According to a new study published by Hong Kong based consultancy, Quinlan & Associates, the global investment banking community could record losses of as much as $240 mln (£188 mln) in their research divisions by 2020 as the EU’s MiFID II regulation changes how investment research is bought and paid for.
Quinlan’s New Study
In Quinlan’s recent study called, “A BRAVE CALL, IS IT TIME FOR INVESTMENT BANKS TO EXPLORE ALTERNATIVE RESEARCH MODELS POST-MIFID II?” the consulting firm estimates that investment banks are poised to generate significant losses in their research operations if revenues drop precipitously due to MiFID II given their high cost structures.
Quinlan estimates that the largest global investment banks spend between $600 mln to $800 mln per year on their research platforms whereas tier 2 banks spend $300 to $450 mln on a fully loaded basis. Given these firms’ cost to income ratios of 90%, a forecasted drop in research revenue of 40% due to MiFID II would lead to a loss of $240 mln post MiFID II based on investment banks’ current cost structure. This estimate does not take into consideration the additional costs associated with MiFID II compliance.
The report concludes that independent research providers, given their lower cost structures, experience pricing their research, and unconflicted independent analyses are likely to benefit in the post-MiFID II world.
Quinlan recommends a few unique options for the sell-side, “To evade these pressures, brokers can opt to transition from the current “fully-integrated” model to alternative research models – namely, operating research out of a separately owned entity, such as a joint venture (JV), or outsourcing research to IRPs…”
We agree with Quinlan’s study on a couple of key points. It is clear to us that sell-side investment banks will probably be forced to rethink their research strategies given their high cost structures, and the likelihood that asset managers will adopt a more rigorous research procurement process post MiFID II. We also agree that independent research firms are likely to gain market share in a post MiFID II world for many of the reasons that Quinlan sites.
However, we are not as bearish about the impact MIFID II will have on sell-side P&Ls as the Quinlan report is. First, we project a much smaller drop in revenue for the sell-side post MiFID II than Quinlan projects. In fact, we estimate only a 15% to 20% drop in revenue driven by the research budgeting mandated by MiFID II.
Second, Quinlan’s static analysis assumes that sell-side firms will keep their existing research cost structures in place. We anticipate that the sell-side will reduce their costs if their research revenue drops. In fact, we have already seen this start to take place at many investment banks as they have not aggressively replaced analysts who have moved on or they have trimmed coverage in sectors they feel they cannot compete in.
Consequently, we don’t expect the financial cataclysm for the sell-side that Quinlan seems to project. Despite this disagreement, we agree with Benjamin Quinlan’s conclusion, “The most important priority for brokers now is to start making decisions around the structural make-up of their investment research offering.”
The team at Integrity Research has years of experience consulting with sell-side and independent research providers in this area including working on better defining what your clients are willing to pay for, restructuring your offering to focus on your competitive strengths, and pricing your research product. If you would like to discuss these topics more specifically, please contact me at Michael.Mayhew@integrity-research.com.