In 2019, the Markets in Financial Instruments Directive (MiFID II) came into force and had a significant impact on equity research: independent asset managers are no longer allowed to accept grants from banks. Another unfortunate side effect is that investment research is now also considered a grant. Asset managers have three options for dealing with this: they can dispense with research altogether, they can pass the research costs on to clients or they pay for research themselves. What is fatal is that none of these solutions provides better service or a more favourable cost structure for investors.

But it is not only the buyers of research who have a problem. MiFID II requires fund companies and investment banks to separate trading fees and research costs. Equity research used to be subsidised by trading commissions, whereas now each service has to be priced and marketed individually. As a result, research teams have shrunk significantly, but remain under pressure. The dilemma: on the one hand, prices for analyses must be competitive. On the other hand, this is problematic for a clientele that up until now was used to free research. In the EMENA region, for example, the number of employees in equity research at twelve major investment banks has fallen by 14% since 2013 (down to 1,200 in the first half of 2018 according to Coalition Development). Thanks to MiFID II the trend is set to continue. Not only did the number of analyses fall overall, the coverage of small caps has declined disproportionately.

In search of new sources of income some providers are now becoming creative. For example, some research houses offer so-called “sponsored research”. Should companies commission such research?

This kind of research coverage is expensive. Companies need to allow for a five- to six-figure sum in their IR budgets every year. At the same time, readers are aware of the “relationship” between the companies and the researchers. Consequently, investors are critical of the analysts’ independence. However, one also needs to consider that research houses and analysts rely on their credibility in the market and therefore strive for independence. So what’s the takeaway? Investors and companies are ultimately in the same boat and high-quality paid research is still better than no research at all.