Many commentators realise that the traditional institutional broking model is no longer sustainable. However, the reduction in the quantity of non-corporate coverage that has already occurred, even before MiFID2 comes into effect, will still come as a shock. The evidence shows that there is no commercial sense in brokers covering non-corporate companies with less than £200,000 daily turnover in their shares.
Let me own up. In the not too distant past I was Head of Research at one of the more successful mid and small cap brokers. I have also been an analyst at ‘bulge bracket’ investments banks and even a fund manager. Thus I have seen the way in which the role of the research analyst has evolved over many years, as well as personally experiencing the challenges of running a research department.
In the golden era of equity analysts, the 1990s, managing a team of analysts was famously likened to herding cats. The ideal analyst was smart, individual, possibly quirky and not too keen on being told what to do. Starry analysts were a must have for any investment bank and, though expensive, were affordable. Since then the additional burden of heavier regulation and the unceasing shrinkage of equity commission rates means employing a galaxy of top rated analysts is only affordable by the richest banks.
For the smaller houses, typically focusing on small and mid-sized companies, the shrinking commission pool means having another look at the business model.
In the past commissions (and trading profits) would have paid the overhead costs including salaries and the fatter but lumpier sums that came from primary business (IPOs and other equity issues) would have filled the bonus expectations. Now corporate revenue is needed just to break even.
In 2007, Panmure Gordon, one of the City’s most venerable institutions was able to say this:
“The UK business model is that, in all bar the most extreme market conditions, all pre-bonus costs are covered by institutional equities and retainer income. We are therefore not dependent on corporate finance transaction income to meet costs.”
Source: Panmure Gordon Annual report 2007