Europe’s impending ban on free research will cost hundreds of analysts their jobs with banks set to cut about $1.2 billion of investment on the area, according to a report by McKinsey & Co.
The consultancy estimates the $4 billion that the top-10 sell-side banks currently spend on research annually is likely to fall by 30 percent as clients become pickier about what they pay for, McKinsey Partner Roger Rudisuli said in an interview. Investment banks’ cash equity research headcount has fallen 12 percent to 3,900 since 2011 compared with as much as 40 percent in sales and trading, leaving the area facing “big cuts” to catch up, he said.
The traditional business of providing equity research to asset managers has been under pressure in recent years. Nonetheless, equity research still offers an attractive business opportunity for banks and broker-dealers that can adapt to deliver the types of research the buy side values and successfully transform their operating models.
Providing research ideas to long-only managers and hedge funds as a companion to execution services has been at the core of banks’ equity operations for decades. Imminent MiFID II regulation requires that research be distinct from trading, and that each be paid for separately. Some observers propose that these combined forces will render the business unprofitable and bring about the end of broker research.
McKinsey’s view is that there will be an end only to equity research as we know it. In five years’ time, sell-side equity research will likely still play a crucial role in the fundamental investment processes of the buy side, but most firms’ research functions will be smaller and more focused, governed by a strategic appreciation of the buy side’s need to produce alpha. The ultimate size of each bank’s research revenue pool, however, will be determined by its ability to efficiently deliver quality, differentiated research, set realistic prices, and control distribution, all through a very different operating model.