How much is investment research really worth?

4 Apr 2018

An unintended consequence of MiFIR

A side effect of the MiFID2/MiFIR regulation is that major investment research houses have been given an unwelcome reality check. It appears that their research is essentially worthless.

Pre-MiFID2/MiFIR large financial institutions drove market participants toward their market operations by offering them the following deal: You trade with us, we add a bit to the trading commissions and you get access to our valuable investment research that you can use when making your own investment decisions or advice to your clients.

With the MiFID2/MiFIR regulation this kind of underhand deals have been put to the test.

From 3 January 2018 this “bundling” of services was simply outlawed. For two reasons: the pricing was totally intransparent. And worse, the research services of big banks were widely assumed to be subject to pressure to serve not only the trading desk, but also the treasury desk. Let me explain.

What research services really do

Banks are allowed to take some risks on their own books and this is typically handled by the “treasury” department or desk. Since the banks are now allowed to carry much less risk than a decade ago, it is more important that the returns on such holdings are top-notch.

Now assume that the research department signals that they are about to publish an analysis likely to stimulate investor interest and drive up stock prices. Obviously, the treasury department may ahead of such publication build up a holding of stock in that precise company. The trading desk may just happen to do the same.

If the publication of an analysis has the expected impact and customers line up to buy the stock, the bank will earn on the trading and on its own book. But this would be insider trading or market abuse???

To calm such suspicions banks have sworn that there were “chinese walls” between the research department and all other departments. A multitude of stories have of course demonstrated that the walls were not Chinese but more likely Japanese paper walls.

In comes MiFIR and the demand to unbundle the research services. This means that the trading commissions would only cover the transaction costs.

The incredibly shrinking price tag

As a result, larger banks were forced to sell their research services separately. It did not go well as they would now have to put a price tag on their services.

The first offers were that “full access” would cost upwards of 1 mEUR per year. Then it fell to 500 kEUR and then further to 250 kEUR and in the end the price fell to zero, in the sense that access would be given to anyone trading more than x mEUR per year but at commissions comparable directly to commissions charged by trading operations without research services.

Some banks have closed their research departments. Others have scaled them down dramatically, redeploying analysts to the far more profitable private equity trade. Some banks have spun their research off into a separate company.

But the conclusion is clear. MiFID2/MiFIR threw a spotlight on one of the cozier arrangements in the world of securities trading.

Subject to the spotlight of MiFID2/MIFIR spotlight, research departments wilted and disappeared. At the end of the day, the research was in most cases shown to be sophisticated marketing tools without real value – except for the banks themselves.

We bet that at the end of the day, not one single retail investor will have suffered losses because of the downfall of the equity research department.

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