Here Comes the Stock Research Shake-Up


Peter Sidoti opened his research shop in New York in 1999. Focused on covering small-cap companies, Sidoti & Co.’s business model was simple: Charge for trading, and bundle research into commissions. For about 17 years that approach worked, Sidoti says.

Then, last year: “The wheels came off,” he says. The commodification of trading made his 3.5¢ commission seem pricey. Exchange-traded funds and shadow indexing also hurt business, as did large banks handling equity offerings for midlevel companies without providing research. Big banks are shrinking staffs, as it costs them about $150,000 to $200,000 per covered company to provide research, including editorial and compliance expenses. Small research shops, meanwhile, are combining or shutting down. “You see research coverage thinning,” Sidoti says.

So given the challenges, what happens to research providers like Sidoti when MiFID II takes effect? “All hell breaks loose,” he says.

The European Union’s revised Markets in Financial Instruments Directive comes into force on Jan. 3, 2018. Among its core aims is reducing conflicts of interest between investment firms and their clients. In the past a portfolio manager might have received brokerage research for free, but under MiFID II that’s considered an “inducement,” which could sway the manager’s decisions about where to direct order flow. The upshot: Money managers will need to pay for investment research they receive.

Vanguard Group Inc., the world’s largest mutual fund ­company, may increasingly turn to internal analysts as MiFID II takes effect, says Kenneth Volpert, head of investments for Europe. “We have a lot of analysts ourselves, so we would rely more on our analysts,” he says. Vanguard will decide in the next couple of months about what external research it will pay for, Volpert says.

While banks such as Crédit Agricole SA have proposed charging as much as €120,000 ($143,500) a year for research services that include access to analysts, Volpert says asset managers need to get under the hood to evaluate such proposals. “What kind of analysts? What kind of insights have they brought historically?” he says. “Sometimes analysts at the dealers have some value, but you need to analyze this more carefully.”

Asset managers are grappling with the cross-border impact of the rules because they apply to funds based in the European Union, regardless of where clients are located. The investment vehicles are often registered in one jurisdiction but managed by teams all over the world. For many firms, it may thus be simpler to apply the rules globally.

BNP Paribas Asset Management Inc. plans to apply the principles of MiFID II to all its activities, including those outside of Europe, which account for 21 percent of its worldwide assets. “As a global asset manager, it would be extremely complex for us to distinguish between portfolios covered by MiFID II and those that are not,” says Philippe Boulenguiez, who oversees research and trading execution for the unit.

The firm says that doing so will make trading and research costs transparent to clients regardless of where they’re based. “We can see in regions outside the EU that clients are interested in MiFID II, and that some institutional investors see MiFID II as ­shaping the future of asset management in their regions,” ­Boulenguiez says. “It is seen as a label of transparency and quality of management.”

Candace Browning, head of global research at Bank of America Corp., says the greater transparency the rules will offer to investors is ultimately good, but she’s not sure the effort will lead to better returns. “The amount of time, money, and effort that’s been chewed up in conforming to this new regulation is mind-boggling,” Browning says.

She expects that MiFID II will lead to a decline in overall spending on research, but it won’t be the end of the industry. “We will continue to have a vibrant sell-side research function,” ­Browning says. “Research plays an important role in the efficient allocation of capital,” providing an independent voice that interacts with all types of market participants. That’s “very healthy” for calibrating expectations about companies.

While the buy side has made good progress in getting ready for some aspects of MiFID II, research is probably the one area where people are behind, Vanguard’s Volpert says. The U.K. ­Financial Conduct Authority’s decision to allow free trials for ­periods of up to three months will help. “My sense is this tweak is intended to give the opportunity to asset managers to explore new research products,” Volpert says. “It’s very good news.”

According to Sidoti, changes are coming much faster than ­people expect. Pricing transparency will likely slash payments for research across the board, he says.

In response, Sidoti is pitching an altogether different model for his shop: getting the companies he covers, not investors, to pay him for research. Issuers that want to sell debt pay rating companies, he points out. “We think equity research is heading the same way as debt research,” he says, citing Moody’s Corp. and S&P Global Ratings as examples.

For someone whose business is being upended, Sidoti is surprisingly magnanimous about the research provisions of MiFID II. “It’s hard to argue this is bad for the investor,” he says.

Here are some tools you can use to come to grips with MiFID II

Displays an overview of solutions that can help you meet regulatory requirements and lets you subscribe to alerts that will notify you of updates and news.

For a buy-side firm, provides a portal where you can manage and display your research content. For more information, go to {RMS <GO>}.

Under MiFID II, trading must take place on specified types of venues, one of which is a so-called MTF, or multilateral trading facility. Bloomberg’s MTF enables trading between multiple counterparties on a nondiscretionary basis.

Dey and Maranz cover equity markets at Bloomberg News in New York. Spezzati covers FX and rates, and Edde covers investing, both in London. With Beth Mellor and Laura J. Keller.

This story appears in the August/September 2017 issue of Bloomberg Markets.

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