Regulators Driving Real Disruption (the bad kind)
MIFID II regulations take effect in January 2018. While the news is accurately reporting the broad impact of the regulations, we are focused on the impact to the research sector and the financial analyst community. Technology is already driving changes in the way research is executed, compiled and published. But given the benefits, this broad disruption is moving much slower than it should. MIFID II is going to accelerate the disruption. I believe the regulatory assumption that the market will pay for quality research is false and the markets will suffer.
In another post I’ll summarize the new regulations for research and how we believe our tools will be a part of the solution. For now, I just need to yell at you to pay attention to this and the ramifications, which will be pervasive.
In short, a research industry shakeout is coming (shrinking by a third), value will come to the fore, direct corporate access will rise, paid-for research and promotion will increase and the impact will be global (Bloomberg).
Here’s some research links to get you started:
- Investor Relations, MiFID II and the looming research shakeout, Bloomberg
- Research In An Unbundled World The Outlook For Sell-Side Research Providers Post-MIFID II, Quinlan & Associates August 2016
- Equity Research Faces “Major Disruption” As Study Finds “Less Than 1%” Of Reports Are Actually Read, Tyler Durden
- Online competitors take on global banks in securities research shake-up, Reuters
- Global Firms “Importing” MiFID Rules to U.S., Half of European Asset Managers Expect “Hard Dollars” to Become Primary Payment for Sell-Side Research, Greenwich Associates
We’ve watched the internet destroy news organizations and journalism to the point where there are few quality sources left. Ask the WSJ, NYT and others how well it worked when they first put in a paywall. It didn’t work until almost all competition was eliminated. The result has been a proliferation of bloggers, spammers and news sites manufacturing stories to generate clicks and advertising revenue. After MIFID II this is how most markets will get the news.
Will good performance drive prices or will ad campaigns and Facebook algorithms feeding on page likes? Free is addictive and a gap will form between crap and quality, real news and fake news. Even good research shops will become obsessed with SEO analysis of their reports and click/share grabbing pics and headlines (Tip: if you buy into this theory, go long on Google and Facebook, wait, you probably did already). Investor relations in smaller firms will need to become more creative or become invisible competing against large caps with big brand names and lots of followers.
Qualitative work is still predominately done by analysts who read reports and listen to earnings calls. 150 page 10-K and a one-hour conference call or 5-page analyst report? Portfolio Managers can’t read everything themselves so they rely on analysts to do the deep dive and report their findings. Our AI powered tools can help them “read” and analyze the same content at machine speed and scale without human bias, augmenting not replacing them.
Where does MIFID II fit in? It accelerates the disruption coming by upending the business model of research: ending the subsidies of both good and bad research collected from trading. The regulatory rationale is sound: take out the subsidy and its conflicts, lower the trading expense of the investor and make research stand on its own. If it has value people can pay directly for it. This will eliminate reports and analysts that aren’t adding value, while the assumption is that fund managers can/will pay for good research with all the money they’ll save, right?
No, the part I think that’s missing is that the quality rises to the top in the current system. While there may be a lot of useless reports whose distribution is simply the equivalent of email spam or those local ad flyers you get in your mailbox, those trading fees pay for some very good analysts. These analysts work at both large and boutique firms and can provide solid independent analysis that benefits the market. This reporting also benefits the companies, knowing that superior performance will be found and exposed.
That said, nothing is going to stop this now and we better get prepared for the new world of research and unfortunately a proliferation of fake news. If you’ve got a good analyst, hold on tight and get them some of our