Equity research is increasingly being subsidized by investment banking and wealth management, as commissions flows have been shrinking since the financial crisis.
Data compiled by Coalition cited in a Financial Times article show that cash equities revenues at the top 12 banks fell 56 per cent from 2007 to 2014 while the number of analysts publishing EMEA research for the 12 top banks fell only 17 per cent.
Although equities revenues are doing better this year (see our premium article), revenues are still well below pre-crisis levels.
Banks are not planning broad layoffs to research staff. Some banks such as Deutsche Bank (see premium article) and Credit Suisse (see premium article) are under pressure from new capital requirements to restructure their investment banking units, but the cuts are focused on other areas.
The net effect is that research costs for the sell side have declined, but not as fast as cash equity revenues. The notion that equity research should be solely dependent on commission revenues is a regulatory construct first introduced by US regulators in the so-called Global Research Analyst Settlement over twelve years ago. The reality is that although investment banking is barred from directly influencing analyst compensation, there is no barrier to investment banking revenues subsidizing research.
Some of the regulatory strictures have been loosened in the recently revised FINRA research rules (see premium article). As a result we have seen some previously independent research boutiques quietly add investment banking to their product mix.
If European regulators follow through on their threat to sever the link between commissions and research, we will see increased dependencies between banking and research, despite regulatory restrictions. Firms such as Morgan Stanley, UBS and Credit Suisse which have large wealth management groups will also continue to benefit from a wealth management subsidy for research.
Research has been a longstanding handmaiden to investment banking, and, if equity commissions continue to suffer, this will become increasingly true.