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Regulators fret about the sector’s Byzantine payment structure: investment banks dominate the market, but do not charge for it. They dole it out free to clients in the hope of future trading business. The understandable fear is that this set-up produces conflicts. Banks may be wary of issuing reports critical of companies; fund managers may end up choosing banks because of their research rather than the efficiency of their brokerage services. New regulations will overturn this model entirely.
MiFID 2, an ambitious set of European financial rules coming into effect next January, will force asset managers to disclose how much they spend on research. So banks will have to “unbundle” their services, billing clients for research and trading separately. Although the rules are being introduced by European regulators, banks across the world will have to change their pricing practices to comply.
These rules will be hugely, and beneficially, disruptive to a grossly inefficient industry. At present, banks blast their clients’ inboxes with thousands of reports, only a fraction of which are read. The problem is that most research is not very useful—it is hard to come up with original insights about big companies when dozens of other researchers are trying to do the same. So when they are presented with a bill for it, many fund managers will balk at paying for research they ignore.
Equity research will not disappear entirely, in part because the industry performs other functions. Surveys have shown that investors are less interested in researchers’ exact forecasts or analysis than in their general industry knowledge.
Moreover, much of equity research is actually about “corporate access”, ie, connecting investors with company managers. Fielding phone calls and acting as chaperones may not be as glamorous as publishing market-moving reports. But they are at least labour-intensive activities. Top analysts will still be valued, as will those specialising in niche fields. Independent research firms will benefit. But fund managers will have to do more of their own analysis. And persuading investors to pay for mediocre research will be harder.