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Strategic Insights

A Brave Call

This follow-on report examines the growing predicament for sell-side players arising from research unbundling, the rise of independent research providers (IRPs), and the ways brokers can work with these new entrants.
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With just over six months until MiFID II goes live, the global investment research industry is on the cusp of major disruption. While a plethora of issues confront both the buy- and sell-sides in the lead up to the implementation in January 2018, pricing appears to remain the key area of contention for the industry, given the substantial misalignment between broker and manager expectations. While many managers still have much to do to meet their obligations under the new regulatory regime, we believe it is the sell-side that is facing the biggest competitive disruption, with downside risks greatest for the global investment banks. Burdened by inherent conflicts between their research and investment banking departments, as well as stubbornly high costs due to complicated cost structures, managers are increasingly looking for alternative content providers in their quest for high- quality, cost-effective research. Independent research providers (IRPs), in particular, have been steadily gaining traction in the lead- up to MiFID II. Much of this reflects their capacity to produce high-quality, independent analyses at a considerably lower cost than major sell-side players. Recently, we have seen a host of new IRPs emerge, with analysts from bulge bracket firms capitalising on low barriers to entry to set up their own firms. Industry consolidation is also on the rise as incumbent IRPs look to consolidate their competitive edge and capture economies of scale. From a provider perspective, many analysts we spoke to cited improved work-life balance and greater intellectual freedom as benefits of working at IRPs, including significantly less focus on producing maintenance research. Some IRPs also adopt revenue share compensation arrangements that are closely tied to individual performance. From a consumer perspective, beyond providing highly specialised content, IRPs have relatively flexible payment models (from annual subscription fees to one-off charges for bespoke reports). Smaller managers are also able to afford investment research, as pricing schedules of IRPs are considerably cheaper. Most importantly, the ability to provide unconflicted, independent analyses sets many IRPs apart from the investment banks, where conflicts still pervade. The continued migration of research spend from incumbents to IRPs, coupled with the high costs associated with sustaining research divisions, is putting increasing pressure on the P&Ls of large investment banks. We believe some investment banking research departments are facing potential losses of up to USD 240 million by 2020 under their current structures. To evade these pressures, brokers can opt to transition from the current “fully-integrated” model to alternative research models – namely, operating research out of a separately-owned entity, such as a joint venture (JV), or outsourcing research to IRPs (either directly or via online research marketplaces (ORMs)), such as Société Générale’s (SocGen’s) partnership with Smartkarma. With the MiFID II regulatory go-live around the corner and a largely negative outlook for major sell-side players on the horizon, we believe some brokers will need to make a brave call around their future business models.

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