In 2018, it suddenly became more expensive to outsource European equity research to banks. Asset managers have responded by bringing more research in-house, according to a recent academic study by researchers in Canada and London.
The study — “The Effects of MiFID II on Sell-Side Analysts, Buy-Side Analysts, and Firms” — provides “early but comprehensive evidence” on the impact of the revised Markets in Financial Instruments Directive, according to authors Bingxu Fang, Ole-Kristian Hope, Zhongwei Huang, and Rucsandra Moldovan.
The European regulation, which came into effect almost 19 months ago, mandated that asset managers and brokers separate the cost of investment research and advisory services from other products and services, like trading execution. In an interview with Institutional Investor, Moldovan explained that this required a “drastic” change from the sell-side’s existing business model.
“This regulation has been making a lot of waves in Europe because it’s been a long time in the making — literally years,” she said by phone. “Everyone was waiting to see what was going to happen, what the impact was going to be.”
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For their study, Moldovan and her co-authors examined how the regulation has impacted sell-side and buy-side research, as well as how it has affected the public companies which lost analyst coverage in the wake of MiFID II.
They found that sell-side analyst coverage of European companies dropped “significantly,” with 334 firms losing sell-side research coverage completely following the implementation of the regulation. The analysts who stopped covering stocks tended to be less experienced and have worse track records compared with those who continued to cover companies post-MiFID II — with the result that the remaining analysts’ ratings of European firms were “incrementally more informative after the implementation of MiFID II,” according to the paper.
The authors were unable to determine where analysts “disappear[ed]” to when they stopped covering stocks, due to a lack of available data. But in their interview with II, Moldovan and Fang suggested that it was probable that analysts were laid off or that they left for other roles — including, potentially, roles as buy-side analysts.
This later possibility is somewhat supported by the study: The four authors found “strong evidence that the number of buy-side analysts increases following MiFID II, suggesting that European investment firms turn to more in-house research after the implementation of the new regulation.”
On top of this increase in headcount, Fang, Hope, Huang, and Moldovan documented an increase in participation on corporate earnings calls by buy-side analysts, amounting to roughly one more question asked by a buy-side analyst per call when compared to the earnings calls of similar firms in North America.
“We can directly observe that [asset managers] are doing their own research instead of relying on sell-side research,” Fang told II by phone. “They are devoting more resources internally.”