(July 24): As Corrine Png rose through the ranks as a sell-side equities analyst, she found herself getting bogged down with administrative and marketing duties that left her with less and less time to do in-depth research on companies she covered.
And, with banks and brokerages keeping a tight rein on their budgets for research in the face of sinking commissions and trading volumes, she feared that the sell-side research industry would gradually lose its relevance.
“[Banks] have to do more with less. Because research budgets come down, the trend of downsizing will continue,” she tells The Edge Singapore. “You are going to end up with analysts who are generalists, rather than being specialised. And, when the experienced analysts leave, they would be replaced by the cheaper, junior analysts.”
Earlier this year, Png quit her position as head of Asia-Pacific transportation research at JP Morgan and teamed up with a business partner to form an independent equity research firm called Crucial Perspective. Png says her role at the new firm will be to produce in-depth analyses of the business of aviation and shipping.
The concerns Png expresses about the state of sell-side equities research could be exacerbated by the implementation of new regulations. On Jan 3, 2018, a new package of reforms in the European Union called the Markets in Financial Instruments Directive II is scheduled to take effect.
Commonly called MiFID II, it stipulates that financial institutions separate the cost of research from transaction costs, and make those costs clear to their clients. In effect, it will force fund managers to ask their brokers to put a price on the research they provide, which the fund managers will then have to disclose to their clients. The result could be that fund managers stop using sell-side research and ask their brokers to provide an “execution-only” service.
While MiFID II technically applies only to firms operating in the EU, it will affect their counterparties across the globe. Law firm Clifford Chance notes that EU-based firms that are part of global financial services firms would need to consider how research is used and shared.
The result of all this could be a consolidation of the research business.
According to a survey by the UK CFA Society, almost three-quarters of financial service industry players expect that there will be fewer sell-side analysts in the future.
Outdated business model?
Brokers and investment banks have traditionally touted their research as a key differentiating factor in the service they provide. However, the natural conflict of interest faced by these providers of sell-side research has long been recognised by investors and regulators.
“The way research was being paid for, it’s linked to trading commissions. So, there’s often an incentive to drive the trading of stocks, even though it could be very short term in nature, or rumour-driven,” says Png.
Equities research has also been known to have been produced to support investment banking relationships.
For instance, Salomon Smith Barney’s telecoms analyst Jack Grubman was among the highest-paid analysts on Wall Street in the late 1990s as his firm raked in billions of dollars in fees from telecoms deals.
Three of his top picks later filed for bankruptcy. Among them was Global Crossing, which Salomon Smith Barney had helped take public in 1998. Grubman had also advised the telco on its merger-and-acquisition bids.
In 2003, after an investigation into “undue influence of investment banking interests on research analysts at brokerage firms”, US regulators accused Grubman of issuing fraudulent and misleading research reports on several telco stocks. He was permanently barred from the securities industry and fined US$15 million.
Over the years, regulators have sought to introduce rules to address the conflict of interest involved in producing sell-side research. For instance, research reports come with analysts’ shareholding disclosures as well as lengthy disclaimers of the brokerage’s potential commercial links with the company that is the subject of the report.
The unbundling of research costs from transaction costs under MiFID II is an extension of these efforts.
Michael Thomas, partner at Hogan Lovells, says MiFID II will remove any hidden conflicts of interest by “trying to ensure that [investment] recommendations are objective, and not being skewed by the business interests of the research firm itself”.
The big question is whether investors will actually be willing to pay for the research produced by brokers once it is unbundled from their trade execution service. Some industry observers point out that demand for traditional sell-side research was already waning on a host of structural changes in financial markets.
Among them was the shift towards more passive investment strategies offered by providers of exchange-traded funds. In 2008, there were about 1,200 ETFs with assets under management of some US$800 billion. Today, there are nearly 5,000 ETFs with AUM of US$4 trillion ($5.5 trillion).
Meanwhile, the hunt for performance has spurred actively managed funds to turn to more varied sources of research rather than the brokers who have traditionally served them. In fact, some could be doing without third-party analyses entirely.
“If you are in a niche market, you do your own research,” says John Foo, CEO at boutique firm Kingsmead Asset Management.
As it is, new players have been emerging in the equities research field and making a bigger impact on the market than traditional broker research, some observers point out.
For instance, an outfit known as Iceberg Research has come to be closely watched for its views on Noble Group, after its consistently negative view on the company over the last couple of years — which drew threats of legal action by the company — proved to have some merit.
Similarly, short seller Muddy Waters has made an impact in the local market over the last few years with negative calls on Noble and Olam International. Most recently, its negative call on Man Wah Holdings caused a selloff in the Hong Kong-listed furniture maker that was once listed on the Singapore Exchange.
Separately, there has also been a proliferation of research commissioned by stock exchanges, as well as a rise in issuer-sponsored research.
“Stock exchanges recognise that volume is generated not just by the institutional investment community, but also by both the private wealth and retail communities, which lack access to reliable data and high-quality research. We are seeing increasingly larger budgets by exchanges being allocated to the provision of research as they compete with each other to become an attractive listing venue,” notes a report put out last year by advisory and investment research outfit Edison Group, Frost Consulting and Bloomberg Intelligence.
Analyst talent on the move
What does this mean for the sell-side industry in Singapore? It seems that, even with less than six months to go before MiFID II comes into effect, many local players are unclear about what is going to happen.
Local banks say they are still seeking clarity from the regulator as well as their European counterparts. The Monetary Authority of Singapore says it is engaging with its European counterparts to ensure that local rules and regulations comply with EU standards.
While the number of people working in the research field is relatively small, an end to research costs being embedded in brokerage commissions could have an impact on jobs across the brokerage and investment banking sector.
Statistics from the Ministry of Manpower show only total layoffs across the financial services sector as a whole (excluding insurance providers). In 2001, as the dotcom crash unfolded, financial institutions reported nearly 2,400 redundancies; the following year saw 2,650 cuts, which moderated to 1,450 in 2003. In 2008, there were nearly 1,400 workers in financial services who were made redundant; another 1,780 were laid off in 2009. The pace of redundancies moderated to 570 in 2010, but began to pick up again in 2012.
Last year, more than 2,200 workers in the sector were laid off.
Analysts and brokers who spoke to The Edge Singapore for this story say there has been a drain of talent from the local equities research field.
One individual who once worked for Standard Chartered’s equities business, which was shuttered in 2015, says he is the only member of his former team who remains in equities research today. Some analysts — including Timothy Ross, once head of transport research at Credit Suisse — have gone on to work for companies they previously covered.
Terence Wong, former head of research at DMG & Partners Securities, now known as RHB Research Institute Singapore, has since started his own investment firm, Azure Capital.
Png, the former JP Morgan analyst, doubts the big banks will ever get rid of their research departments, but she is betting that smaller players such as her new outfit could make a name for themselves by providing in-depth analyses to wealth managers, high-net-worth individuals and family offices, which she says are being underserved by the industry.
“The big banks will always keep their equity research arm. They are like supermarkets in a way, so they want to provide a full spectrum of financial services,” she says. Yet, their cost structure is likely to prevent them from delivering what investors really need. “More time will be spent on trying to market, advertise your research to more investors, to earn more revenue, rather than having the time to sit down and do the research.”
