A interesting Bloomberg article titled “Wall Street Cracks Down on Free Sharing of Analysts’ Notes” has crossed our desk last week ignited a discussion within our team about the the market for investment research.
The article points out how brokers, to some extent driven by regulatory pressures, are overhauling the process of producing and distributing of research and using online portals to track what gets read and by who- and bringing closer to be able to finally see how much investors are willing to pay for analyst report.
As a refresher, most of equity commissions paid by investors to brokers are split into two components: Execution and Non-Execution. Execution component pays for physical cost of trading and cleaning the transaction, and non-execution pays for other services such as investment research and corporate access. In a bundled commission environment, those two components are not separated and captured by the broker executing the equity trade.
CSAs (introduced in 2007) enabled fund managers to separating commissions into payment for executing trades from payment for research, however most argue they were not not sufficient to determine the value of services consumed, nor control spending. Furthermore the commissions (whether bundled or unbundled) actually belong to the asset manager’s end client however the asset manager has the full discretion of how to spend it.
The direction of regulatory travel is towards complete unbundling, something that we believe , will reshape the economics of institutional equity business, carrying with it serious implications to asset managers, sell side firms and IR teams.
We see those five questions are at the crux of the debate:
1- What has been happening to global trading commissions, which still drive the vast majority of supply of research and corporate access services?
Post crisis environment brought about the worst bear market for equities since the 1930s. Combination of depressed equity valuation, lower trading volumes, lowers fees generated from IPOs and primary market activity, a steady shift from active to passive investing meant a significant decline in available commissions for equity businesses providing research and corporate access. The effect was particularly severe outside North America where commissions are calculated as a percentage of the value of the share price. Emerging markets as a whole have also suffered their own set of dynamics which have further reduced comission dollars and meant instances of banks shutting down entire operations (ex. DB in Russia, CLSA in , Nomura in)
So what did this mean for broker revenues? Frost Consulting estimates that there has been a 43% reduction in global commissions for equity research, leading to a 40% reduction in budgets allocated by the 600 or so reduction in budgets allocated by the c 600 firms producing equity research from US$8.2bn at the peak in 2008 to US$4.8bn in 2013.
2- What would regulators like to see commission payments used for?
In short, just for execution. The UK’s Financial Conduct Authority wants brokers’ research to be treated as a cost to the manager and paid out of their own P&L rather than paid for out of client funds- a reform known as “unbundling”. This may eventually lead to a “priced” market for investment bank research which could transform the market in which consumers (investors) only receive the products they want and purchase in which personalisation, interactivity, niche focus will be critical for commercial success. The changes could provide an advantage for independent and specialist firms. In 2014, the FCA already banned using client commission payments for Corporate ACcess in the UK in 2014, a rule that is still looks that is yet to be adopted flouted
3- Are investors treating commission spending as if they were their your own?
Milton Friedman, the US economist, once said that perhaps the most wasteful form of spending is spending someone else’s money on somebody else: you are then “not concerned about how much it is, and not concerned about what you get get”. Perhaps there is a little bit of thoughts that can be applied to current discourse in the asset management industry. Regulators feel that allocation of spending (and hence the pricing) of broker services would have been different if investors had to pay for it from their own pockets. Surely, they argue, more considration would go into what is valueable, hence
In last year’s survey by the CFA Society UK, almost half of respondents think that Investment firms in the UK do not manage dealing commission – which is a client asset – as carefully as if it were their own money.
payments as if it were your own?
5- What do investors value most from brokers and how is that value priced?
Investors consume a number of services from brokers, and
Experts say that one of the trickiest aspects of pricing research is working out its value.
Reverse roadshow / investment trip to
Face to face management meeting at home
An Investor Conference
Call with reserach analyst
Bloomberg: Ballad of a Wall Street Research Analyst, Told by Brad Hintz