating”.
Whatever you think of MiFID II, it will change the research market dramatically. And one of the main issues is that the industry has to adapt quickly. If it doesn’t, research firms will risk losing clients or even shutting down.
Who’s Got a Target on Their Back
The buy-side will need to look at the different types of research they’re receiving and decide whether it’s useful, whether they need it, and how much they’re willing to pay for it. At this point, for example, it will be extremely difficult for new entrants, as the buy-side is not willing to commit to anything new until they understand who they have on their books and what the added value is.
In the long term, MiFID II will create an even playing field between independent research providers and the sell-side. In the short term, however, the industry will go through the motions. And with larger investment firms expected to cut their research budgets by 30-50%, a massive clean-up operation – in terms of who’s on who’s books and for what – is coming.
One could intuitively say that the top five sell-side banks in a dense and fragmented market are safe. However, the rules are a bit different when it comes to research.
Indeed, players 6 through to 20 and beyond will experience the most turbulence, from pivoting their research strategies to closing their research divisions completely.
At the same time, as we know, research has never been a moneymaker for banks, it was more a support mechanism for corporate finance. Which means that some of the bulge bracket investment banks could potentially decide to give up their research departments altogether, if the corporate finance teams decide to stop sponsoring corporate research and more analyst talent drips out.
The Big Squeeze
For smaller asset management firms, it also becomes more expensive to continue to receive high-quality research as they lack sufficient scale to get the right level of “research purchasing power”. They need to find more money to pay for research, which is hard when their fees are being squeezed already.
With the boom of passive fund management and somewhat lacklustre performance of actively managed funds, one question arises: why would an investor pay the 2% management fee for actively managed funds, when passive funds charge 0.1%?
With active management fees already high, the additional burden of the cost of research cannot be easily passed onto the client, and thus has to be absorbed by the firms – they will need to find a way to survive, while being caught in this race to the bottom.
For those buy-side firms that choose to scrimp on the costs of expensive, high-quality research, this may have an impact on their performance, especially in an environment where investors are desperate for alpha.
So the other option is funds accepting to take a hit on their own margins. Being squeezed from all sides, it’s a catch-22 that will likely drag out throughout 2018 and beyond, or at least until the pricing models become more normalised.
The Right Price
In order for the buy-side to feel comfortable having a number of providers on their panels, the pricing models have to make sense.
At the moment, subscription models prevail, and we will see a huge concoction of subscription models. Research houses will be offering a variety of subscription options centred around the following themes:
- Asset class: equity, fixed income or macro
- Sector based – industry verticals, large cap v. small cap
- Regional pricing – based on client location or research coverage
- Usage based: “all you can eat” model, per unit/seat pricing in bundles or single units
- Product based: analyst access, written collateral, corporate access, conference attendance
Research providers will likely bundle these different parameters or offer bespoke pricing based on usage. For example, one firm can offer one subscription for one million dollars a year, and that will probably give the client waterfront coverage. Another one can say: for five analysts on the buy-side, we will charge $20,000 and cover them for access to Asia consumer research. A third combination may be: we will give you access to twenty of our analysts calls a year, for $100,000.
Come 2019, whoever will be left standing will also be able to prove beyond any doubt that they are offering real value to their clients.