The impact of a big shake-up coming to sell side research, as a result of regulatory changes in Europe, will cause research to become more expensive for both banks and asset managers worldwide — but the resulting transformation could result in business model that is profitable, according to a new working paper from consulting firm McKinsey & Co.
“Despite the challenges of a rapidly changing economic and regulatory environment, the equity research business has the potential to be an attractive opportunity for banks and broker-dealers that successfully adapt by anticipating and responding to the buy side’s needs and by transforming their research business models,” the authors write in the research paper, entitled “Reinventing Equity Research As a Profit-Making Business.”
The exact catalyst for change is anticipated, both in the new report and by the industry in general, to be the January 2018 adoption of the second phase of the Markets in Financial Instruments Directives, a set of market reforms and investor protections known as MiFID II that are taking effect in Europe. While the MiFID II reforms are only required in Europe, they are broadly expected to have global implications — and nowhere more so than in research.
That’s because MiFID II requires banks and broker-dealers to charge for each piece of research independently, resulting in a broad unbundling of research. Suddenly the buy side will know exactly what research they are buying — and the expectation is that, as a result, they will buy less of it, or at least consume it differently. Rather than just taking the research that is offered to them by the banks or broker-dealers, the buy side will seek out the research that is most valuable to them.
The view of banks surveyed by McKinsey is that there will be an industry-wide drop in equity research revenues of 30 percent of more over the next three years. Further, McKinsey anticipates that “for asset managers, as research becomes an itemized cost, profits could be sharply reduced — by as much as 15 to 20 percent” for firms in Europe. In other words, for European money managers, the cost of research will now come out of their profits.
There will, of course, be some winners from the great research shake-up. McKinsey anticipates that independent research providers will enjoy an increase in revenues, some at the cost of the large bulge-bracket providers.
For their part, banks and broker-dealers will have to overhaul their research operations. “For the first time, bank and broker-dealer equity research will operate as a free-standing profit center, forcing a transformation of the business,” the paper’s authors write. “The buy side will pay broker-dealers for actionable research that adds investment value, but the demand will fall far short of the mountains of research that banks currently supply ‘for free.’”
Buy side consumers of equity research, such as long-only managers and hedge funds, are demanding less in the way of standard research reports and more customized products, the authors find. This, McKinsey says, can include such items as access to analysts and corporate management as well as new forms of information and analytics in the form of big data and artificial intelligence.
The McKinsey authors note that while transforming the equity research business will be challenging, the firms that can pull it off will be those that can anticipate and respond to the needs of their buy-side clients and transform their models accordingly. The truly creative thinkers may even be able to transform research into a profit center all its own.
