Image courtesy: David Iliff
The investment research industry is evolving rapidly post the 2008 financial crisis and a large part of this evolution is being driven by regulatory changes. Regulators are trying to level the playing field in many areas by improving transparency and monitoring in the investment management industry. “Unbundling of Research” is one such measure, which has been much talked about in the past few years and might force several sell-side research providers to change their investment research strategy.
Unbundling of research is here…
In the bundled regime, sell-side firms were producing research and investment ideas and distributing them for free to buy-side firms (asset managers). If asset managers were satisfied with the research, they could ask the sell-side firm to execute the trade for which the sell-side firm charged a “bundled commission” which paid for the research as well as execution of trade.
However, unbundling of research – as proposed by the new MiFID II regulations in Europe which will now come into effect from January 2018 – can disrupt this arrangement. The new regulation might make it mandatory for asset managers to pay for research and execution separately. The guidelines on how this new regulation is to be implemented are still in the works, but fundamentally, such a regulation will change the competitive dynamics of the investment research industry in Europe.
…and it will hit small and medium investment banks the hardest
We believe that mid-sized and regional investment banks will be worst hit by this regulatory change, which prohibits the use of trading commissions to pay for research. According to Greenwich Associates, total European institutional equity commission volume paid in 12 months ended Q2 2015 was EUR 3.4 billion, out of which about 52% was for research. This means that research and trading constitute approximately equal parts of the bundled commissions, and competing separately in both these markets can be a tough ask for the small and medium sized investment banks.
- In the execution market, these banks will be directly competing with their larger peers, which means they will need additional technology investments into their execution platforms, and keep execution costs competitive in order to compete effectively.
- To sustain in the research market, they will have to compete with their larger, global counterparts on one hand, and niche Independent Research Providers (IRPs) on the other. As a result, they will need to improve their research quality, coverage and distribution, while keeping the costs competitive.
Therefore, its time for them to change their investment research strategy
However, the mid-sized investment banks can also use the regulatory changes brought about by the impending MiFID II regulation, as an opportunity to redesign their investment research strategy. They can start by looking at what their larger peers did more than a decade back – engage the right offshore outsourcing partners to bring in scale and efficiency into their research functions.
Finding a competent offshore outsourcing partner who can help them scale their research coverage and uncover niche investment themes at a competitive price can really be one strategic move that can enable them to remain competitive in the investment research market. Off-shore research teams can bring-in the following advantages for mid-sized investment banks:
- Expand research coverage without investing additional fixed cost or administrative time in on-boarding and managing your team.
- Access experienced analysts and teams at competitive prices as the geographical cost arbitrage still remains in play.
- Spend more time on client development and distribution of research.
- Benefit from the highly efficient research processes and frameworks, developed by outsourced investment research providers over the years.
- Leverage efficiency in research costs for technology investments in making execution more competitive.
Bottom-line: While the investment research market is getting tougher for mid-sized investment banks, it also presents an opportunity for them to improve their competitiveness. With the implementation of MiFID II regulation postponed to January 2018, now is the right time for mid-sized European Banks to work on their research strategies and start identifying research partners that can help them stay competitive in the unbundling era.
Anupam Ashish is the Co-Founder of Pure Research Private Limited, a customised research firm with offices in New Delhi and London. Anupam and his team work with clients worldwide to deliver high quality customised financial research services to buy-side as well as sell-side firms.