The following is commentary from Henk Slotboom, RBA, Managing Partner of Netherlands-based The Idea-Driven Equities Analyses company (the IDEA!), an employee-owned independent research provider focused on the Benelux countries and listed Benelux companies.
‘Like a bolt from the blue’. This is probably the best way to describe the decision by Dutch Rabobank to carve out its equities brokerage services and research and outsource these to Kepler Chevreux [link requires subscription]. The partnership between Rabobank and Kepler reveals much about the current research environment and how it is being impacted by new regulatory pressures from MiFID II.
Partnership between Rabobank and Kepler Cheuvreux
Both sides describe the new partnership as a model that combines Rabobank’s banking and Equity Capital Markets relationships with Kepler Cheuvreux’s research expertise and distribution reach. According to the press release, the partnership provides Rabobank’s listed clients with better access to the investor community. This will link the corporate clients of Rabobank to over 1,200 institutional investors that are serviced by Kepler Cheuvreux through its 115 sales managers and sales traders, working from a multi-local network of 13 offices in 10 countries. The partnership offers research coverage on approx. 700 European stocks across 32 industry sectors by 90 analysts.
As part of the deal, Rabobank will acquire a 5% equity stake in Kepler Chevreux.
When judging by the text of the press release, this all seems a rather logical choice. On a stand-alone basis, Rabobank’s equities brokerage and research was a predominantly domestically focused business, perhaps with the exception of the Food & Agriculture sector. Thanks to the new partnership with Kepler Chevreux, this will now be extended to a pan-European basis.
The impetus: investment banking
Yet, at the same time, the text of the press release seems to tell us something else: Rabobank’s focus in equities is not so much on serving institutional investors but instead on its corporate clients seeking access to the capital markets; i.e., a clear focus on primary business and other corporate deals (IPOs, M&A, capital raisings, etc.).
For most of the traditional larger integrated players, corporate deals are the rainmakers. The secondary business merely provides the infrastructure needed to win these corporate deals; i.e., research coverage as a display of expertise, a sales force to build a large clients’ base (and thus establish placing power) and a trading platform to maintain a market/an aftermarket in the securities of one’s corporate clients.
Traditionally, the secondary business has always been a rather modest (if profitable at all) contributor to these integrated players’ overall results. It was – in a manner of speaking – ‘a necessary evil’.
Most developed markets, like the Dutch/Benelux market, are still overbroked. This implies that everybody is trying to win the hearts of pretty much the same buy-side clients. The latter group is often heard complaining about the lack of quality they get from the traditional players. Often heard criticism relates to the fact that there is too much focus on maintenance instead of idea-driven/in-depth research, that they have to deal with young inexperienced sell-side staff and that they are concerned about potential conflict of interests (i.e., a broker’s sell recommendations will not help to win corporate business).
Against this background, the prospects for some of the secondary desks will not be helped by some radical changes. Apart from the current strong shift away from stock-pickers’ funds towards index-linked investing (ETFs and other trackers), the regulatory environment (MIFID II) will likely restrain the buy-side’s budget for external research going forward.
Although Utrecht-based Rabobank has always ranked among the top-3 players in its sector in the Netherlands, there has been a gap with ABN Amro and ING when it comes to the equities business. When looking at most of the larger corporate deals, the names of its Amsterdam-based rivals tend to be on the tombstones more often than that of Rabobank’s. In the 2016 Thomson Extel survey for the Benelux, ABN Amro (top ranked at 4,647 points) and ING (runner up with 4,384 points) were clearly ahead of Rabobank (#3 with 3,994 points), although it has to be said that the top-2 positions for individual analysts were held by Rabobank employees.
Like Rabobank, both ABN Amro and ING focus on the Dutch/Benelux market. With so many of the products and services being more or less alike, the question arises whether there will be enough buy-side appetite for three large fully integrated players? Wouldn’t two (one prime contact with one to spare) be enough? After all, everyone that provides a service expects to be paid at the end of the day.
It therefore very much looks as if Rabobank has made a similar assessment as small brokers confronted with cash payments for research by the increasing use of commission sharing agreements (CSAs) after 2006: to either invest in bridging the gap with its two main rivals or pursue a different course all together.
Differentiation is key
Bridging the gap alone would probably not have worked. To a large extent what a bigger Rabobank could have offered would have been largely ‘more of the same’. In a market where the buy-side is expected to trim the number of sell-side contacts, one needs to differentiate or be a real specialist to take the place of other brokers. Besides, it takes time to replace others on a clients’ broker list; time Rabobank maybe felt it did not have.
By entering into this deal with Kepler Chevreux, Rabobank has indeed opted for differentiation. At the same time, it results in a very clear focus (only corporate clients) and on a potentially higher margin activity. Effectively, Rabobank has outsourced the secondary activities to the Kepler Chevreux platform, whose research covers more stocks and geographies and which serves a much larger clients’ base. At first sight, a win/win situation.
The future will tell whether this will be the case in practice as well. After all, Kepler Chevreux presents itself as Europe’s leading independent broker. However, how will Rabobank’s corporate clients for example respond when deciding where to put their business if Kepler Chevreux happens to have a sell rating on its stock?
This is not meant to suggest that Kepler Chevreux will lose its independent views as a result of this deal. However, it is meant to illustrate that both entities serve very different client groups whose interests may not always be aligned. It will be interesting to see how both sides will deal with that.
In its June 21st press release, Rabobank also said that combined Rabobank and Kepler Cheuvreux will be the number one equity brokerage house in the Benelux. This assumes that most of Rabobank’s secondary clients automatically transfer all their business to Kepler Chevreux as well. Yet, the facts that some of them may already have a business relationship with Kepler, whereas others may see this as an opportunity to further trim their broker lists, do not automatically imply that the new combination’s size will be the exact sum of the two separate entities. Still, it seems fair to say that this deal has created player powerful enough to challenge both ABN Amro and ING when it comes to the equities business.
Most importantly, this marks yet another step in a market consolidation process that started in the past decade. In a way, this has made the marketplace more transparent. Apart from the top-3 large players, there are two medium-sized integrated domestic players left: Kempen & Co (owned by Van Lanschot Bankiers) and NIBC Markets (the former SNS Securities). Both of these players have a prime focus on Dutch/Benelux mid and small caps. Yet, at the same time, they each try to differentiate in a different way.
Kempen’s offering also includes a pan-European coverage of the Life Science and Real Estate sectors, whereas – thanks to its membership of the European Securities Network (ESN) NIBC Markets’ multi-domestic offering shows some resemblances with that of Kepler Chevreux’s. The thing they have in common is that they combine primary with secondary business, a combination often feared to compromise unbiased views.
In the past decade, unbundling created room for specialized players, research-only providers and execution only houses. MIFID II will probably strengthen the position of these ‘new kids on the block’. The use commission dollars to pay for research will be tied to strict rules, which will not only affect the size of research budgets themselves but – as a logical consequence – also where they are spent. Independent research boutiques are best positioned to offer the buy side exactly what they are looking for: unbiased views.
Unlike the integrated firms, independent research boutiques do not have to factor in how their views might be perceived by the companies they write about and therefore how this could affect other sources on income. Apart from that, the research they produce is not aimed at generating order flows (i.e., trading commissions). Research-only boutiques solely depend on how much added-value they bring to their buy-side clients. Because of this, the interests of the research provider and their clients are fully aligned. Last but not least, it is completely transparent how much they get paid for what, which is one of the key-objectives of MIFID II.
Although the ‘indies’ will largely aim at the same clients as the large integrated houses, I personally do not believe that they really compete against each other. Instead, they represent both sides of the equation. The large integrated houses have the scale and power to move markets, can offer liquidity, determine who gets what with IPOs, etc. In that respect they can best be compared with supermarkets: offering a wide variety of choice and convenience to their clients. Like in the supermarkets business, scale matters and thus the consolidation among the integrated houses is set to continue in the years ahead.
The independent research boutiques on the other hand can best be compared with the specialty stores. There are plenty of things one can buy in a supermarket. However, the best meat products can still be found at a butcher’s, the best fish at a fishmonger’s and the best veggies at a greengrocer’s. The growth in this segment illustrates that more and more consumers are convinced that every penny spent here is well worth it. Under MIFID II, one can expect a similar trend within the research industry.
Henk Slotboom has been an investment professional since 1983. During his career he held several research, sales and management positions at both domestic and international investment banks. At the end of the 1990’s, he was responsible for setting up the Dutch franchise of Julius Baer brokerage, where he held the position as general manager. A few years later, he joined Insinger de Beaufort as part of the management team and was co-responsible for restructuring the bank’s brokerage arm. In 2007 he co-founded the Idea-Driven Equities Company (the IDEA!), the Netherlands’ first independent research-only boutique, where he works as managing partner. Mr. Slotboom has earned several investment awards.