Transforming the Way Research Is Bought

June 23rd, 2014

UK regulators are changing the face of the research industry.  Here are two related articles: the latest news on regulatory actions and an insightful commentary from a UK based broker.

FCA to Release Review Results

The UK Financial Conduct Authority (FCA) gave notice that it will publish its long-awaited ‘thematic review’ of commission usage on July 10th.  We don’t expect major surprises, but the review results will set the tone for the FCA’s negotiations with European regulators on MiFID II.

From November 2013 to February 2014, the FCA conducted a supervisory review examining both asset managers and sell-side brokers to examine current market practices and business models linked to the use of dealing commissions.  Because the final policy statement on the use of dealing commissions was more stringent than the draft version, we inferred that the review hardened the FCA’s position.

The FCA will hold a meeting with selected industry representatives when the review results are published to outline the thematic findings and “set out our current thinking on the way forward”.  Save the date.

Dealing Commission Reform Vital to Transparency

The following is a guest commentary from Nicholas Dray, Manager of Independent Research & Commission Management at Marex Spectron, a London-based broker which introduces independent research to asset managers.

The way that firms treat dealing commissions and ensure transparency in the reporting of research costs will change significantly following a recent policy statement by the UK Financial Conduct Authority (FCA).

On May 8, the FCA published its policy statement on the use of dealing commissions which clarified its definition of what could be considered ‘substantive’ research and consequently eligible to be paid for via trading commissions. The regulator’s plan is to reduce conflicts of interest inherent in the bundled research and execution model and ensure the best value possible is achieved for investors. Central to this is the regulator’s aim that investment managers seek to control the costs passed on to their customers with as much rigour as they pursue investment returns.

The policy statement reiterated their stance that corporate access cannot be funded from dealing commissions, while bundled services and mixed-use assessments are subject to guidance and while judgements by firms are likely to make different assessments of the value and price of eligible services, the onus will fall on investment managers to demonstrate that the judgements were made with the best interests of clients at the forefront of the decision.

Investment management houses are now obligated to produce a clear research policy which will form part of their marketing material. The changes are incorporated in amended Conduct of Business Sourcebook (COBS) requirements pertaining to the use of dealing commission (COBS 11.6)  and came into effect on June 2nd.

Marex Spectron’s Independent Research & Commission Management team recently hosted a breakfast seminar which focused on the changes to research valuation and treatment of dealing commissions. Attended by over 25 buy-side firms, the seminar allowed interested firms to participate in a wide-ranging discussion on the implications of the FCA’s policy statement prior to the imminent implementation of the new regime.

Speakers included Neil Scarth from Frost Consulting, a consultancy focused on equity commission unbundling and related market structure/regulatory change, , and Peter Allen, Managing Director of Lombard Street Research who spoke in his capacity as Co-Chair of Euro IRP, an industry association for Independent Research Providers (IRPs).

Scarth highlighted the need for investment managers to place a value on the research they pay for via commission while noting that the FCA accepts that the same research can be worth different amounts to different funds. He sees the key requirements on investment managers now include the need to 1) decide on which research products and services will be used, 2) determine whether they meet the FCA’s substantive guidelines, 3) develop a research budgeting and valuation process and document it and, finally, 4) ensure that accurate records of all these processes are kept as evidence of the judgement-based obligations now imposed on managers.

In our view, the FCA’s findings have been drawn within the context of the objectives of MiFID II, where the underlying theme is improved transparency and fairer treatment of clients. While we remain confident that a ban on research commissions for the procurement of research remains the FCA’s ‘nuclear’ option, we are aware that a Thematic Review on Competition in the Research Market will be released later this year [now scheduled for 10th July, ed.] – the review of the use of dealing commissions is not over.

Marex Spectron believes that the policy statement will lead to further take-up of CSA models by the buy-side as they seek to demonstrate transparency in their research spending. Rewarding research providers who provide a substantive research service with competitive pricing will make them more attractive to investment managers who will be looking to demonstrate sound judgement in the research services they take.

Central to this concept is the ability to accurately and transparently manage all dealing commissions, a service that the team at Marex Spectron have offered for many years. Recently, we have enhanced our CSA offering by offering a market-leading Commission Management platform to our clients in conjunction with our execution services. The platform is a fully-integrated online portal which allows clients to easily and transparently manage their dealing commissions across all their panel brokers via one sophisticated interface.

Marex Spectron sees the benefits of increased transparency in pricing and that buy-side houses who adopt will add value to their clients.  We see this as an opportunity for Independent Research to continue to steal market share from the bulge-bracket.  The continued pressures on research budgets will force Investment Managers to look outside the traditional avenues for ideas. Further pressure on research departments within the sell-side will probably result in further reductions in both headcount and coverage.

Marex Spectron is one of the world’s largest privately held brokers of financial instruments in the commodities sector and a leader in facilitating trade in physical energy products. It also offers brooking services covering a broad range of financial products. Marex Spectron’s Independent Research & Commission Management Desk specialises in introducing IRPs to the buy-side on a case-by-case basis. Introductions are made only after ensuring IRPs are of the highest quality and of complete relevance.  As well as the introductory service, Marex Spectron manages Research relationships on behalf of the buy-side, including all administrative aspects such as fee negotiations, invoicing, renewals and service T&Cs.  Marex Spectron also focuses on analysing the ongoing regulatory research framework and the changes affecting the research industry in general, particularly in light of the recent FCA’s review on dealing commissions.

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Equities League Tables

June 18th, 2014

Bank of America Merrill Lynch, Goldman Sachs and J.P. Morgan had the highest market share for U.S. cash equities trading, according to the latest Greenwich Associates survey, with Morgan Stanley and Credit Suisse close behind.  Divergence between the Greenwich trading market shares and research rankings reflect the reality that commission flows do not always follow research value.  The Greenwich results generally correspond with reported equities revenues from the investment banks, but the first quarter rankings differ.

U.S. Cash Equities Market Share

According to the Greenwich survey, Bank of America Merrill Lynch had 8.5% U.S. cash equity trading market share followed by 8.3% market share for Goldman Sachs and J.P. Morgan, yet Greenwich assigned a first place tie to all three firms.  Greenwich said that Morgan Stanley and Credit Suisse each had trading market shares of 7.8%.

The Greenwich survey was conducted between December 2013 and February 2014, incorporating interviews with  225 U.S. equity portfolio managers, 815 buy-side equity analysts, and 316 U.S. equity traders.  The survey is primarily focused on large long-only asset managers.  Greenwich’s summary results can be found here:

Divergence from Research Rankings

The Greenwich trading market shares differed from the research rankings assigned by portfolio managers and analysts.  This is not an uncommon result for asset managers which conduct internal broker votes.  Success in the internal broker vote does not always translate into commensurate commission volume.

In the case of the Greenwich survey, J.P. Morgan topped the research rankings from both portfolio managers and analysts, yet did not have the highest trading share according to the poll.

The research rankings also differed between portfolio managers and analysts, with PMs ranking Credit Suisse’s research fourth, but analysts not ranking Credit Suisse research in the top seven at all.  Not surprisingly, the PM research rankings have a greater correspondence with the ultimate trading share.

Ranking Reported Equities Revenues

The survey results correspond to our own league rankings for reported equities revenues, although for the first quarter Morgan Stanley, Goldman Sachs and Credit Suisse were the top three firms for reported equities revenues, followed by J.P. Morgan and Bank of America Merrill Lynch.

.                                                     Source: Integrity Research Associates

Reported equities revenues are global, not U.S. specific and they include revenues from derivatives trading, prime brokerage, and equity securities lending.  For those few firms which provide detail on cash equities results, cash equities is the largest component, representing 40%-50% of total equities revenues.

Comparing results from the prior year, Morgan Stanley’s equity sales and trading revenues grew 16% from the first quarter of 2013, reflecting increased client activity across all equity products and “particularly strong performance in prime brokerage.”  Conversely, Goldman Sachs declined 17% from the prior year, but much of that decline was explained by the sale of their Americas reinsurance unit in 2013.

Global equities revenues for the top ‘bulge’ investment banks represented $11.2 billion in revenues, down -4% from the prior year.

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Wall Street Suffers Plunge in Equity Volumes & Volatility

June 16th, 2014

Despite the pickup in equity commissions seen in 2013, Wall Street is now experiencing a sharp downturn in equity trading volume and volatility over the past few months – factors that could lead to a decline in equity commission revenue in the 2nd Quarter of 2014.

Volume and Volatility Plunge

Since April 1st, 2014 average daily trading volume in stocks that comprise the S&P 500 continues to slip and is now 17% below the level seen in the 1st Qtr of the year.  As a result, equity trading volume in these bellwether stocks is now 29% below the average trading volume seen over the past five years.

Another factor which drives equity trading commissions is volatility in the stock market.  Volatility, as measured by the CBOE Volatility Index (VIX) dropped to a six-year low in early June, leaving the VIX 40% below its 10-year average.

One factor which could be contributing to the decline in equity trading volume are the roll out of the Volcker Rule which has limited proprietary trading and risk taking at Wall Street banks.  In addition, recent press and regulatory focus on high frequency trading could also be drying up volume from this group of market participants.

Consequently, we expect that equity commission revenue is likely to shrink during the second quarter of 2014.  Fortunately, equity commissions are a small part of the revenue pie at many of the large Wall Street banks, excluding Goldman Sachs and Morgan Stanley that generate 20% and 21% respectively from equity sales and trading.

IPO Volumes Remain Robust

The good news for most Wall Street firms is the fact that investment banking revenues are likely to more than offset the weakness seen in equity commission revenue in the second quarter.

According to data collected by Renaissance Capital, IPO Volume so far this year has surged 40.9% to 25.8 bln when compared to the same time frame in 2013.  In addition, IPO volume in the second quarter of the year is up 44.3% to $15.3 bln from $10.6 bln seen in the 1st Qtr 2014.

The improving domestic economy, rising confidence among CEOs, and continued record low interest rates have all combined to fuel very strong activity in the U.S. IPO market so far this year – a trend that is likely to continue for the remainder of the year.

Potential Impact on Research Biz

Falling equity commission revenue caused by weak trading volumes and a drop in volatility will result in smaller commission balances at buy-side firms which can be used to pay for sell-side and alternative research providers.

This is likely to have the most immediate negative impact on firms heavily reliant on trading commissions to be compensated for their research, like boutique firms with trading desks or those that have a large number of broker vote clients.  Alternative research firms that have a significant portion of clients pay them in hard dollars won’t feel the pinch – at least not at first.  On the other hand, larger sell-side firms that also have investment banking businesses will be shielded from the worst of the drop in equity commissions.

Hiring in the research business probably won’t see too much of an impact in the near term as most firms won’t respond to a one quarter drop in commission revenue.  In fact, we would not be surprised to see some sell-side firms boost analyst hiring to be able to keep up with the strong gains in IPO volume.


Recent US equity volume and volatility data suggests that equity commissions are likely to dip in the second quarter of 2014, despite posting a double digit gain last year.  These trends will have a negative impact on the revenue of some research providers – particularly boutique broker dealers who rely on trading desks and the broker vote to get paid.

However, the most important issue is whether this trend will continue into the second half of the year, as the longer that equity commissions slip, the more pronounced an impact will be felt in the research industry.


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US Commissions Up 11% According to Greenwich

June 11th, 2014

U.S. equity commission volumes increased 11% during the year ending February according the latest Greenwich Associates survey.  ‘High-touch’ commission rates used to pay for research also increased modestly.  The survey confirms an improved U.S. commission environment over the last year, a welcome relief from five years of steady commission declines.  The positive trend carried into the first quarter of this year, but the second quarter is looking less robust.

Commission Rebound

Greenwich’s annual U.S. Equity Analyst Study estimates that U.S. cash equity commissions increased to $10.34 billion from $9.3 billion for the 12 months ending February 2014.  We estimate that the portion of commissions allocated to research/advisory grew even faster, approximately 16% from $5.4 billion to $6.2 billion.  According to Greenwich, 80% of the overall commission increase came from spending on research and other related services.

Sources: Greenwich Associates, Integrity Research Associates

Higher Commission Rates

Survey respondents also reported that ‘high-touch’ commission rates, which are used to pay for proprietary research, increased from an average of 3.53 cents per share to 3.58 cps as of February 2014.  The increase is small, but breaks the steady decline from the pre-crisis rate of 4 cps.

Greenwich Associates expects the modest increase in high-touch commission rates to continue into 2014, but views this as a recovery to historical norms rather than a long-term upward trend.

Falling Bulge Market Share

Bulge bracket investment banks have continued to lose research market share, according to the survey.  Greenwich tracks 9 bulge bracket firms, 47 smaller broker dealers including regionals and specialist independent research firms, and 19 independent research firms not organized as broker dealers.

In 2007 the bulge bracket had a 78% share of trading and 71% share of research. As of February, the bulge bracket shares have dropped to 64% of trading and 53% of research, with mid-sized/regional brokers, sector specialists and independent research firms benefiting.

Note that the spread between bulge trading share and bulge research share has widened over the last 7 years.  Commission management platforms have helped the bulge firms maintain a larger share of overall commission spending (64%) despite the continued erosion of research market share (currently 53%).

2014 Commission Environment

Although billed as a 2014 report, the Greenwich survey largely reflects the 2013 commission environment.  Nevertheless, the upbeat commission environment extended into the first quarter based on our reading of bulge bracket equities revenues.

Sources: The Wall Street Journal, Credit Suisse Group

Market volumes have been trending down during the second quarter, however, with May registering the lowest trading volume on major U.S. exchanges since 2007.  If desultory volumes continue, it will not bode well for continued improvement in commission spending during 2014.


Greenwich expects continued improvements in commissions and rates to ‘historical norms’.  This is an appealing prospect for research providers, but by no means a slam dunk.  On the plus side, hedge funds are a bellwether for research, and continued growth in hedge fund AUM is bullish for commissions.  We expect this trend to continue to be a positive for research.

Another driver of commission growth has been equity allocations.  We have seen increasing allocations to equities from bonds by asset owners.  Unfortunately, that trend is largely behind us.

We suspect that some of the U.S. commission improvement has been fueled by tapering insider trading prosecutions.  We’ve seen a massive rebound in expert network usage over the last eighteen months, and we think that is symptomatic of PMs and analysts getting back to work after an extended compliance freeze.

The larger trends are negative.  Asset allocations continue to shift from active to passive management, which we believe is one of the fundamental drivers of commission declines.  Electronic trading will likely resume a growth trajectory as buy-side (and sell-side) trading resources are constrained, increasing pressure on commission rates.  Regulators, led by the FCA in the UK, are increasingly pressuring commission spending, including bans on payment for corporate access through commissions.

While the commission losing streak has been broken, a major upswing in commission spending is unlikely.  We expect commissions to be up slightly for the year, with worries on whether the uptrend can continue to 2015.


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Wall Street Jobs Picture Improves Modestly In May

June 9th, 2014

Wall Street firms experienced a modestly improved jobs picture in May as fewer layoffs were announced due to a slowdown in the recent rightsizing trend among investment banks.  However, this does not portend a rosy outlook for the financial services industry since banks remain cautious about bringing on new staff.

May Challenger, Gray & Christmas Report

According to Challenger, Gray & Christmas’ monthly Job Cuts Report released last week, the financial services industry announced a drop in planned layoffs during May of 1,151 jobs.  This is a 72% decrease from the 4,124 planned job cuts announced in April.  However, the number of planned job cuts last month remains 390% higher than the number of layoffs announced in May of 2013.

Another piece of evidence that the jobs picture is improving on Wall Street is the fact that financial services firms have announced 41% fewer layoffs on a year-to-date basis — 20,581 layoffs so far this year compared to 35,091 during the same period in the previous year.  This suggests that the pace of right sizing in the financial services industry might finally be turning around.

Despite this improvement, planned hiring at financial services firms fell 100% in May as no new hiring was announced during the month from 350 new jobs announced in April.  In addition, the number of new May hiring plans represents a 100% drop from the meager 69 new jobs announced in May of the prior year.  This weakness is borne out by the fact that year-to-date hiring plans in the financial services industry remain weak as 54% fewer new jobs have been announced so far in 2014 when compared to the same period in 2013.

Major Industry Moves

As we warned last month, Barclays Plc’s eventually announced that it plans to slash 7,000 jobs at its investment bank between now and 2016, signaling that its effort to build a global bank has come to an end.  This is in addition to the 12,000 job cuts that the lender announced it would make in February of this year.

In May, the Royal Bank of Scotland PLC announced that it would slim down its trading operations at its Stamford CT headquarters, cutting costs and refocusing its business on its home UK market.   RBS is planning to shed 400 jobs across its US business over the next 18 months in order to prepare for new banking regulations which are expected to go into effect over the next year.

Although no job cuts have yet been announced, a number of bank analysts have warned that JP Morgan Chase, which currently employs over 250,000 worldwide, could announce massive layoffs in the next few months due to increased regulatory pressure and a squeeze on bank profits.  Some suggest that CEO Jamie Dimon could announce a new round of layoffs totaling as many as 10,000 jobs.  These analysts also surmise that Dimon may decide to throw in the towel given the extensive regulatory oversight that the industry is facing, and that JP Morgan has had to deal with in the past year.

Bullish Developments for Industry Employment

Despite the negative impact of new regulations, a few developments should be seen to be constructive for Wall Street’s near-term employment outlook.

Globally, business conditions continue to improve and corporations are holding significant cash reserves so M&A activity is likely to continue to increase, supporting increased staffing at investment banking departments.  In addition, the regulatory changes which are pressuring banks, have also boosted the hiring of compliance and risk management professionals by banks, broker-dealers, and hedge funds.

Relevance for the Research Industry

While improving, the employment outlook on Wall Street is nothing to get excited about – at least not for the research industry.  Improvements seen in firms’ cash equities business earlier this year, and a pickup in M&A activity should support existing research staffs.

However, despite a rising equity market, trading volumes were extremely weak in May.  A continuation of this slowdown, on top of the regulatory pressures that banks are facing, could keep a lid on new hiring of analysts or research sales staff.

As a result, we remain cautiously optimistic about the employment outlook in the research industry. Unfortunately, the fundamentals of the market don’t look like they will support a robust pickup in hiring anytime soon.


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Autonomous UK Business Surges, But…

June 4th, 2014

Autonomous Research, a UK-based independent research firm, reported that its UK business surged in the fiscal year ending March 31st to exceed £25 million for the first time.  Unfortunately, some recent developments could pose future problems for Autonomous and other successful independent research firms.

2014 Financial Results

Founded in 2009 by former Merrill Lynch bank analyst Stuart Graham, Autonomous Research reported that the revenue for its UK research business rose 19.7% to £25.6 million (approximately $43 million) in the period ended March 31st, 2014 from £21.4 mln in the prior year.

Administrative expenses rose 26.5% from £7.1 mln to £9.0 mln in the most recent twelve month period.  Consequently, the firm’s operating profit reportedly rose 15.5% to £16.5 mln ($27.7 mln) from £14.3 mln during the same period.

These results do not include the performance of Autonomous’ rather significant US business which currently employs almost two dozen staff.

Growth in Trading

Besides the robust growth seen at the firm in 2014, another interesting insight seen in Autonomous’ recent financial report is that the way buy-side clients are paying for their research is shifting.

For example, in 2013 47% of the firm’s business was paid for using CSA’s, 37% of revenue came in the form of direct equity trading, and 13% came from direct fixed-income (credit) trading. However, in 2014 the percent of clients paying for Autonomous’ research with CSA’s fell to 40%, the percentage paying by executing equity trades with the firm stayed unchanged at 37%, and the percentage paying for the firm’s research by trading with them in fixed-income securities surged to 22%.

Clearly, in 2014 Autonomous’ customers were more interested in paying for their research by trading directly with the firm rather than directing other brokers to pay them using Commission Sharing Arrangements.

Potential Impact of Regulatory Changes

Of course, the obvious question we ask ourselves after reviewing these financial results is how the FCA’s recent policy changes regarding the use of commissions to pay for corporate access and investment research might eventually impact a successful independent research firm like Autonomous.

Obviously, going forward UK asset managers will not be able to pay a research firm like Autonomous for the corporate access services it provides using client commissions (either trading or CSAs).  Instead, they will have to pay Autonomous for this service using hard dollars – a move that many asset managers will be loath to do.

In addition, we expect that the FCA’s recent policy pronouncements around the use of client commissions to pay for research will prompt most UK asset managers to become more cautious in their use of “bundled commissions” to pay for research as they will have to justify their commission spending.  In our mind this could prompt a reversal in the recent trend seen at Autonomous where a greater percentage of their revenue comes in the form of direct trading commissions.  Clients will likely use more CSAs or hard dollars to pay for the firm’s research in the future.  The real question is whether this will translate into reduced revenue for the firm.


Autonomous Research’s UK operations posted an extremely bullish financial report for the twelve months that ended March 31st, 2014 reflecting the continued success that the firm has been able to experience since its founding five years ago.

Unfortunately, recent regulatory developments in the UK could create headwinds for an independent research firm like Autonomous which has historically been able to produce a highly desirable research product, and which has built the infrastructure to enable clients to pay for their research the way they preferred.

The management team at Autonomous Research (and at most other investment research firms) will need to start reevaluating their business models and decide how best to grow their research businesses given the new rules of the game.


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New UK Regulation Has Big Impact

June 2nd, 2014

Today marks the UK deadline for the ban on the payment of corporate access with client commissions and a broader set of new commission requirements.  Asset managers have been scrambling to comply with new regulatory language requiring a more thorough valuation of research, in addition to other changes.  Investment banks, after their initial shock, have been revamping their corporate access services.  Meanwhile the UK regulator threatens more actions later this year.

Short deadline

When the Financial Conduct Authority (FCA) published its new guidance on research commissions it set a deadline giving less than a month for implementation with the haughty statement “We believe firms that are already compliant with our existing rules and have sufficient systems and controls to demonstrate compliance should not need to make material systems changes under the amended provisions.”

The reality is that even the most diligent asset managers were blindsided by the extensive new provisions requiring asset managers to proactively value research services, including bundled research from investment banks.

Additional requirements

Under the new guidance, investment managers are encouraged to perform “fact-based analysis” to price research services. This includes comparing unpriced bundled services to priced services such as independent research and/or estimating the cost to internally perform the service.

The FCA also ‘reminded’ asset managers of the duty under general regulatory provisions to keep commission management records, ‘clarified’ the definition of research by requiring that it be substantive, and nixed corporate access as research.

A mad scramble

Asset managers are grappling with questions such as whether every piece of research needs to be ‘substantive’ or whether is sufficient if the overall service is ‘substantive’.  One asset manager has reportedly implemented a regime to label whether each piece of research is substantive or not.

Many asset managers are reviewing all their research services to ensure that they meet the new ‘clarified’ definition of research.  We are told that some international long-only firms are planning to implement the UK guidelines globally.  Large European-based asset managers are also querying whether to adopt the UK guidelines.

No wonder then that the buy-side trade association, the Investment Management Association (IMA), is reportedly miffed, particularly after its close collaboration with the FCA during the rule making process.

Corporate access

The IMA’s annoyance pales in comparison to the shock experienced by the investment banks, which expected the FCA to soften its final rules in response to numerous meetings and comment letters.  Instead, the FCA tightened the final provisions further, adding language which pressures banks to begin pricing their research services.

For corporate access, the bank response is damage control.  All research providers have been bombarded with client letters requesting that if they are charging for corporate access, stop doing so.  The investment banks still intend to offer corporate access, since it is an important part of relationships with issuers.  However, the direct costs will need to come down, which will mean downsizing teams dedicated to UK corporate access.

Pricing problems

Even so, there is a gaping bid/ask spread between what banks expect to be paid and what asset managers are willing to pay out their own pockets.  As we have reported in the past, the going rate in the US for management access is around $4,500 for access during a conference and $7,500 to $10,000 for non-deal roadshows.  That varies with the scarcity of the senior management, and, as the Financial Times has breathlessly reported in the past, it can go as high as $20,000 for hard-to-get executives.

UK asset managers have a different perspective now that the money comes out their pockets.  The values they are offering are reportedly an order of magnitude less than what the banks expect.  One asset manager is said to be sending out checks for £100 after each meeting to prove to regulators it is paying out of its own pocket.  The checks barely cover the cab fare.


Some banks have put a moratorium on UK corporate access, shepherding their corporate clients to other domiciles.  Others are exploring workarounds.  Unlike corporate access, conferences appear to meet the ‘substantive’ guidelines (as we have noted, the average fee for conference participation in the US is $35,000.)  Banks are organizing virtual conferences with 5-6 issuers and around 15 investors, with analysts acting as moderators.

As we suggested earlier, technology will also play a role.   Video conferencing reduces the costs for all involved, as well as allowing UK managers to piggyback on meetings organized by colleagues in other domiciles.  Technology also offers the possibility to dis-intermediate the banks altogether, although we don’t expect to see this happen anytime soon.


The FCA has made it clear that it may take further steps to reduce or eliminate the ability to pay for research with client commissions.  It is reportedly waiting until November to release the results of its recently completed thematic review of commission practices, to give time to monitor asset manager compliance with its new guidelines.

Asset managers are also concerned with regulatory fallout from MiFID II, which is currently addressing provisions which will impact research commissions.  The FCA is a party to those negotiations.


The new FCA guidelines are much more than a mere clarification, and are causing turmoil for asset managers and investment banks.  The FCA expects research commissions to decline on the order of £500 million (US$800 million) which is its estimate of corporate access spending by UK managers.  We doubt spending will shrink that much, but the FCA’s focus on the bottom line will keep pressure on asset managers to better manage their research budgets.

Corporate access will continue, albeit in truncated or virtual forms.  Similarly, investment banks will continue to offer waterfront research coverage.  There may be more pricing transparency on the order of service levels (platinum, gold, etc.) with ample opportunity for negotiation on what is included in each level of service.

Some observers expect independent research firms to benefit from the changes.  It is true that independent research is a useful benchmark as asset managers try to value bundled research.  And it is also true that the cost of independent research is frequently an order of magnitude less than what investment banks are typically paid.

Independent research firms also know, however, that uncertainty and confusion are not ideal sales environments.  And then there is the ongoing fear of further regulatory restrictions which may impact all research firms, independent or not.  The frenetic scramble to comply with PS 14/7 may only be a start of a long slog for UK asset managers.

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A Kinder Gentler Anonymous Analytics

May 28th, 2014

Hacktivist-affiliated Anonymous Analytics just released a new research report: a high conviction buy recommendation on Demand Media (DMD). In a statement made to Integrity Research, Anonymous Analytics says it is “trying to find our boundaries” as it tests whether the Muddy Waters business model of profiting from positions taken before a report’s release works as well for long positions as it does for shorts.

Demand Media

Demand Media is an under-followed small cap stock with a current market value of $400 million.  According to Thomson Reuters First Call, it is followed by 6 sell-side brokers, and the average rating is ‘Hold’.  Analysts following DMD have generally given up on the stock since Google changed its search algorithm to thwart DMD’s initial strategy of generating low-cost (and low-quality) content geared to gaining high search rankings.

Anonymous Analytics argues Wall Street is overlooking improvements in DMD’s fundamentals and external catalysts to growth.  Consistent with its past reports, the new 34-page analysis is well-researched and thorough.  It makes the case that DMD will profit from a new ICANN program to expand domain name extensions and cites web statistics suggesting that DMD has turned around its content strategy in the wake of Google’s smackdown.  

Muddy Waters Business Model

Taking a position in a stock before you issue a report is a business model adopted by a handful of firms, Muddy Waters perhaps being the best known.  However the model should rightly be called the Andrew Left business model, since the founder of Citron Research (formerly pioneered the approach in 2001.

The model can be lucrative.  Former Muddy Waters contributor Jon Carnes, who subsequently started his own website, has claimed that he and his contributors made about $10 million shorting Chinese companies.

The downside is increased risk of lawsuits and regulatory actions.  Canadian regulators accused Carnes of producing a fraudulent report on Silvercorp Metals Inc. (SVM) and one of Carnes’ researchers was jailed by Chinese authorities (who allegedly were assisted in their investigations by Silvercorp).  Andrew Left of Citron has been the subject of numerous lawsuits and was disbarred for three years by the National Futures Association for allegedly having made ‘false and misleading statements’.

But then again, any short-oriented researcher risks the legal wrath of its subjects, as Gradient Analytics (née Camelback Research) found when sued by Overstock and Biovail.

Shorts v. Longs

According to its disclaimer, Anonymous Analytics itself holds no direct or indirect interest or position in Demand Media.  The disclaimer also says:

“However, you should assume that certain contributors to this report, as well as their members, partners, affiliates, colleagues, employees, consultants, muppets clients and investors, as well as our clients have a long position in the stock or debt of Demand Media (“DMD” or “the Company”) and/or options of the stock, and therefore stand to gain substantially in the event that the price of the stock increases.”

As Anonymous Analytics suggested in a statement made to Integrity Research “This report is more of an experiment to see if anyone cares about long ideas coming from us.”  Short ideas are attention-grabbing and controversial, making them more media-friendly.  Good news is an oxymoron, hence, other than this obscure blog, you are unlikely to see much written about its DMD call.

Similarly, the market impact on DMD is likely to be more muted.  DMD closed up 2.8% after Anonymous Analytics’ report was released.  In contrast, short calls often have immediate double-digit impacts.

In its statement to Integrity, Anonymous Analytics indicated that short ideas are stressful: “Most people don’t appreciate the time, resources and emotional fatigue that go into a fraud report. If you’re calling a company out as a fraud, you need to come correct – there is no room for error. It’s challenging and there are lulz to be had, but the pressure can also be soul-sucking.”

Acquiring Information through Unconventional Means

We also asked Anonymous Analytics about its tagline, inquiring about the ‘unconventional means’ it uses to acquire information.  Anonymous Analytics insists in its disclaimer that all information used in its reports is publicly available.  It defines ‘unconventional means’ as more thorough due diligence than is typically practiced by Wall Street analysts:

“So, Sino-forest was taken down entirely on public information. But just because something is legally defined as public information does not mean it’s public knowledge or it’s easy to access.   SAIC filings, web traffic, daily number of trucks leaving a manufacturing plant –technically this is all public info, but very few people can or have the ability to get it and/or interpret the data in a meaningful way. That’s the type of stuff we specialize in, and it’s very different from the traditional sell-side research we’ve all come to know and love.”


Investment research is a tough business, largely subsidized by client commissions.  It is hard to differentiate your research from the crowd, hard to get in front of clients, hard to get paid.  For a handful of research firms, the so-called Muddy Waters business model is a viable option, albeit fraught with legal risks.

What is interesting is the application of this model to long ideas: lower legal risk but will the rewards be there?  If so, the business model may be one more approach to filling the void in small cap stock coverage we discussed yesterday.

Nevertheless, don’t assume Anonymous Analytics has given up on short ideas.  Their last words to us: “But don’t worry – we still got a lot of frauds left to blow up.”

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On The Other Hand: A Growing Research Void

May 27th, 2014

In recent weeks we have written a few articles about the improving outlook for cash equities and the equity research business.  And while the research business has clearly been on the mend in the past few quarters, some trends – like a growing void in small cap research coverage – suggest that the underlying health of the research industry may not be so robust.

Weak Market Conditions & Regulatory Changes

The five years between 2007 and 20012 were not been banner years for the cash equities and the equity research businesses.  Most financial market participants agree that the equity commission pie shrunk 30% to 50% over this period.  While Integrity’s estimate for the drop in global equity commissions over this time frame is not quite so sharp, we estimate that buy-side spending on global equity research dipped 20% during the same period.

As we have mentioned in recent articles, equity commissions have rebounded higher over the past 6 months.  Despite this improvement, there are some storm clouds on the horizon which don’t bode well for the business – at least in the UK and Europe.

The FCA’s announcement earlier this month that “investment managers should use client dealing commission only to pay for substantive research or costs related to executing trades” will prohibit UK asset managers from using client commissions to pay for management access.  Some believe that a similar regulation may also be adopted in Europe.

One consultant, Richard Phillipson of Investit, suggests that this could reduce the amount that UK asset managers pay for investment bank research by 50%, as a considerable amount of the commission pie is currently spent to pay banks for corporate access.

Impact on Capital Markets

The negative impact of these developments has been significant over the past few years, and could continue to hamper the capital markets in the future.  One obvious effect of the weakness in the equity commissions from 2007 to 2012 has been a deep cut in the number of equity analysts employed by sell-side firms.  Some suggest that the number of equity analysts actually fell by 50% during this period.

The consequence of these layoffs has been a drop in the number of companies that receive research coverage.  As of December 31, 2012, Keating Investments published a white paper revealing that nearly 29% of all exchange listed companies had zero or no meaningful analyst coverage of their stocks.  This, however, understates the impact on small or micro-cap stocks as 55% of companies with market caps of less than $250 million have little or no analyst coverage.

Unfortunately, the lack of research coverage has a proven negative impact on the cost of equity capital, meaning the equity prices for stocks with no coverage are generally lower than the price of similar sized companies in comparable industries.  Ultimately this could hinder the growth prospects of these uncovered or under covered companies and negatively impact their willingness to invest and hire.

This issue has not gone unnoticed by regulators and lawmakers.  The European Commission is considering what to do to encourage research coverage for small and mid-sized companies.  This concern also prompted the JOBS (Jumpstart Our Business Startups) Act, signed into law on April 5th 2012.

The JOBS Act specifically allows investment bankers and research analysts to formally collaborate on an IPO for a smaller “emerging growth company” (although appropriately retaining the independence safeguards designed to protect investors), and it allows equity research to be published immediately after the IPO, instead of waiting 40 days.

Possible Solutions

Although the public sector is rightfully concerned about the negative economic impact of declining research coverage and is considering possible options, a number of market-based solutions are available.  For example:

  • Issuer sponsored research: Some uncovered or under covered public companies choose to directly pay research firms to cover their companies.  These issuers have made the commercial decision that the benefit of research coverage greatly outweighs the cost of that coverage and the market perception that this type of research is biased.  However, a limited number of high quality issuer sponsored research firms, and the credibility concerns some investors have with this type of research, has kept it from gaining considerable traction in the marketplace.

  • Exchange “fee based” research: Over the past decade, a few third-party initiatives have sprung up to try and address the credibility issue associated with issuer sponsored research.  Most of the programs that have gained the most traction have been run by stock exchanges which directly hire research providers to write the research on behalf of uncovered listed companies thereby removing the economic incentive on the part of the research firm to write overly optimistic research because they are being paid directly by the corporate issuer.  The London Stock Exchange, as well as exchanges in Australia, New Zealand, Singapore, Malaysia, and India have all developed similar “fee based” research programs.  

  • Increased buy-side coverage: Some market participants suggest that the real answer to the problem of declining sell-side research coverage is to have asset managers increase their own internal research efforts to cover more public companies.  And while some buy-side firms have expanded their research departments to address this issue, the cost to do so is normally quite high prompting these firms to pass on these costs in the form of higher fees to their clients.  Also, this approach is inefficient as it would require buy-side firms to duplicate their efforts as they would cover many of the same companies.  

  • Alternative research: A more economically rationale approach to addressing declining sell-side research coverage is for buy-side firms to pay alternative research providers to undertake this research.  Not only can most alternative research firms produce this research at a lower cost than buy-side or sell-side coverage, but an alternative research firm can spread the cost of this coverage across a number of buy-side clients.  Unfortunately, most alternative research firms find it hard to justify covering small cap companies as investors are interested in a wide range of different stocks, thereby making the demand for research coverage on any single company limited.


We clearly see evidence of a rebound in the cash equities and equity research business over the past few quarters.  However, this doesn’t mean that the research industry is healthy and robust.  You certainly would not believe this if you were the CFO or CEO of a small or mico-cap company that did not have research coverage, or a small-cap money manager looking for research on the hundreds of names in your interest list.

Unfortunately, recent regulatory developments, like the FCA’s announcement that UK asset managers cannot use client commissions to pay for corporate access is likely to make it even more difficult for small-cap UK (and potentially European) companies to get sell-side research coverage.  Many UK investment banks will probably experience a significant drop in equity commission income, prompting fewer analysts on staff and less research coverage.

In our assessment, small cap public companies will probably have to look for research coverage in less traditional ways, like from issuer sponsored research firms or from exchanges with “fee based” research programs.  Buy-side firms, on the other hand, will either need to increase their internal research departments or they will need to procure more alternative research to fill the growing research void.

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Cash Equities Volumes Open With Strong First Quarter

May 21st, 2014

Cash equities trading in the US and Europe remained robust in April, continuing a strong start to the year.  European trading volumes increased on aggregate by 18% during April compared with a year earlier, according to an analysis by UBS cited by Financial News.  April volumes decreased 5% from March’s levels, but remained significantly higher than year-ago figures.

US equity volumes told a similar story.  Combined cash volumes for NYSE, Nasdaq and regional exchanges remained at higher levels than the third and fourth quarters of last year, but eased slightly in April from the first quarter.

US cash equities volumes dropped 3.7% from March and were off 1.2% from the previous April.

The April volumes come after the biggest first quarter for European equities volumes since 2011, with shares worth over €2.5 trillion traded across European markets.

The first quarter was also positive for US cash equities volume which was up 10.8% relative to the first quarter of 2013 and up 1.4% from the fourth quarter of 2013.

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