The world’s investing heavyweights are falling in line to make a decision that will cost them millions — and it is terrible news for stock analysts (BLK, TROW, UBS, CS)

• Top asset managers are electing to absorb millions in
  research costs in response to financial reform in
  Europe.
• Firms would face daunting compliance challenges and
  lose a competitive edge if they decide to pass the costs on to
  clients instead.
• That’s pushing research managers to slash their
  budgets for third-party research, with Credit Suisse predicting
  a 50% drop in research spend. 
• That
   
  spells bad
  news for stock analysts across Wall Street.

This could costs them
millions each year — but could pay off in the long
run.
flickr

The world’s largest asset managers are falling in line and
deciding to absorb millions in research costs ahead of the
implementation of European market reform that’s shaking up Wall
Street.

That could spell a gloomy future for Wall Street stock analysts,
many of which could find themselves without a job.

The financial reforms — known as MiFID II (Markets in Financial
Instruments Directive) — are set to go live at the start of 2018,
and a headline effect is a requirement that asset managers pay
for research separately from commissions for trading execution.
Free and bundled research will be prohibited.

This essentially leaves firms with two options: bear the brunt
and start paying for all the research themselves, or pass the
cost on to clients.

Easy decision, right? Pass the new cost of business along to
clients and pad the profit margin.

But most asset managers are planning to do the opposite. A
majority of the largest-20 asset managers are willingly absorbing
multi-million dollar costs and funding the research internally,
according to a research note from Credit Suisse.

Credit Suisse predicts that many publicly listed asset managers
in Europe will try and keep the spend at roughly 3% or less of
profit before taxes. The bad news for stock analysts: That would
mean a 50% “compression” in research budgets.

In other words, there’s going to be a lot less money to go around
for research analysts.

Here’s Credit Suisse: 

Base case estimates by management consultants for research budget
shrinkage were in the range of 20-30%. However, these scenarios
did not envisage a switch to wholesale cost absorption onto asset
manager P&Ls. We think the new base case will move closer to
a 50% contraction (albeit with an even greater reduction in the
number of research providers), with scope for a greater decline
if unbundling goes global.

They’re not the only bank employees with a grim outlook.

Trading revenues have declined steadily — and
European financial reform won’t help that cause at
all.
UBS

Wall Street’s marquee trading teams — already experiencing

headwinds and steady decline — will suffer a 1.5% hit to
revenue growth in 2018 and beyond thanks to research unbundling
and increased transparency requirements under MiFID II, according
to a note last week from UBS.

Credit Suisse says 7% of total equity trading revenues are at
risk from the contraction in research budgets.

Why not pass along to clients?

Taking on the cost rather than having clients cover it may seem
counterintuitive, but the calculus makes sense when you dig into
the implications of both options. For starters, choosing to pass
the cost along to clients comes with an extensive and complicated
array of restrictions and requirements, according to Credit
Suisse.

“Given the degree of complexity of these rules and risk of
compliance failures, it is, perhaps, understandable why many
asset managers have chosen to absorb the costs of third party
research onto their own P&Ls from 2018,” the firm wrote in
the note.

“The perceived risk of falling foul of the complex rules when
using client funds is high and there are incremental ongoing
operating expenses associated with compliance,” the note
continued.

It could also put asset managers at a competitive disadvantage
compared with more client friendly firms paying for the research
themselves. Credit Suisse notes that many firms announced their
intention to pay for research shortly after two industry giants,
BlackRock and JPMorgan Asset Management, set the tone and
declared their intention to absorb the costs.

That indicates money managers believe losing business to such
competitors is a plausible result that could outweigh the
research costs.

Moreover, paying for the research could engender goodwill from
both clients and regulators.

Eventually, every asset manager will hew the line
set by BlackRock and
JPMorgan Asset Management, Credit Suisse predicts.

“We think it will become standard industry practice for asset
managers to absorb research costs onto their P&Ls. Outliers
will only be able to avoid this over the short-to-medium term as
competitive pressures build,” the note reads.

Here’s a chart that Credit Suisse compiled, using information
from the Financial Times, showing which option a variety global
asset managers have chosen, so far:

Credit Suisse