Job losses, IRP growth loom as banks cut research costs
The fallout from regulations that force sell-side companies to charge separately for research will result in job losses and reductions in analysis spending at banks, according to a report by McKinsey. However, such regulations will also usher in an era of growth for independent research providers (IRPs). The arrival of the European Union's MiFID II rules in January will result in banks slashing $1.2bn of investment in research, McKinsey said. IRPs are likely to help fill the void, according to McKinsey Senior Partner Roger Rudisuli, who explained they'd benefit because they have a lower cost base and can generate higher returns by having a niche focus. 
An increase in independent equity research providers will be one of the main results of MiFID II rules that will require unbundling of research costs from execution, putting those firms in a unique position to establish what those once-opaque costs will be across the investment banking industry going forward, according to a McKinsey & Co. report released Wednesday.

The report, “Reinventing Equity Research as a Profit-Making Business,” listed the increase in research-only providers as one of five business models the sell-side will adopt because of the Markets in Financial Institutions Directive II, which takes effect at the start of 2018. The regulations will require all financial firms that do business in the European Union or have clients in the EU to disclose research costs as a distinct line item, rather than in bundled commissions with executions.

The rise in independent research-only providers will have several benefits that will be passed on to money managers, said report co-author Roger Rudisuli, senior partner at McKinsey, in an interview. They are a lower cost base vs. large investment banks; a more niche focus on investing that can generate greater alpha for managers than broad-based equity research from bulge-bracket firms; and size that makes them better able to provide research to smaller managers that can't afford the larger banks.

“Hundreds of these research firms exist already,” Mr. Rudisuli said. “The bulk of them charge specifically less than the commissions charged by investment banks. Under MiFID II, this will make them more attractive to asset managers and asset owners.”

By contrast, Mr. Rudisuli said, larger investment banks have difficulty pricing research since that's historically been part of their bundled commissions. “The top 10 banks spend $400 million to $500 million on equity research each year,” Mr. Rudisuli said. “They only know the cost of research to them. They don't know the real cost to clients or the revenue banks get from research. Unbundling will mean they will need to determine whether they can provide research at a value to clients and to their business.”

Mr. Rudisuli said several recent surveys of money managers have shown that about half of them expect to pass on the cost of research to assets owners, while the remaining firms will take on the costs themselves. “That means banks and research providers will have to show the value of research,” he said. “Right now, there's a lot of me-too research. There are 50 to 60 analysts covering Apple. Do that many provide value?”

The other business models cited by McKinsey are: