We are now atthe first anniversary of the arrival of the new rules requiring “buy-side” firm, such as pension funds, unit trusts, hedge funds and private equity funds, to purchase research as an ‘unbundled’ product, detached from an execution fee.
This sounds esoteric to those outside the financial markets, but in fact this change mandated in the second Markets in Financial Instruments Directive (Mifid II) created a huge shift requiring “sell-side” investment banks to price and sell their research into equities, currency and other financial investments rather than provide it free to clients.
As many feared, it has unleashed a price war as “bulge bracket” investment banks seek to gain market share ahead of an expected consolidation of research providers.
We believe this price war is detrimental to the financial industry overall and ultimately for the buy-side firms who use the research.
Large investment banks are currently pricing their research low in order to push smaller research providers out of the market. They expect a consolidation of the industry and want as much market share as possible now in order to be one of the eventual winners.
Currently this price-war is good news for buy-side funds and asset managers, especially as they are themselves experiencing strong price pressure from their own customers particularly through a shift towards lower margin passive funds. This too is translating into hard negotiations with investment banks over the cost of their research.”
Despite the twin pressures of the price war and the buy-side’s push for lower prices, the value of financial research has never been stronger and research providers need to hold their nerve.
How much would a portfolio manager pay for speaking to an analyst with the right information at the right time? The value is immense, and this information is potentially worth billions of pounds. Therefore, despite the pressures I don’t believe the research industry will commoditise anytime soon.
For instance, funds that mainly dealt with equities were already used to paying for research before the arrival of Mifid II and consequently see its value in the investment process.
On the other hand, fixed-income funds had always received trade ideas for free and, so far, have demonstrated a lower willingness to pay for research.
Another positive is that Mifid II has triggered a strong push for innovation among sell-side providers, with their research becoming more specialised and heterogeneous.
Investment banks are trying to differentiate their value proposition from their competitors, both by providing research through different channels and also by making their content more innovative. The provision of raw data has consequently become almost as important as traditional written content.
Many commentators believe the high fixed costs sustained by mid-sized research players will ultimately drive them out of the business, or at least retreat from any global ambitions, leaving only a handful of truly global players.
This will be a problem if we see larger banks absorbing research costs over the long-term, as opposed to passing on charges to customers, because they see providing research as a crucial function for other business areas of the bank as a whole, such as primary market activities.
If larger banks are inclined to keep their research business barely profitable in order not to lose the revenue streams from the other business area, this would spell trouble for smaller banks which cannot afford to dip into their own pockets to cross-subsidise providing research.