A new report on European independent research suggests that independent research will offer more agency brokerage payment options. We have seen agency brokers such as ITG and Instinet embracing independent research as a way to increase and retain commission flow. The report suggests that more independent research providers will embrace a brokerage model, whether developed in house, ‘rented’ or by affiliation with third party agency brokers.
The report, commissioned by EuroIRP, the trade association of European independent research providers, and the Centre for the Study of Financial Innovation, reviews the state of independent research and makes a number of recommendations. We reported earlier on the report’s attack on the ‘commissionability’ of corporate access services. The report — Has Independent Research Come of Age? — can be accessed on the EuroIRP website.
Although independent research is growing in Europe, the relative share remains small. According to Thomson Reuters Extel, the collective share of independent research providers in the European market remains below 5%. This is equivalent to between about $300m and $400m of Europe’s estimated $8bn commission pool.
The independents which have been most successful in the Extel survey are firms such as Redburn Partners and Autonomous Research which have brokerage capabilities. As we have reported previously, Redburn was the first independent to break into the top 20 of the Extel survey. Autonomous has added agency brokerage as a priority (ironically also hiring Lord Myners, the original proponent of unbundling.)
Extel 2010 – Top 10 Independent Research Providers Ranking
Rank Research Provider Weighted Points
1st Redburn Partners 22364
2nd Autonomous Research 4846
3rd Absolute Strategy Research 4110
4th Helvea 3294
5th Arete Research 3080
6th New Street Research 2231
7th BCA Research 2044
8th Capital Economics Limited 753
9th Auerbach Grayson 444
10th DRUGANALYST equity research 421
The EuroIRP report encourages other independents to follow suit. “One potential response is for IRPs to attempt to capture a larger share of the revenue stream by offering agency broking services…”
One option is to affiliate with agency brokers such as Instinet and Bloomberg Tradebook which offer distribution arrangements for independent research providers. These firms can give investors the ability to pay for research through bundled commissions, although independents need to be careful that they are receiving transparency from their agency broker on what trades have been directed to them.
Another option is to build the capabilities in-house, similar to the route Autonomous has taken. This is not inexpensive. Becoming a brokerage firm involves added costs of registration and compliance. For U.S. firms, being a broker makes it easier to have commissions directed to you by execution brokers. A trading desk is even more expensive, but provides the greatest benefits of directed trades.
The report envisions a consortium approach to the brokerage option: “A potential model for the future is one in which providers of unique services are grouped together under a co-branded umbrella organisation to market themselves more effectively, to meet the cost of regulatory compliance and to offer execution services to have the potential to capture more of the value chain.”
In the U.S., IRC Securities offers a similar approach which has been utilized by analysts in the process of setting up their own boutiques, including Meredith Whitney, Ivy Zelman and Dana Telsey. IRC Securities’ Research Prime offering provides brokerage supervisory and compliance services on an outsourced basis.
In the U.S., another motivation for independents to go the brokerage route is the increased compliance scrutiny of investment managers. We know of a number of asset managers which prefer research providers to be registered brokers or registered investment advisors. Being a broker provides comfort to the compliance officers within the asset managers.
The added pressures of brokerage and compliance may lead to consolidation. “’I can foresee a world where there is a scale game in the independent research sector,’ says one fund manager. ‘With a trend towards tighter regulation, the larger, more successful firms will be better able to meet rising compliance costs. Tougher regulation might lead to sector consolidation.’” Perhaps. We have been predicting consolidation for some time, but the independent research segment, with its low cost base, is remarkably resilient.