Deutsche Bank Is Quitting Stock Trading. What It Means for Equity Research
Barron's
Jul 15, 2019
Deutsche Bank (ticker: DB) created a stir Sunday when it said it was cutting 18,000 employees, about 20% of its workforce, to save roughly $7 billion dollars in annual expenses. Those numbers are large enough on their own to create waves on Wall Street, but they’re not the only thing creating a buzz. In fact, while changes at the German bank were widely expected, one aspect of those changes was not—Deutsche Bank’s decision to exit the equities trading business but to keep its research division.
Historically, equity sales, research, and trading staff functioned as one division, separate from investment banking, commodities, or fixed income sales and trading. That’s because trading commissions were how Wall Street brokerages got paid for their stock research—portfolio managers bought and sold stock through the trading desk and got the research for “free.”
But a new rule recently implemented in Europe has changed all that. That rule, known as Mifid II, requires fund managers to pay for stock research separately from trading commissions. Mifid II—it stands for “markets in financial instruments directive, part II”—made it possible for Deutsche Bank to get rid of its struggling equity-trading business, but still maintain its research group. Deutsche appears to have seen opportunity in research, but the Mifid II rule has been pushing others out of the business altogether and ultimately could make research more difficult to access.
It is difficult to overstate the impact Mifid II has had on the equity research business. Since Europe implemented the new rule in 2018, research budgets have been cut to 19% from 14% compared with 2017 levels, according to Richard Johnson, principal in the market structure and technology group at industry data provider Greenwich Associates. What’s more, the average asset manager was paying more than 18 different research providers at the beginning of 2018. That dropped to less than 16 by the end of 2018, and it is likely going to get worse. As a result, Johnson says, half of asset managers want to reduce their spending on research, while 43% want bring it in house.
And they’re putting their words into action. “The result [of MIFID II] is a giant sucking sound from research budgets,” says David Jackson, founder of Seeking Alpha, a crowdsourced research platform Jackson started after leaving Morgan Stanley where he covered technology hardware as a research analyst.
Fewer dollars means fewer stocks being covered. “We’ve been gathering research coverage data on small- and medium-size companies,” explains Arun Daniel, portfolio manager at J O Hambro in Boston. “Coverage has been bleeding down [small- and medium-size company research] by about 10% a year for the last few years.”
Banks aren’t taking that standing still. Some firms will merge to try to grab larger shares of both the trading and research markets—like Piper Jaffray(PJC), which bought trading execution firm Weeden earlier this year. Others, like Deutsche Bank, will exit trading altogether. And some will just fade away.
Firms will either have to be large to take advantage of scale, or small and nimble. The middle, quite frankly, will have a hard go of it. “I see a barbell system developing where you have the very large brokerages and a thriving boutique research space,” says Gordon Haskett analyst John Inch, who left Deutsche Bank to join Gordon Haskett in 2018.
And if anyone is winning, it might be the boutique firms—a small firm that doesn’t have the same trading infrastructure or the breadth of coverage as a so-called bulge-bracket brokerage like Goldman Sachs (GS). Before Mifid II, that made getting paid with commissions hard for a boutique, but after Mifid II, with low firm overhead, boutique firms will have an easier time selling product to institutional investors. That’s great for firms like Yardeni Research, a shop founded by Ed Yardeni. “[Mifid] has reduced commission dollars and created a more competitive market, which is benefiting those boutique research firms that provide unique insights and services,” Yardeni told Barron’s.
Deutsche Bank told Barron’s it is committed to keeping research but did not elaborate. The bank, we assume, must see value in keeping portions of its equity-research business intact. Analysts, after all, provide insights that support the investment banking business, even if paying analysts from investment banking fees has been prohibited since the dot.com bubble burst. Bankers also rely on research insights to generate ideas, just like money managers do, and companies want stock coverage after selling stock issues to public investors.
There may be life in research yet.