The ground is starting to shift and buckle underneath investment bank research, months before a scheduled earthquake. On January 3, 2018, the bundling together of research and execution charges into commission rates will end in Europe with the coming into effect of Mifid II.
Although the Markets in Financial Instruments Directive will only apply to the European Union, strong tremors are already being felt in Asia.
“Mifid II is getting the entire world more focused on research payments,” says Damien Horth, head of Asia Pacific research at UBS. “For funds based in Europe, the operational complexity means that the path of least resistance is to apply it globally. And you also have this natural trend that if you have a global business, you want to go to the best practice. Ratification is seen as the highest possible standard.”
The burden of further regulation aimed at greater pricing transparency and protection of end investors has aggravated strains from intense competition. Since 2015, Standard Chartered has closed its global cash equities and underwriting businesses, Barclays has withdrawn from Asian cash equities and Nomura has abandoned European equities. In February, CLSA said it was getting out of cash equities in North America, jettisoning its star bank analyst Mike Mayo. Credit Suisse added to the trend in March.
Under Mifid I, the industry was given considerable leeway to self-regulate, but persistent abuses prompted a more draconian tightening. “The argument is that some asset managers may have been purchasing and paying for this research using trading commissions, which is actually not their money – it is the money of the fund, or the asset owners,” said Stephane Loiseau, head of cash equities and global execution services, Asia Pacific, at Société Générale.
The bar has also been raised considerably on the substance, quality and pertinence of investment research provided by banks. The UK’s Financial Conduct Authority has led the way, with guidance on the need for “substantive research” that must “be capable of adding value to the investment or trading decisions by providing new insights … represent original thought … and must not merely repeat or repackage what has been presented before; have intellectual rigour and must not merely state what is commonplace or self-evident; present the investment manager with meaningful conclusions.”
As Horth notes: “There’s a much greater focus on transparency across the value chain, which is leading to the industry being much, much more focused on the value-added brought to the table.” Transparency carries its own cost to the industry, however. Who is going to foot the bill for research, if not the end investor?
“If the asset manager is being asked to pay for the research out of their own P&L, which is what Mifid in Europe is doing, that adds to their cost base,” Loiseau points out. “There will be cost pressure on the research providers as well, so a reasonably well-expected consequence is that money spent for research will decline.”
CLSA chief executive Jonathan Slone has publicly lashed out at Mifid II and regulators “who like nothing more than to delve into the private affairs of companies, and pootle around with their arrangements on how they pay for information, liquidity and knowledge”. Slone’s outburst drew attention to CLSA’s vulnerability in this new world. A cash equities house mainly known for the quality and independence of its Asian research, CLSA was swallowed in 2015 by CITIC, the Chinese investment banking giant.
Accentuating a trend
“Mifid II is only accentuating a trend over the past few years, of the strong getting stronger and the weak getting weaker,” says Horth. “The increased transparency is putting even more pressure on the research ecosystem.”
At present, the cost of global research services can be eye-watering. Hong Kong-based consultant Quinlan & Associates says global bulge-bracket banks have quoted ‘millions per year’ for providing the largest global fund managers with unlimited access to their research; at the low end the costs are $250,000–$300,000 per year.
Last year, consultant Benjamin Quinlan predicted a decline of as much as 25%-30% in global research spend by 2020. Fidelity International’s use of external research “has steadily fallen in recent years and it will continue to fall” as the firm invests further in its in-house research and IT platform, spokesperson Mariko Sanchanta told FinanceAsia.
Tokyo-based Nikko Asset Management is buying in more outside research to complement its own, according to chief investment officer Yu-ming Wang.
In an interview with FinanceAsia, Wang said he broadly welcomed Mifid II. “Investors are looking to break down the components so they only pay for what they want, and this is directly related to unbundling the research side. It is a good idea to price it explicitly, because there is a good deal of research that’s what I call noise or advertising, and maybe this will dial it down.”
The global asset management industry is already in the throes of intense price competition from the rise of low-cost passive index trackers, and in particular, exchange-traded funds (ETFs) that cost almost nothing to run.
Net global inflows into ETFs grew by $380 billion or 14% in 2016, compared with 0 to 1% for the global asset management industry, according to a joint report in March by Morgan Stanley and Oliver Whyman, titled ‘The World Turned Upside Down.’
No sacred cows
At best, the report forecasts flat operating revenues in asset management from 2016 to 2019, and only if the industry ruthlessly cut costs. It says: “Adopting a ‘no sacred cows’ mindset to costs will be critical to success as businesses are rewired for the new reality.” But the option of slashing research spend is never raised in the report.
Horth of UBS points to a winnowing of overcapacity on the sell-side.
“If you go back six or seven years, there were 15 firms trying to be global in research. They had all built up global networks of analysts and economists and strategists, and it got to a scale where some people in that ecosystem were producing very bland research. It was not particularly value-added, and for some of the European banks that was in the US, for some of the US banks that was in Asia.”
Banks still committed to full-service equity research are trying to enhance its relevance and appeal.
UBS, which has about 150 writing analysts in Asia Pacific, including at its China joint venture, has hired psychologists to help analysts think differently and ask better questions. There is also a new ‘Evidence Lab.’
“We describe Evidence Lab as a primary research platform. It includes consumer survey professionals but also data scientists, people with geospatial expertise and overall expertise in primary research that can help our analysts address the issues of the day,” Horth explains. “It is absolutely part of our strategic response to the challenges that the industry is facing and we think it is helping our research stand out from the crowd.”
One example of the Lab’s work was web-mining 80,000 records to review price trends in China for infant milk formula.
But to a growing cohort of industry revolutionaries, such initiatives are merely whistling in the wind, a doomed attempt to revive a model that is fundamentally broken.
In 2015, Société Générale ended its alliance with London-based Asian equities boutique JapanInvest, which was bought by China’s Haitong International; in 2016, it closed its India equity research desk. With no equity research left in Asia, the No. 2 French bank has decided not to rebuild one. Instead, SocGen has taken the radical step of teaming up with Smartkarma, an online research marketplace (ORM) that hopes to do for investment research what Amazon did for shopping (see interview). SocGen now hands out Smartkarma log-ins to its clients.
Quinlan estimates the global market for these ORM start-ups will reach $1.4 billion by 2010 and $2.4 billion by 2025, or 15% and 30% of the global research wallet respectively.
“In an unbundled model, it’s very difficult for a bank to afford to maintain a big analyst presence in any market,” Loiseau contends. “There is a huge amount of interest in these independent platforms.”
