- Equity research firms have seen revenue slashed in 2018, with some experiencing drops of as much as 60%.
- The catalyst for the decline is sweeping European financial reform that went into effect January 3. Though the rules originated in Europe, they’re having a global impact.
- For global banks, where research isn’t a profit center, falling revenue isn’t a giant concern — at least not yet.
- For struggling specialist and domestic firms without diversified revenue streams, the decline poses a more existential threat.
- Some boutiques have capitalized on the new environment and have outperformed top-tier banks.
Some of the top equity-research shops in the world have seen revenue decline by 10% to 30% this year — and those are the lucky ones.
Others are staring at declines of as much as 60%, according to figures from the consulting firm Oliver Wyman.
Equity research revenues were widely anticipated to decline after the Markets in Financial Instruments Directive II, the complex and sweeping European regulatory reform, went into effect January 3.
That’s because one of its headline provisions prohibits free and bundled research, requiring asset managers to pay for it separately from commissions for executing trades — a significant departure from past procedure that has shaken up the industry.
Since most asset managers elected to absorb the cost of research rather than pass it along to their customers, they were expected to trim their research budgets and the number of analysts they work with.
“I was dealing with 10 of you; I don’t want 10 of you anymore, I only want the five best of you,” Mary Erdoes, the head of JPMorgan Chase‘s massive asset and wealth-management business, explained at an analyst conference in November.
And that’s how it’s been playing out thus far in 2018, according to research from Oliver Wyman, which speaks with top management at financial firms and has been following the MiFID II impacts closely.
“Almost every buy-side client has come out as absorbing the research cost, placing further downward pressure on prices,” said Michael Turner, a partner at Oliver Wyman.
Turner explained that the leading banks had seen research revenue drop 10% to 30% compared with last year. The upside is that they haven’t been losing many clients.
For global research banks firmly outside the top five, the year has been more of a struggle.
“Tier-two banks have seen much worse declines, with some up to 60% down in research revenues,” Turner said.
It’s a much more mixed bag for specialist and regionally focused firms. Some boutiques have actually outperformed the tier-one global banks, while others that lack a distinct offering are getting battered as bad or worse than the tier-two banks.
“We’ve seen a wide divergence in specialists and domestics,” Turner said. “Some who have a particular content edge have actually outperformed the big banks, with slight revenue gains, while those without a niche have been really hurt.”
Overall, Oliver Wyman expects global equity research revenue to decline 30% to 40%, or $2 billion, by 2019. Trading execution revenue has remained surprisingly resilient.
It’s not a crisis for everybody
It’s important to put these figures into context. There is roughly $60 billion in equities-related revenue worldwide, according to Oliver Wyman and others, and equity research accounts for only about $5 billion of that pool.
It’s not chump change, but for global banks, declines in research revenue don’t pose dire consequences, given the size of the banks and their breadth of activities.
“It’s bad, but it’s not an existential crisis,” Turner said. “We expect few capacity withdrawals, especially at the global banks, given the importance of research for other areas of the firm.”
Research itself isn’t a major profit center, but it plays a role in myriad other business lines at bulge-bracket banks, especially trading execution, equity derivatives, and prime brokerage (servicing hedge funds). It also affects investment banking, including equity capital markets.
Erick Davis, the CEO of the research firm Autonomous Research, a boutique that specializes in financial firms, says the revenue pool that research indirectly contributes to could exceed $100 billion, if you combine global equities with capital markets.
For the big banks, remaining connected to the customers who fund that larger revenue pool is more critical than taking small losses from the shrinking $5 billion equity research pool.
“It’s disadvantageous to screw up customer relationships around research,” said Davis, though he questioned the sustainability of treating research as a loss leader and expected that some banks would eventually have “tough decisions that need to be made.”
For firms that specialize in research, however, such a decline is far more critical.
“Specialists who have seen revenues drop by more than 40% will be in a real tough place at the end of the year,” Turner said.
‘They just pulled a rug out from underneath everyone else’
Davis’ firm is among the cadre of specialists that have outperformed in 2018. Autonomous has retained most of its clients and is optimistic about its revenue opportunity going forward, hiring one new senior analyst and their associate away from a global bank this year, Davis said.
Why have some specialists fared so well? Part of that has to do with how investors and asset managers have cut and reprioritized their research budgets in the post-MiFID II world.
What Erdoes described in November has largely aligned with what Davis has heard from large clients: They’re looking for just five or six global research firms. That “opens up a lot more wallet to specialists,” said Davis, who observed that buy-side firms had embraced a more intense relationship with research shops that provide niche, premium products, as Autonomous does.
The types of firms left out in that picture: the tier-two global banks and the regional or specialist firms that don’t offer a premium product — the companies that Oliver Wyman say have been worst hit thus far in 2018.
The global banks suffering this year can thank JPMorgan, in part, for their pain. Last year, when banks were figuring out how to price research separately in preparation for MiFID II, the bank reportedly undercut the competition and came out with an entry-level price option of $10,000 — one-fourth what some rivals were considering.
“It was massively disruptive to firms that cover all sectors,” Davis said, adding that it was probably a brilliant strategy by JPMorgan, which has a strong research offering. “They just pulled a rug out from underneath everyone else that had come out with a pricing point for global sectors.”
Despite the ugly numbers to start the year, it’s still early on and there hasn’t been a scramble to cut analyst jobs.
One top equities headhunter told us they weren’t “seeing any analysts going out to the market,” but the story could change by the third quarter.
Even then, talented analysts aren’t likely to find themselves out of work.
Given the desire of asset managers like Erdoes to work only with the “five best,” it’s essential for competitive research shops to staff the best analysts.
The head of one global bank’s research department, who told Business Insider in November that there was “a resurgence in competition for the best talent” ahead of MiFID II, said he was “still seeing escalated levels of competition for world class talent.”
Mediocrity is what will get left behind.
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