- The relationship was not clearly defined.
- The amount paid for research depended entirely on the size of the trades, not an independent assessment of the value of the research.
- Fund managers are human and will have biases towards using certain favoured brokers, regardless of the quality of the bank’s research.
In other words, banks that produced research of relatively poor quality could still get paid similar amounts for that research, if the fund manager had a bias to their bank’s trading desk. In addition, trading desks without strong client relationships could still receive orders if the fund manager had received some of the bank’s research and loosely fulfilled their obligation to direct some trading activity to them.
Now that there is a clear distinction between trading commissions and research fees, an obvious path ahead emerges.
Stage one: research costs
This could be a race to the bottom to maintain clients.
Big banks will be very keen to retain and maximise key client relationships to ensure they still receive high levels of trading activity.
Although research will no longer be compensated for via trading, if a client regularly uses a bank’s research and speaks with its analysts and sales team, they will be more likely to maintain their level of trading activity.
Smaller banks or independent research providers, who might start to get cut off under the new system, might now look to compete by undercutting the research prices of the big banks. This would put pressure on the big banks to cut research fees, because they want to maintain relationships and subsequent levels of trading commissions.
Once one of the big banks does start to cut fees, it will be hard for the others not to follow. For example, Credit Suisse has recently announced that it will provide some of its fixed income research for free. This has been met by condemnation by the biggest US banks, because they realise how this could turn into a race to the bottom.
In other words, research might become a loss leader for the big banks for them to retain client relationships and trading volumes. The banks might then respond to falling fees by cutting costs in their research departments, reducing the number of analysts and, potentially, compensation. This could turn quality sell-side analysts away from the industry.
The result of this would be lower quality and depth of research provided on the sell-side and less efficiency in the market. Asset managers might respond to this by moving the research function entirely in house.
However asset managers choose to respond, this brings us to the other big loser – the fund manager who depends too heavily on sell-side research.
