A year after new EU rules forced banks and brokers to charge investors for equity research, the pressure on small brokerages to make ends meet is becoming intense and more look set to merge or even shut up shop in 2019.
According to dozens of executives at major hedge funds, asset managers, banks and brokerages, the picture looks bleak for smaller brokers who are being undercut by large banks and face increasingly cost-conscious asset managers.
Smaller brokerages have far less clout in negotiating contracts with investors, forcing some to cut prices or research, carve out a niche with bespoke research or, in more drastic cases, team up with a rival or close.
Smaller brokerages' research generally focuses on certain key market segments, usually via a strategy team that assesses value and quality as a means of identifying themes and stocks of interest to investor clients which are then analysed in greater depth. Often, this involves stock specific research from analysis to in-depth reviews and thematic pieces, catering to clients’ requests.
The aim of the EU's Markets in Financial Instruments Directive II (MiFID II) was to increase transparency and ensure investors got a fairer deal, but the dominance of the big banks is also pushing some regulators to have a rethink.
"MiFID is going to have continued significant ramifications. I always felt the fourth quarter [2018] or first quarter [2019] would be when the change starts to bite," said Steven Fine, chief executive at mid and small-cap broker Peel Hunt.
Before MiFID II came into force in January 2018, banks and brokerages bundled the cost of research into their overall charges for executing customer trades, or gave it away free. Under the new EU rules, they must bill institutional investors for everything from research to meetings to conference calls, and separate research from execution fees.
Itemising the services has caused havoc.
US bank JP Morgan led the charge in 2017 before the rules came in by offering research subscriptions to investors for as little as $10,000 a year, a fraction of the six or seven figure sums some smaller boutique firms had hoped for.
The move roiled Europe's fragmented stockbroking sector and put pressure on rivals to follow suit or risk losing business.
One year into Europe's big experiment, data from Greenwich Associates shows 60 per cent of research services are still handled by the global investment banks, suggesting they have not loosened their grip on the market since the new rules came in.
While large investment banks are more willing to fund their research teams to maintain their edge in equity capital markets, the pressure is only set to get worse for smaller rivals and the small companies they cover, executives said.
Recent merger talks between Australian investment bank Macquarie and UK broker Liberum were a sign of things to come in 2019, said Nigel Bolton, co-head of fundamental equities at BlackRock, the world's biggest asset manager.
"That's the sign that brokerages and banks are saying 'now we've been trying this for a year, it's not improving, we're going to have to do something more radical.' And I think you will see that happening in 2019."
Market regulators in the UK and France have raised concerns about the impact of a subsequent decline in research coverage and trading liquidity for smaller firms - and may yet take action.
In an interview with the Financial Times in November, the head of the French markets watchdog, Robert Ophele, said MiFID had had "very detrimental" effects on research, particularly of mid-cap companies, and called for a review of the legislation.
The fragmented nature of the UK market means brokerages there are undergoing the biggest change, but firms in the euro zone are also under pressure.
In November, AllianceBernstein announced plans to buy Autonomous Research, an independent firm with offices in London, New York and Hong Kong and more than 35 analysts, according to Reuters.
German private bank Berenberg has laid off staff in its equities business amid pressure from MiFID II, the FT reported last year.
Others, including London's Numis and Peel Hunt, say they are expanding research teams to fill a gap left from cutbacks by rivals.
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Mr Fine says he won't budge on the prices his company charges, and expects the impact of the loss of some research clients to be cushioned by revenues elsewhere in the business, including corporate finance.
Still, pressure on research prices may be here to stay, with asset managers in a strong bargaining position. Finding it hard to charge the bill to investors, most asset managers are paying for it themselves and using less, leading to a slide in total industry spend of about 30 per cent.
Penny pinching led to an average budget cut by asset managers of about 20 per cent in 2018, with a reduction of another 5 per cent to 6 per cent expected in 2019, according to Greenwich Associates research.
Asset managers are also expected to reduce the number of research and advisory firms they use to 15.3 in 2019, from 15.7 last year and 20 in 2015, it said.
Richard Buxton, chief executive of Merian Global Investors, said his firm began pricing research separately before the new rules kicked in, with year-on-year budget reductions of 10 per cent that should continue in 2019.
"We don't want waterfront coverage from a whole raft of big firms. It's 'we like your analysts in these three sectors and everything else, frankly, we're not prepared to pay for.'"
With global investment banks predicting a lacklustre 2019 for financial market returns, you might expect the guardians of pension assets to chase performance either by seeking the alpha promised by hedge funds or warming to Brexit-beaten UK stocks, The National reported last month.
You’d be wrong on both counts.
Amundi, Europe's biggest fund manager, teamed up with Create-Research to survey pension managers across the European Union. The poll covered 149 plans overseeing €1.89 trillion (Dh7.86tn).
Asked which investments they anticipate will deliver their targeted returns in the next three years, the funds overwhelmingly favoured global equities, which were selected by 64 per cent of respondents. Infrastructure, which has gained in popularity in recent years, came second and was chosen by 58 per cent. So how did hedge funds fare in the beauty parade?
They were selected by just 3 per cent of the survey participants, putting them 23rd out of 25 asset classes. Only currencies and gold garnered less support from the pension managers.
That's a pretty damning indictment of the industry's collective efforts to convince investors that it offers value for the higher fees charged.
Matthias Desmarais, head of research at broker Oddo BHF in Paris, said he expected more cuts in research budgets when talks with providers kick off in 2019 - before brokers recover some pricing power from 2020.
Mr Bolton was not so sure. He said his team's research spending would stay lower as managers think twice about paying for a broker's research or access to their analysts - with quarterly reviews and a huge monitoring and reporting exercise to check usage and spending.
One hour with an analyst can cost as much as £1,000 (Dh4,669).
Stiffer competition has also forced brokerages to look at selling their wares in new ways. RSRCHXchange, an online marketplace for research, said the number of firms selling research on its site has doubled to 400 since January 2017.
"People want to monetise their research more than ever before," co-founder Jeremy Davies said.
