A Possible Differentiator for Sell-Side Analysts’ Survival in the New
MiFid II Era?
The new European Commission MiFid II regulation is now in effect, as of January 3. Impacts on sell-side research firms’ business models, capital markets and public companies in Europe will be immediate. Repercussions will eventually affect similar institutions in the U.S., due to global competition in the capital markets. Anticipating when, how or how severe is the subject of professional debate.
MiFid II is meant to provide comprehensive reform and an integrated EU financial market. In the space of this blog, I will narrowly reflect on its mandatory unbundling of pricing and services aspects. The impacts of these will cause current Aftermarket research business and financial models to be under attack, in terms of the reason(s) for and actual purpose of sell-side analysts’ existence.
Sell-side analysts should take a good look at the rapidly growing mainstream investor interest in ESG / Sustainability, as it could provide a critical life-line to bring their syndicated research to a new level of purposeful differentiation and survival.
Are sell-side analysts letting themselves be beaten by buy-side analysts in exploring ESG / Sustainability in investment analysis and coverage theses? How much of what sell-side analysts have traditionally produced is replaceable by quantitative algorithms? Could the threat of MiFid II to Aftermarket research firm’s revenues be enough to more broadly convince the sell-side community that the time has come to re-balance research report templates and commentary to include extra-financial and non-financial ESG / Sustainability performance monitoring?
As I have pointed out in previous blogs:
- The CFA certification exams have already anticipated the need for analysts to understand ESG / Sustainability in investment analysis, as the subject knowledge is now required in all three certification exam levels.
- SRI-Connect, the global marketplace for SRI and corporate governance research where institutional investors and quoted companies involved in sustainable development meet online, indicates at least 10X the number of buy-side analysts versus sell-side analysts among its membership.
- Investors are increasingly interested in expanded communications to include sustainability goals and performance discussions, a.k.a. extra financial, non-financial, intangibles or other. Public companies can do more to bridge germane sustainability program successes into IR communications strategies.
Following this logic, Aftermarket research analysts (both sell-side equity and fixed income) could be uniquely positioned to become key facilitators for improved ESG / Sustainability performance analysis and communications. They already traditionally serve as a bridge between company (IR) and investors.
U.S. sell-side analysts may have got a bit of a reprieve through the S.E.C., but will it last?
- The U.S. Securities and Exchange Commission did issue regulatory relief as of October 26, 2017, that is meant to provide a 30-month delay in the implementation of the European Union’s MiFid II’s research rules by U.S.-based, sell-side firms.  
• But will U.S.-based firms be able to wait that long in practice to remain competitive with their European rivals? What will happen in the intervening months and when 30-months is up?
• Will this SEC reprieve be able to mitigate the likelihood that sell-side firms would abruptly cut back their analyst coverage of small and mid-cap issuers?
What sort of stress is the buy-side also experiencing in the concurrent shift from active to passive investing that could make them even more fierce competition to sell-side analysts?
- “If fundamental asset managers don’t hurry and reduce their bloating research supply chain now, then passive investors will take the business.” – Mike Tyrell, founder of SRI-Connect
- There is open debate as to how much sell-side research revenue could be impacted by MiFid II and whether investment firms, already dealing with these active / passive pressures, will or can pay separately for external sell-side research and will / can they pass the cost on to their customers.  
Isn’t it also about time for the aftermarket research professionals to re-visit where human analytical capital provides the critical differentiating perspective to beat the markets that computers can’t?
- As pointed out in a recent FTfm ESG investing post, quantitative algorithms may not be so good at evaluating corporate culture, management strength and myriad [ESG] factors that matter – not everything that counts can be counted by algorithms.
Could MiFid II actually turn out to be a godsend to force a critical re-think of sell-side research models?
Have some analysts already begun to shift toward ESG / Sustainability analysis in their research reports?
I used AlphaSense to run a simple “ESG” word search in its aftermarket research subscription feature, to see what I might find across all industries, filtered for just the last 12 months and just in the U.S.
Source: AlphaSense query * Search resulted in 103 companies, but ~80 net of false positives; multiple results per company
Source: AlphaSense query
- Search results included 902 occurrences in all, across 103 companies, 11 sectors, 54 industries and 81 sub-industries, as automatically counted by AlphaSense.
- • Adjusting-out any false positives, these results suggest that aftermarket analysts have commented about ESG on just +/- 80 companies.
If you’ve read any of my previous blog posts on AlphaSense, you appreciate how 80 companies is a small fraction of the number of companies that actively communicate about their sustainability programs and performance progress.
It is also interesting to note how limitless the possible market demand for aftermarket research coverage of ESG / Sustainability performance analysis and communications could be, as more of the nearly 8,700 publicly listed companies on U.S. stock exchanges intentionally develop sustainability programs and communications.
- The ESG references and commentary found in this search were by equity analysts at: HSBC [$HSBC], Deutsche Bank [$DB], William Blair, Credit Suisse [$CS], Cowen and Company [$COWN], Gabelli [$GBL], JP Morgan [$JPM], BMO Capital Markets [$BMO-TN]; and by fixed income analysts at: National Bank Financial [$NBF], Société General [$SGEN], Natixis [$NTIX] and Macquarie [$MACQ]
• One firm’s telecommunications and media sector equity analyst incudes ESG metrics alongside traditional financial metrics in his research report template, as found in 6 sector peer company reports.
• A few excerpted, unattributed comments to give you a sense of the sort of approaches analysts are taking in their ESG commentary:…over the 10 years, ESG investing has risen in prominence……Sustainability, a focal point for [company x], is likely a key factor for some investors Environmental, Social and Governance investing styles…having increased in popularity in recent years……the absolute size of the ESG market is difficult to quantify, but could provide [company x] an offset to the expected pressure from……Management noted opportunities in the solar sector and related to Environmental, Social and Governance (ESG) themes……ESG is a performance factor…The results show that this ESG factor can add financial value in portfolios……Sustainable investments with the underlying ESG (Environmental, Social and Governance) are gaining traction among regulators, asset managers and shareholders…
A few aftermarket research analysts appear to have “gotten the memo,” but is this enough to save their field from grim, MiFid II-related contraction? This is unlikely, unless more sell-side and fixed income aftermarket research analysts quickly step-up in knowledge and coverage of ESG / Sustainability across their respective coverage universe(s).
Please seize the moment to branch into ESG/Sustainability performance coverage
– The opportunity is real and the demand is obvious!
1. AlphaSense: Might Growth in Passive Sustainability Investment Strategies Be Complementary
2. European Commission: MiFid II
3. AlphaSense: Sustainability in the Mainstream
4. SGAAnalytics: Interview with Mike Tyrell
5. NIRI: SEC Grants Relief on MiFid II
6. Bloomberg: U.S. Shields Wall Street From MiFid II Threat to Research Model
7. Reuters: U.S. securities regulator grants Wall Street EU research rules reprieve
8. IR Magazine: SEC ruling on MiFid II means business as usual
9. IR Magazine: Cut in equity research will be less dramatic under MiFid II, research finds
10. IR Magazine: Fidelity International to pass on research costs to investors
11. IR Magazine: Firms to absorb the cost of investment research under MiFid II
12. FTfm: ESG Investing
13. Google: quick search
Pamela Styles is principal of Next Level Investor Relations LLC, an Investor Relations consultancy with dual IR and ESG / Sustainability specialties.