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TOP 10 CHALLENGES FOR INVESTMENT BANKS 2017


RETHINKING
THE RESEARCH
FUNCTION

How can investment banks use digital technologies to make research profitable?

Aside from unique insights provided by a limited number of specialized boutiques, non-differentiated sell-side research is not something the buy side has typically needed or wanted. As the research landscape evolves, and new digital technologies and competitors emerge, investment banks have an opportunity to leverage their data in new ways and earn money managers’ increasingly limited research budget dollars.

The research business
model is bad

Historically, investment banks have chosen to give away research for free in the hope of attracting trading commissions in the future. In turn, they used investment banking fees from initial public offerings (IPOs) to support research activity.

That all changed with recent regulations, which set out to separate research from investment banking activities and prevent companies from disclosing information to research analysts before it is publicly available. As a result, the opportunity of sell-side analysts to provide quality research and alpha-generating ideas has been greatly diminished.

At the peak, between 2000 and 2003, Sanford C. Bernstein estimates that roughly 40 percent of investment banking fees from IPOs were used to support research.

Source: warrington.ufl.edu pdf

Electronification is changing the game

The rise of electronic trading and alternative trading services has driven equity trading margins to nearly zero. There is some speculation that the buy side is actually paying for research with “tack-ons” to base execution rates, but the reality is that any incremental revenue is minimal and shrinking.

Even for high-touch, agency-bundled US equity trades, commission rates averaged just 3.58 cents per share in the first quarter of 2014 (Greenwich Associates). Electronic trade is rapidly becoming an important part of the trading landscape for Fixed Income, Currencies and Commodities (FICC) too, slowly pushing this market toward the same fate as the equities business.

Average commission rates for US equity trades ranged from 1.07 cents per share to 3.58 cents per share in the first quarter of 2014.

Source: Greenwich Associates

Information has been commoditized

In the past, sell-side analysts had access to information that was not readily available to the general public. More important, they often had exclusive access to information deemed material to the business results of the companies they covered.

New regulations and the internet have changed all that. Regulation Fair Disclosure prevents companies from disclosing information to analysts unless it has already been made publicly available; and the internet has exponentially increased access to information for everyone. Small players with low-cost structures and innovative business models are taking advantage of these low barriers to entry to join the research space.

MiFID II will increase selectivity

In January 2018, the Markets in Financial Instruments Directive II (MiFID II) rules designed to separate broking, or trading, from research fees are expected to take effect. Many fear that these rules could have a profoundly negative impact on the investment banking industry’s research revenue.

MiFID II will force asset managers to pay for research services out of pocket or carve out a separate research budget with investors, instead of passing on costs through the price of securities. Faced with the true price of research, money managers are likely to be more selective when choosing research providers and more critical of the services provided.

Research budgets could shrink by 25 to 30 percent, or $15 billion, post MiFID II implementation.

Source: Quinlan & Associates

Next steps

Think of fintech as both a threat and an opportunity

Niche service providers might have unique insights that can and will generate alpha—whether it’s for your firm, themselves or someone else.

Get involved in the digital conversation

Eighty-six percent of investors say that blogs, social networks and message boards have a growing impact on their investment decisions (Brunswick Group).

Set your firm apart with digital delivery

A full-service delivery platform that’s mobile, interactive and regulatory compliant could help understand buy side client consumption patterns and increase revenue.

Conclusion

Sell-side research is one of the most challenging issues facing the investment banking industry in 2017.

As the research business model continues to shift in response to trading electronification, information commoditization and new regulation, banks must evolve.

Sell-side firms have access to vast quantities of historical and real-time market data that have the potential to create meaningful research products and services. By tapping into new data sources, including social media, and leveraging advanced analytics, including sentiment analysis, firms can reinvigorate the research function and create alpha-generating trading strategies with a monetary upside.

Challenge Highlights

Discover how investment banks could use digital technologies to make research profitable again.

Get in touch

Bob Gach
New York
Owen Jelf
London
Chris Brodersen
New York