China's financial research industry must adapt to disruption
By Navjot Singh
Financial research, which includes private equity and credit inventory research, is not something that is talked about much in the public sphere globally and not just in China, unless it is related to public equity research. Until recently, it has been a heavily structured sector which has only been known within the financial industry, specifically to hedge fund managers and investment managers and it has been proven to be valuable because it fills information gaps so that any individual investor does not need to analyse every stock. This actually makes the market more efficient. Little used to be known about the world of independent research firms in the financial industry. In contrast to what some people may think or have an impression of, the financial research business practice is not as boring or closed to the outside world; and thanks to strict legal checks, gone are the days when suspicions arose impropriety occurring in the industry. Nowadays, as the world is going through the fourth industrial revolution, the revolution of digital transformation, it is inevitable that these independent research firms need to change and adapt to the current times.
A Chinese investor checks stock prices on her smartphone in a brokerage house in Beijing, Thursday, Feb. 25, 2016.[Photo: AP/Mark Schiefelbein]
So what exactly do these independent research firms do? The role of research is to provide information to the market because the lack of information creates inefficiencies that result in stocks being misrepresented and can create many other ‘domino effect’ issues. However, one thing to bear in mind is that throughout history, the role of research hasn't changed, but it is the environment and trends that influence financial research which have changed, and that in itself is a clue as to how things may change in the future. So, what are the key changes in the financial research industry and is there any glimpse of what may lie ahead?
Firstly, it's worth pointing out how research in the financial industry is laid out. In today's market, the financial research industry is split into two areas: Wall Street research (i.e. major brokerage firms) and other research (i.e. independent research firms, such as Third Bridge (高临), a leading research partner for global businesses).
Independent research firms and boutique brokerage firms are at an advantage and are providing research on the stocks that have been often left ignored by Wall Street, which are built up of around 70% of research. Why? Because Wall Street usually, in more cases than not, is more concerned with research on companies that fall into the ‘Big Capitalisation’ bracket, i.e. those with a capitalisation value of over $10billion.
This, as well as reforms that placed restrictions on the equity research operations of Wall Street banks, has given way to the rise of independent research firms over the past twenty years and allowed these firms to become one of a number of credible sources of information on the majority of stocks.
INCREASED COMPLIANCE DEMANDS LEADING TO OPPORTUNITIES
There have been a few changes where the financial industry has had to move most of their research to third-party companies due to certain compliance issues. One of the big changes was in 2000, when the US Securities and Exchange Commission adopted Regulation Fair Disclosure. This meant that financial institutions could no longer disclose information to certain individuals, such as research analysts in investment banks, before it was made available to the general public.
And most recently, European regulators are introducing legislation known as MiFID II, which in January 2018 will reform and inevitably accelerate the evolution towards unbundling research from trading commissions and will be a major boost for independent financial research firms. No doubt that the heads of investment are eagerly reviewing the changes around MiFID II and are extremely busy negotiating with brokers who keep lowering their prices. With these new rules, investors should expect 2018 budgets to be very conservative.
Unencumbered by bank regulations and perceptions of conflicts of interest, firms such as Third Bridge (高临) will be the net beneficiaries of the European Union’s (EU) MiFID II’s new rules surrounding research unbundling. According to a recent article in the Financial Times, asset managers, banks and brokers are locked in fierce negotiations over the cost of investment research ahead of the introduction of the far-reaching MiFID II rules. It’s clear that to remain competitive, independent research firms are having to respond to changing customer behaviour. The desire to strengthen investor protection, as well as lessons learned from the financial crisis, have led to the updating of the regulations. The benefit of MiFID II is that it will introduce far more prescriptive requirements in many areas of product governance, covering the overall creation and distribution of financial products.
The rules will force asset managers to split out the cost of research, which is used by portfolio managers to help make investment decisions, from the cost of buying and selling securities.
New reforms to China’s financial system will closely mirror the MiFID II package, the chief executive of the China Europe International Exchange (Ceinex) claimed in September 2017.
“We’ve just declared intentions to outline China’s version of MiFID II,” Han Chen, chief executive of Ceinex, told Risk.net. “The government has prioritised attracting interest and liquidity from outside the country, so it’s going to be very similar to MiFID II.”
Industry experts predict that European asset managers are expected to cut their spending on research from investment banks and place more emphasis on gathering data through other viable sources, such as fee-based research services. In fact, fee-based research bridges the gap between investors who want credible research for cost-effective prices and companies for whom the big firms in Wall Street may not necessarily have the resources to provide such granular research.
It goes without saying that the pace of technological change has increased at a dizzying rate in every industry and even more so in the financial research industry. Looking back since the financial crisis in 2008, some of the key impacts on the financial research world in the last few years have been the continued move towards globalisation and the digital and mobile revolution. Countries such as India and China are gold mines for the independent financial research industry and those markets are, in my opinion, more open than in the West simply because of the nature of how business is done there. These events have transformed the financial research industry, and will continue to do so. It is now becoming obvious that the accelerating pace of technological change is the most creative force in the financial research industry today.
THE IMPACT OF THE DIGITAL REVOLUTION
With the recent advances in mobile, voice recognition technology, artificial intelligence (AI) and data storage, there has been an explosion of ‘Big Data’ capabilities and the challenges of how to handle it. This wealth of information has resulted in an increase in research techniques that may not have been easily feasible before. Given the financial regulatory and business challenges and the potential for increased usage of things like AI in research, it will pave the way for independent financial research companies to prosper because they will have the tools that the big investment banks may not have. Large global banks, such as HSBC and JPMorgan, are developing AI systems which can mine customer data for useful insights to improve their services and attract more customers.
Social media is having a tremendous impact on the way people communicate information about their brands, products and services. It only takes one tweet or an update on LinkedIn for someone to provide a slight clue as to what may happen in regards to a potential merger, for example. A company such as Third Bridge (高临) may have over ten years of rich data, but how does one manage it? It’s all worthwhile saying that we have AI, cognitive computing/machine learning all converging with Big Data, but to turn this into useful data going to be the key challenge.
The key opportunity for data from independent research firms and clients comes from informing clients so they can make better decisions from the research that provided by companies . We have been using the term 'Big Data' for several years now but the reality of the situation is that very often is that Big Data not necessarily ‘Smart Data’ but can be classed as useful data. This can be how data is presented in a much more impactful and visual for clients. Very often clients will have all this volume of data at their fingertips but they don’t know what to do with it. So, the easier the independent research firms can make the data to consume for their clients and visualise it so that they can see what is important, then clients would be able to make more informed investment decisions.
Other ways in which digital is disrupting the financial research industry are by the use of social media, which raise a raft of regulatory issues in the financial industry (e.g. most social media platforms are internally blocked within banks). Nevertheless, in order to generate feedback from users of a certain product or service, financial research analysts still heavily leverage the use of social media as a means to communicate effectively with audiences globally and to find people to interview.
For example, a few years ago, it would have required a paid service or other means to find someone to interview. However, with the emergence of professional platforms such as LinkedIn you can directly connect with the person, provided they give you permission to do so. In some other areas, because of cultural differences of how business is done, people only use social media for financial research. This is a fact in China, for example, where it is considered normal for professionals to engage in conversation and build rapport using the WeChat app. The app, owned by China's Tencent, is almost ubiquitous in the country - nearly a billion people use it every month for everyday tasks from ordering a taxi to paying for a coffee.
Whereas in Hong Kong (which essentially is like Chinese mainland these days), the UK or US you may have a hundred apps doing 100 different things, WeChat can do a hundred things all in one app. I would not be surprised if one day WeChat (or an app in the West) would also allow research analysts to connect with a client at a consulting firm immediately. For those in the West, adapting to that digital and social disruption and embracing technology such as WeChat is going to the key to success.
The key challenges for the financial research industry are going to be managing the pace of change. Nevertheless, the good thing is that they should be able to move beyond compliance work to becoming truly trusted business partners for their clients that can help them grow their businesses.
As a final thought, it is worth noting that all these changes in the financial research industry are not just towards more quantitative techniques but also for qualitative research, and that’s what matters the most. For any organisation to survive disruption, it must look outside its own walls at what’s happening, and the financial research industry is no different. But will it adapt to the disruption? We shall see.
(Navjot Singh is a British author and journalist）