Less is More


New York – Obama’s embrace of the so-called Volcker Rule is part of the broader trend of financial specialization, as the universal banking model evolves into a more fragmented financial landscape.  Investment research is already being impacted by the specialization trend, and the Volcker Rule promises to reinforce and possibly accelerate the trend.

The financial crisis weakened larger financial institutions far more than smaller, more specialized firms.  The smaller firms had less exposure to toxic securities, were less leveraged, and often not trading for their own accounts.  Jeffries Group is a case in point.  According to a recent Wall Street Journal article, Jefferies has been on hiring spree since the crisis, growing its staff by 16% to 2,628.  Most regional firms have gained business and market share.  Check out the share prices for Stifel Financial or Piper Jaffray.  Stifel’s stock is higher than it was pre-crisis, nearly double what is was two years ago.  How many large financial firms can boast that record?

The trend toward specialization is one we reported in May of last year.  Suzanne Duncan of the IBM Institute for Business Value predicted at the Investorside Independent’s Day Conference that the trend will be to de-construct the one-stop-shop institutions. Specialist providers are both more profitable, and better able to manage risk.  Scale is a hindrance, not an asset.

Commission Sharing Arrangements (CSAs), which allow investors to trade with one counterparty and direct commissions to different research provider, illustrate the trend.  Bulge bracket firms used CSAs as a tool to increase trading volume at the expense of regional and agency firms.  After the Lehman Brothers bankruptcy, the trend reversed and regional and agency firms gained share at the expense of the bulge firms, as we have reported previously.

How specialized is specialized?  The Volcker Rule is being interpreted as reinstating the separations between investment banking and commercial banking.  All well and good, but we see specialization going deeper.  The hysterical headlines that resulted two weeks ago from a fairly routine Goldman Sachs disclosure memo (“We may trade, and may have existing positions, based on Trading Ideas before we have discussed those Trading Ideas with you…We will also discuss Trading Ideas with other clients, both before and after we have discussed them with you”) illustrated that maybe the conflicts within investment banks won’t be as palatable post-crisis as they were pre-crisis.

The specialization trend is rewarding capital markets specialists.  Jeffries has benefited from its capital markets strengths.  Other examples include the agency brokerage firms, which are now broadening their capital markets offerings.  Liquidnet has been adding research capabilities to garner a bigger share of commissions.  BTIG recently invested in an analytics provider for similar reasons.

The little guys are getting bigger, but remain focused on capital markets.  Take Hudson Securities, a Jersey City brokerage which in 2004 was generating $10 million in revenues.  Post-crisis, it has hired a new CEO, a veteran from Jeffries, added twenty-two people, and announced last Friday that they are acquiring Next Generation Equity Research, a boutique equity research firm based in Chicago that focuses on small and mid cap stocks.

The implementation of the Volcker Rule would help to reinforce a trend that is already under way, which is the increasing fragmentation of the large financial conglomerates.  The changes in the financial landscape can’t help but impact investment research, which is simply one product line in the capital markets business.  So we can expect continued changes in the research space, reflecting in part the broader changes in the financial institutions business model.


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