- Top asset managers are electing to absorb millions in research costs in response to financial reform in Europe.
- Firms would face daunting compliance challenges and lose a competitive edge if they decide to pass the costs on to clients instead.
- That’s pushing research managers to slash their budgets for third-party research, with Credit Suisse predicting a 50% drop in research spend.
- That spells bad news for stock analysts across Wall Street.
The world’s largest asset managers are falling in line and deciding to absorb millions in research costs ahead of the implementation of European market reform that’s shaking up Wall Street.
That could spell a gloomy future for Wall Street stock analysts, many of which could find themselves without a job.
The financial reforms — known as MiFID II (Markets in Financial Instruments Directive) — are set to go live at the start of 2018, and a headline effect is a requirement that asset managers pay for research separately from commissions for trading execution. Free and bundled research will be prohibited.
This essentially leaves firms with two options: bear the brunt and start paying for all the research themselves, or pass the cost on to clients.
Easy decision, right? Pass the new cost of business along to clients and pad the profit margin.
But most asset managers are planning to do the opposite. A majority of the largest-20 asset managers are willingly absorbing multi-million dollar costs and funding the research internally, according to a research note from Credit Suisse.
Credit Suisse predicts that many publicly listed asset managers in Europe will try and keep the spend at roughly 3% or less of profit before taxes. The bad news for stock analysts: That would mean a 50% “compression” in research budgets.
In other words, there’s going to be a lot less money to go around for research analysts.
Here’s Credit Suisse:
Base case estimates by management consultants for research budget shrinkage were in the range of 20-30%. However, these scenarios did not envisage a switch to wholesale cost absorption onto asset manager P&Ls. We think the new base case will move closer to a 50% contraction (albeit with an even greater reduction in the number of research providers), with scope for a greater decline if unbundling goes global.
They’re not the only bank employees with a grim outlook.
Wall Street’s marquee trading teams — already experiencing headwinds and steady decline — will suffer a 1.5% hit to revenue growth in 2018 and beyond thanks to research unbundling and increased transparency requirements under MiFID II, according to a note last week from UBS.
Credit Suisse says 7% of total equity trading revenues are at risk from the contraction in research budgets.
Why not pass along to clients?
Taking on the cost rather than having clients cover it may seem counterintuitive, but the calculus makes sense when you dig into the implications of both options. For starters, choosing to pass the cost along to clients comes with an extensive and complicated array of restrictions and requirements, according to Credit Suisse.
“Given the degree of complexity of these rules and risk of compliance failures, it is, perhaps, understandable why many asset managers have chosen to absorb the costs of third party research onto their own P&Ls from 2018,” the firm wrote in the note.
“The perceived risk of falling foul of the complex rules when using client funds is high and there are incremental ongoing operating expenses associated with compliance,” the note continued.
It could also put asset managers at a competitive disadvantage compared with more client friendly firms paying for the research themselves. Credit Suisse notes that many firms announced their intention to pay for research shortly after two industry giants, BlackRock and JPMorgan Asset Management, set the tone and declared their intention to absorb the costs.
That indicates money managers believe losing business to such competitors is a plausible result that could outweigh the research costs.
Moreover, paying for the research could engender goodwill from both clients and regulators.
“We think it will become standard industry practice for asset managers to absorb research costs onto their P&Ls. Outliers will only be able to avoid this over the short-to-medium term as competitive pressures build,” the note reads.
Here’s a chart that Credit Suisse compiled, using information from the Financial Times, showing which option a variety global asset managers have chosen, so far: