New York, NY – A few weeks ago, Meredith Whitney, chief executive officer of the independent equity research firm bearing her own name, wrote that financial services firms globally would cut as many as 80,000 jobs in the next 18 months due to slowing revenue growth. Based on a number of trends, we agree that Wall Street is likely to struggle in the coming months, a factor that should have a dampening effect on the entire investment research industry.
Trends Suggesting Weakness
Recently, various Wall Street firms have reported weaker financial pictures due to a slow-down in profits from the fixed-income, commodities, and currency markets. For example, Barclays Capital’s income from trading bonds and commodities fell 40% in the first half of the year due to the sovereign debt crisis.
In addition, the cash equity market continues to exhibit weakness as both volumes and commission rates decline. A few months ago, Greenwich Associates reported that the amount of brokerage commissions paid by U.S. institutions on trades of domestic equities decreased 13% to an estimated $12.1 billion from the 1st Quarter 2009 to the 1st Quarter 2010. U.S. buy-side institutions initially expected that equity commission payments would rise in 2010.
This drop in equity commissions has resulted from two factors — declining trading volumes and sliding commission rates. According to Greenwich Associates, the average equity commission rate paid by U.S. institutions fell 4.1% from 2.90 cents in 2009 to 2.78 cents per share in 2010 as the buy-side continues to move from high touch to low touch trading. More recently, NYSE Euronext reported that its trading volume of US cash equities was down 22.6% over the first eight months of the year, when compared to the same period in 2009.
Based on these trends, we would not be surprised to see U.S. institutional equity commissions to drop at least 25% for the full twelve months of 2010 when compared to 2009.
Impact for Various Players
These developments suggest difficulties for a wide range of players in the coming months. As we have mentioned in recent months, agency brokers are likely to be squeezed in the near term as buy-side clients struggle to allocate their shrinking equity commission pool. We have heard that in the past few months, a number of institutional investors have started limiting the amount of “execution only” business they do in order to pay their research providers. This has led a growing number of agency brokers to seek out alternative research firms to partner with so they could provide their clients with value-added research in addition to their execution services.
We expect that alternative or independent research firms will also feel the pinch in the coming months as asset managers find themselves with a smaller commission pool from which to pay them. Given the difficulties experienced by many alternative research firms in 2009, the prospect of a second straight year of weakness is likely to lead a number of firms to look for partners who can help them rebuild their businesses.
We suspect that these trends are likely to make partnerships or outright acquisitions between agency brokers and alternative research providers more likely in the coming twelve months than we have seen in the past.
Regional and bulge bracket investment banks will also find themselves struggling to eke out the same research payments they received in the past. However, we think these firms will do comparatively better than agency brokers or indie research providers as buy-side clients can receive a wider range of products from them — including execution services, CSA and CCA payment services, investment research, and access to the IPO calendar.