There is already a lot of literature, stats and polls on MiFID2 and its implications for investment research. But I got some interesting perspectives – MiFID2 through an offshore lens – during my discussions with few asset managers, offshore leaders and a couple of research heads and COOs. No hardcore stats but I have put them together as four themes – sell side response, buy side response, COOs response and others – all with an offshore perspective. Summarised below:
1. Sell side’s revenue model changed up-front but operational models are still evolving
The maintenance research of entire sell side research coverage – financial models, company and sector reports – is being bundled and offered through a platform. The buy side clientele will pay a fixed platform fee for accessing the research.
The other activities such as bespoke research, management meets, roadshows or thematic pitches – where onshore analysts spend about 40% of their time – are offered as consulting assignments and billed as “pay-per-use” or “pay-per-package” models.
But the operating models are likely to evolve over the next 18-24 months based on the actual economics - i.e. revenue and cost impact.
Offshore implications:
The KPO players are trying to reduce the cost of research for banks through modelling feeds and automated platforms. Their functions are currently limited to financials and research summaries. These platforms are marketed with efficiencies anywhere between 10%-40%. But so far, the offtake is limited due to complex nature of banks legacy systems, regulations and analysts’ reluctance.
But soon, the margin pressure is likely to accentuate under MiFID2 regime. This will force sell side firms to simplify their research processes and leverage automation extensively. But the critical success factor is to create a platform that is nimble and cost competitive. Also, the transition to the platform should offer minimal disruption to gain user (analyst) acceptance. This was the very reason why sell-side firms were reluctant to replace their incumbent offshore vendors with new ones, even at deep discounts.
This means a longer transition process and will not immediately disrupt the existing KPO services. But this opportunity in the long-run cannibalises the traditional offshore FTE revenues. However, it will create a sticky client base with a stable fee-based revenue.
2. Buy side is signing up for the sell side research but keeping options open:
The profit pool of the European buy side firms could reduce by as much as 20%. Still, they expect to maintain overall equity research budget intact at least for 2018. Currently, they are signing up for research with one or more sell side firms. However, they are also actively evaluating strategies for optimising their “dollar-value-of-research” consumed. Initial observations indicate that the trends across the players are not uniform. The large buy side firms are shoring up their inhouse research teams. But the smaller ones are looking to partner with specialised research providers. The Quant investing continues to be in favour and the asset managers are willing to pay for alpha-generating quantitative strategies.
Offshore implications:
The KPO players are seeing increasing demand from buy side firms in equity and credit research. The opportunities are two-fold.
The larger buy side firms that are ramping up their inhouse research teams are looking for junior associates in an offshore location. The nature of work is limited to data collation and research support. The model is akin to a conventional offshore FTE or project model.
The midsized firms are looking to partner with specialised independent research firms. But some buy side firms have seen success with KPOs ability to produce high quality research. Those players are exploring partnerships with KPOs to get thematic and alpha-generating ideas in a white-labelled format. The quant practice is also an opportunity but requires a highly specialised talent and continuous up-skilling.
Another nascent trend is the need for proprietary and alternate data sources to support buy side’s inhouse research views. Some of them are hiring data scientists to generate insights from alternate sources such as social media, transportation data and weather satellites, as well as some market data. They are open to partnering with players who could provide these insights. Traditional KPOs have limited capabilities in this area.
3. The sell side research COO / CRO (revenue) function is becoming more challenging
The Chief Operating Officer (COO) role is becoming more challenging. Earlier, the focus was on prioritising the research franchise value over maximising client wallet share.
Going forward, there is a need to justify the unit-level economics of research function. Further, they need to continuously justify the research value addition to the buy side and the larger market participants. This is crucial for optimising their pricing power. In addition, they will also have to deal with newer operational complexities such as revenue and cost management, tracking consulting hours, clients’ ability and willingness to pay, managing receivables, pricing, discounts etc.
All this is creating a unique and rich set of research management data. This data and related analytics will be valuable to COO / CROs to predict, transform and drive the research business performance.
Offshore implications:
Going forward, offshore teams can offer help in COO / CRO driven initiatives. Some of these include systematically tracking data related to production and distribution, readership, client engagement, market feedback and so on. For some banks are creating this as a could be a centralised COO function with an offshore support. For others, it is offshore analysts maintaining the data for their onshore counterparts (analysts) as per COO / CRO requirements.
A product or service to help banks demonstrate and differentiate their value add in a structured manner to buy side will be a great solution.
4. Innovative research distribution approaches remain a pain area and an unmet need
The sell side research distribution has come a long way over the past decade. They successfully transitioned from conventional PDF and excel broadcasts to include better approaches such as podcasts, html threads etc. However, one of the areas that remain a concern for them is to create a more interactive and engaging feed to their buy side clientele. So far banks have shied away from making large investments in this area because of the need to justify the ROI on the legacy systems of the cost centre.
But the new revenue model may force banks to further differentiate their research dissemination. For instance, in the earlier regime, the focus of research was to create an in-depth analysis and magnum opus reports. Going forward, banks may have to create a shorter but compelling content to stimulate interest among buy side clientele, which will generate leads for hard dollars through bespoke / consulting engagements. This creates a strong need for a very compelling research presentation.
Offshore implication:
This is a nascent trend and sell side firms are still wary of making additional investments in an uncertain environment. However, discussions to shape their thinking could create new opportunities. Initial discussion areas could be on interactive content and visualisation to help enhance their presentation, tracking the click-path of the distribution statistics supported by analytics and insights. Any tech-enabling the solutions that embed into clients' workflow systems will be the key differentiator and an opportunity that conventional KPOs are not present yet.
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