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Research unbundling

Updated: Dec 13, 2019

A serious risk for stockbrokers and listed companies

The world of company research has been changing at a rapid pace since the introduction of MiFID II (Markets in Financial Instruments Directive) in January 2018 in the European Union. Suddenly, asset managers had to explicitly pay for company research and could only pay brokerage to stockbrokers insofar as it related to the execution of trades.

This regulatory change did not just force transparency onto asset managers, causing them to explicitly account for their research expenditure via their P&L, but also led to them being more particular regarding which research they really needed and were willing to pay for.

Instead of receiving and consuming all stockbroker research and only rewarding the most preferred via brokerage, asset managers now had to write a cheque for all research received. As a result, most, if not all, asset managers proceeded to cut the amount of research they received, as well as the number of research houses they transacted with.

The immediate consequence of this move was an aggressive reduction in brokerage in the European Union, putting severe pressure on stockbrokers. This has led to reductions in research budgets and coverage, with the resultant impact on research quality and sell-side analyst jobs.

A February 2019 survey by the CFA Institute points to an up to 11% reduction in budgets for large stockbrokers, with roughly half of respondents reporting reduced coverage (especially in small- and mid-cap stocks), with just under half of sell-side respondents believing that research quality has declined and most respondents citing a reduction in sell-side analyst jobs.

In recent months, listed UK brokers have posted weak results, including losses by WH Ireland and Arden Partners and a profit warning by Cenkos. In May 2018, Deutsche Bank announced a restructuring, which would cut more than 7 000 jobs and it warned of a difficult second quarter.

The post-MiFID II environment has impacted South Africa, as well with local asset managers and stockbrokers. An early scalp has been the operations of Deutsche Bank, which has scaled back on advisory, corporate broking and sponsor services and has all but excited research in South Africa.

Already, highly rated analysts like Larissa van Deventer have departed to competitors and will likely be followed by many others, if there is sufficient demand. Others will find themselves back in the job market.

We see the global and South African trend continuing with the likely outcome being consolidation, leading to reduced research output and coverage and an increase in the availability of skilled analysts.

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