Deutsche Bank is closing down its equities sales and trading business…but keeping on nearly all of its research analysts? Apparently the analysts’ research will be sold for cash for whatever institutional clients want to pay for it, but they will mainly be expected to support the equity capital markets franchise, with the resulting obvious conflicts of interest being managed by some means or other.
This decision raised quite a bit of comment when it was announced and to be honest, it does look quite odd. When equity research has been shedding jobs faster than any other area of the banking industry for the last few years, why would Deutsche be keeping on analysts while eliminating their main revenue line?
The answer is that the job losses should actually have given us a clue about how difficult equity research is to kill. Even after years of losses, there are still 4,000 equity analysts working in London alone. In the US, large-cap stocks like GE or Blackrock have as many as 18 or even 20 analysts covering them (and these lists only include the lead analysts; junior team members might expand it to two or three times that length).
Given the huge overcapacity in equity research, the amazing thing is not that jobs have been lost as a result of MiFID, but that the cuts have been so small. Firms will sometimes cut sectors, sometimes rationalise their smallcap (or largecap) teams, but they tend not to cut research back completely unless they are closing down the whole franchise. And, as Deutsche shows, sometimes not even then.
The trouble is that although it’s a highly marginal business when looked at in P&L terms, equity analysts tend to do a lot of work that they are not directly paid for. They help on deal research, for example. They often provide a vital “touch point” for management access to corporate clients when the investment banking department doesn’t have a direct CEO-level relationship. They contribute to “consensus estimates”, which nobody wants to pay for but which form the baseline that everyone uses to decide if a set of quarterly results was good or bad. And they can act as all-purpose sources of expertise and knowledge on their areas of specialist knowledge.
None of these functions are easy to monetise, but they are all the sort of thing that you would miss if it was gone, and where the banks would end up recreating something like the research department if it was let go in a cost cutting exercise. (This is actually the basis of some useful career advice for young equity analysts – the more people in different divisions who would miss you if you were gone, the safer your job is). And that accounts for the extraordinary longevity of an area of investment banking that always looks precarious, given its high cost base, uncertain link to revenues and doubtful rationale for even existing to people who believe in efficient markets.
I started work as an equity analyst in 1998 and retired in 2014. During my career, I noticed that the demise of equity research was always imminent. It was going to be destroyed by quant funds, buyside analysts, index funds, hedge funds, the post-dot com regulatory settlement, smart beta (ie, quant funds again) and MiFID II. I also notice that equity research is still here, although most of the people who predicted it was a dying industry are not.
Now, if I want to, I can read a new article every week telling me that equity research is going to be killed off by machine learning and alternative data. I somehow doubt it. Equity analysts are the cockroaches of the investment banking sector, they always survive. Ten thousand years from now, the strange life-forms that slither through the ruins of Wall Street and Canary Wharf will still be paying money for sell-side research, although they may not know why.
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