By Gianluca Corradi, Head of UK Banking Practice at Simon-Kucher & Partners
Do this as a second title: MiFID II implications on Investment Research. Avoiding price wars and focussing on value is key for the success of the industry in a post-MiFID II world.
Make this paragraph stand out separate from the article some how at the beginning as it summarzies the article:
The Research industry is at a pivotal moment due to the imminent implementation of the MIFID II regulation. There is a widespread view that this will disrupt the industry, bringing down profitability. However, Simon-Kucher& Partners believes that there will always be a need for high quality research and that the players who adopt a smart differentiation strategy will stand out from their competition, increase market share and generate better profits.
This begins the full article:
January 3rd 2018 is a seismic day for the Investment Research industry which will experience a radical change in the very fundamentals of its business model.
From this date the new MiFID II regulations require buy-side clients(i.e. Asset Managers and Hedge Funds) to pay an unbundled commission for purchasing Research products and services, clearly separated from execution fees. The current logic ‘I will give you the research for free, if you trade with me’ won’t be applicable anymore and will instead be considered as a prohibited ‘inducement to trade’.
Until now, research has effectively never been priced and sold as standalone product. Separating research from trading is likely to push the industry into a period of discovery and intense negotiations among players in the market since there is no reference point to begin the contractual discussions. Consequently, banks are facing a situation often seen far more frequently outside financial services – the launch of a new product in the market.
There is an increasing concern that the result of this fundamental shift in perspective will ultimately trim banks’ profits and cause significant consolidation in the industry, reducing the number of research providers.
After the discovery phase, as the research products become more and more ‘mature’, the expected status quo situation will likely see the emergence of a handful of global research providers on the one hand and on the othera number of specialised players that defend a market niche. Those stuck in the middle will ultimately need to decide whether to step up their investments to join the first group or to devote all their resources to create their own niche. In any case, there seems to be no room for everyone and, for those who make it, profits won’t probably return to pre-MiFID II levels.
Although the overall picture looks gloomy, we at Simon-Kucher & Partners think that not all hope is lost! Far from it. Even accounting for the extreme industry consolidation scenario happening, which it may not, we are convinced that this will in the end increase the willingness of buy-side institutions to pay for high-quality services.
And if the buyers are willing to pay more for quality, banks need to position themselves so they can price accordingly… which can be easier said than done without a clear strategy and strong buyer insights.
Of course, from the perspective of the bankers on the sell-side, their clients have a high bargaining power and will use it to extract favourable conditions. However, even buy-side firms have a lot to lose if they are not careful and push too hard for price reductions that hit the quality of the research.
Ultimately, Investment Banking is a relationship-based industry and it will always remain so. Relationships between banks and asset managers are so intertwined that the negotiations around research costs will always take into consideration the big picture. Buy-side firms, for example, have to evaluate the trade-off between paying a higher price on research or burning bridges completely,risking the loss off a preferential channel for capital raises or bond emissions.
However, in the new world quality will take on more importance than it did previously. When everything was free of charge, quality didn’t really represent a factor in decision-making. Next year, when funds’ or consumers’ money will be spent for purchasing research, the classic demand and supply dynamic will become prominent. If the content generated by a sell-side provider is considered of better quality, demand for it will increase, and considering a limited supply, price will necessarily rise and so will profitability.
Investment banks must not make the mistake of considering their research products as ‘commodities’. This is the key for transforming the challenge ahead into an opportunity. Research should not be perceived solely as a report, an analyst call or a visit to a CEO, but rather as the process for generating investment ideas, and ideas have tremendous value.
Unfortunately, history doesn’t seem to have been favourable to players that have gone through a situation similar to that which banks now face. In similar instances the existing players’ fear of losing market share has led many industries into damaging price wars. It will be bad news for banks if they too launch into the mutually assured profit destruction of tit-for-tat prices cuts that will ultimately see valuable research sold at Poundland prices.
Simon-Kucher& Partners’ 2016 global pricing survey of more than 300 bankers across 25 countries found that the majority of the respondents acknowledge that their industry is undergoing a price war. What’s even more interesting is that 89% of respondents blamed their competitors for triggering it. The thinking is ‘they started it, we can only follow suit by decreasing our prices’. This is exactly how the commoditisation process begins and when prices go down it is extremely difficult, if not impossible, to bring them back up.
Global leaders in the sell-side space should ponder whether crushing competitors with extremely low prices is the right strategy or is it better to resist the temptation and keep prices economically sustainable. Competition dynamics are multi-faceted – a bank might be ranked top-3 in a particular asset class, but fall below the top-10 in another one. An aggressive strategy in one asset class is necessarily going to trigger a retaliation somewhere else, thereby contributing to lower profit levels for every provider.
In our opinion, banks need to face the regulatory challenge by simultaneously assessing their relative strengths vis-a-vis their competitors, and quantify the value they deliver to buy-side clients. Focussing on the value delivered from their research, and measuring the relative power to charge a fair price for it is key in ensuring a profitable future for the industry.
In this transition year, it will be of outmost importance for investment bankers to focus on their negotiation capabilities to strike satisfactory deals during talks with asset managers and hedge funds. Having a clear view of the overall profitability of the relationship with the buy-side will also be important in avoiding disruptions in other businesses that banks have with the same clients.
An outlook on equities and bonds
By Rupert Thompson, Chief Investment Officer at Kingswood
The equity market rally paused last week with global equities little changed in local currency terms. Even so, this still leaves markets up a hefty 10% so far this month with UK equities gaining as much as 14%.
The November rally started with the US election results but gathered momentum with the recent very encouraging vaccine news. This continued today with the AstraZeneca/Oxford vaccine proving to be up to 90% effective in preventing Covid infections. This is slightly below the 95% efficacy of the Pfizer and Moderna vaccines already reported but this one has the advantage of not needing to be stored at ultra-cold temperatures. One or more of these vaccines now looks very likely to start being rolled out within a few weeks.
Of course, these vaccines will do little to halt the current surge in infections. Cases may now be starting to moderate in the UK and some countries in Europe but the trend remains sharply upwards in the US. The damage lockdowns are doing to the recovery was highlighted today with the news that business confidence in the UK and Europe fell back into recessionary territory in November.
Markets, however, are likely to continue to look through this weakness to the prospect of a strong global recovery next year. While equities may have little additional upside near term, they should see further significant gains next year. Their current high valuations should be supported by the very low level of interest rates, leaving a rebound in earnings to drive markets higher.
Prospective returns over the coming year look markedly higher for equities than for bonds, where return prospects are very limited. As for the downside risks for equities, they appear much reduced with the recent vaccine news and central banks making it clear they are still intent on doing all they can to support growth.
Both factors mean we have taken the decision to increase our equity exposure. While our portfolios already have significant allocations to equities and have benefited from the rally in recent months, we are now moving our allocations into line with the levels we would expect to hold over the long term.
Our new equity allocations will be focused on the ‘value’ areas of the market. The last few weeks have seen a significant rotation out of expensive high ‘growth’ sectors such as technology into cheaper and more cyclical areas such as financials, materials and industrials. Similarly, countries and regions, such as the UK which look particularly cheap, have fared well just recently.
We think this rotation has further to run and will be adding to our UK exposure. This does not mean we have suddenly become converts to Boris’s rose-tinted post-Brexit view of the UK’s economic prospects. Instead, this more favourable backdrop for cheap markets is likely to favour the UK.
We will also be adding to US equities. Again, this does not represent a change in our longstanding caution on the US market overall due to its high valuation. Rather, we will be investing in the cheaper areas of the US which have significant catch-up potential.
We are also making a change to our Asia ex Japan equity holdings. We will be focusing some of this exposure on China which we believe deserves a specific allocation due to the strong performance of late of that economy and the sheer size of the Chinese equity market.
On the fixed income side, we will be reducing our allocation to short maturity high quality UK corporate bonds, where return prospects look particularly limited. We are also taking the opportunity to add an allocation to inflation-linked bonds in our lower risk, fixed income heavy, portfolios. These have little protection against a rise in inflation unlike our higher risk portfolios, which are protected through their equity holdings.
Optimising tax reclaim through tech: What wealth managers need to know in trying times
By Christophe Lapaire, Head Advanced Tax Services, Swiss Stock Exchange
This has been a year of trials: first, a global pandemic and, now, many countries facing the very real possibility of a recession. For investors, private banks, and wealth managers, these tumultuous times have manifested largely in asset price volatility, ultra-low interest rates and uncertainty about when things may level out, as well as questions about what can be done to safeguard portfolio performance.
The answer here lies within identifying and creating efficiencies to maximise performance and minimise cost, and while there is a slew of options as to how to do this, they are often siloed or have a single USP. Tax optimisation, on the other hand, provides benefits to all, not just in increasing returns for investors, but also in creating economies of scale across stakeholders, creating millions – if not billions – in savings for banks.
Evolving tax reclaim
The tax reclaim process used to be a tedious one banks had to manage themselves, and required detailed, industry and country-specific knowledge to stay on top of constantly shifting requirements and regulations. And when we consider that many countries – such as the UK – allow for capital gains exemptions, tax optimisation may not seem like an integral part of the process. However, this isn’t the case for all countries, and can lead to severe after-tax implications on global portfolios.
Furthermore, even if you’re able to avoid double taxation, getting the money back is not always as simple as it sounds. This, combined with the fact that countries often have contradictory taxation rules or requirements, makes navigating the tax reclaim space a challenge even for those with the right expertise and experience.
Ultimately, providing tax optimisation to investors ends up being a heavy lift for private banks and wealth managers, who often don’t have the right solutions, are relying on outdated technology and manual processes. While this is generally fine for business, it is no longer fit for the purpose when it comes to tax optimisation. To date, knowledge and expertise have been the key to protecting and maintaining profitable investments and avoiding tax leakage. However, through tax optimisation services starting to emerge, portfolio managers can now manage and reinvest easily.
Today, technology has evolved the process so that banks are able to access and submit tax reclaim – and the relevant documentation – online, leaving the tech provider to coordinate next steps with custodians and tax authorities behind the scenes. In essence, taking the legwork out of the process while assuring consistency and completeness in execution.
Simplifying tax through tech
While tax optimisation may seem like an easy choice in theory, it is not always the go-to for every private bank or wealth manager. Without the right supports and setup, including innovative technologies and automation, tax reporting must be done manually, leading to labour intensive processes and huge time wastage. Changing these processes can be overwhelming for those used to a certain way of operating.
By making tax reclaim digital, banks will be more able to optimise returns and gain efficiencies while reducing redundancies and unnecessary complexities. Cloud based solutions or platforms can offer a safe and secure solution for banks, wealth managers, and investors to access and submit any information required, processing the data automatically for conformity and completeness.
It is critical that providers who intend to offer tax services are able to do so efficiently with the right software and data processing capabilities. Not only does this drive continuity in service and efficiencies in process, but it is the only sustainable way to handle such a complex landscape sustainably without wasting time or money.
End-to-end, technologically driven tax services offer a huge number of advantages to private banks and wealth managers, the most important of which is the ability to provide continuity through tumultuous times. As we move through the end of 2020 into 2021 this will only be increasingly important as banks, managers and investors look to provide new services to clients and strengthen existing relationships in a difficult market.
As investors seek to find returns amid the global economic downturn, the demand for innovative solutions will only increase. Technology like cloud-based software, AI, and data optimisation can all serve to improve not just the tax reclaim processes, but the overall client experience within capital markets. Private banks and wealth managers are suitably equipped to provide these innovative solutions, but those who do not prepare themselves effectively and keep ahead of trends will run the risk of losing current and new clients to someone who can offer more for less.
Equity Sharing – How do you choose the right plan for you?
By Ifty Nasir, co-founder and CEO of Vestd, the share scheme platform
In a survey of 500 SMEs, nearly half told us that the pandemic had made them re-evaluate how they operate. That’s not surprising as they’ve been faced with some unique challenges this year. Government support during the early stages of the pandemic, is now being extended till March 2021 but many businesses continue to struggle.
Making good people redundant improves cashflow in the short term but will have a long-term damaging impact on the business. At the same time, motivating employees, who are working remotely and worried for their jobs, is not easy. It’s therefore not surprising that equity sharing, in the form of ‘share’ and ‘option’ schemes has become even more popular, with one in four SMEs now sharing equity with their employees and wider team
However, sharing equity can be a complex area and is easy to get it wrong. When it goes wrong there is a danger that you create tax issues (for you and your employees), de-motivate your team and even create future funding issues for the company. It is therefore really important that you choose the right scheme to set-up, but make sure you manage it too.
Below is a brief summary of the main schemes used by Start-ups and SMEs in the UK today. There are similar schemes and considerations globally.
- EMI Option Schemes – This is the most tax efficient scheme. Recipients pay just 10% Capital Gains Tax (CGT) on any value growth. The employer can also offset both the cost of the scheme and the value growth achieved by employees against its Corporation Tax liability. You can also set conditions to control the release of equity, such as time served or performance. The recipient can’t simply walk away with shares, having delivered no value (which is one of the top concerns of many of the businesses and founders we talk to). EMI Option Schemes are used by 41% of SMEs (who share equity) and, for good reason, are the most popular. Read our full guide to EMI for more information.
- Ordinary Shares – This is the issuance of full ordinary shares in the business, often without conditionality and with immediate effect. They are most often issued against cash investment. Once an employee (or any other recipient) has ordinary shares, you have no control over what happens to the shares thereafter. The individual can simply walk away with the shares, so we don’t normally recommend them for contribution that’s yet to be delivered. They’re also not tax efficient, as the recipient will have to pay tax at their marginal Income Tax (IT) rate, on any value the shares have at that point. These are used by 31% of SMEs.
- Growth Schemes – These are a good option when the founders have built value into their company. The recipient only shares in the capital growth of the business from the date that the shares are issued. You can give growth shares to anyone (not just employees) and you can attach additional conditions. These shares limit the risk of the recipient having to pay income tax on receipt of the equity, as they do not hold any value when they are issued but do pay CGT on the value growth at sale. Growth schemes are used by 31% of SMEs. Read the full details on Growth Shares here.
- Share Incentive Plan – SIP – This is a tax efficient plan for all employees that gives companies the flexibility to tailor the plan to meet their needs. Share Incentive Plans are used by 23% of SMEs.
- Unapproved Options – These are not very tax efficient as the recipient will pay IT on any value inherent in the share, above the exercise price, when they exercise the option. That said, they do provide more flexibility than the other options and are the easiest to set up as you don’t need HMRC approval. Unapproved Options are used by 22% of SMEs.
Is it worth the hassle? Earlier this year (i.e. during the first lockdown ) we carried out a piece of research with business leaders, exploring their attitude towards sharing equity with employees and wider team. We spoke to over 500 owners of SMEs and identified six main business benefits to doing so:
- Recruitment. You can combine salary with equity, to create compensation packages that match, or improve on, offers made by other more established companies with deeper pockets.
- Retain the best talent. Share schemes are proven to increase employee retention and can help you reduce if not avoid hiring costs.
- Increase productivity and performance. Studies have shown that employees who are also shareholders are more committed to their work and contribution because they feel directly vested in the growth in value of ‘their’ company.
- Improve employee engagement and happiness. The more all employees feel included in the mission, direction, and success of the business, the more they’re motivated to contribute to the company.
- Relieve cashflow pressure. Equity can be used to reduce the need for finance. Instead of paying people top rates and large bonuses, you can incentivise them via shares or options…giving them a share of the future they are helping to create.
Recruitment and retention are clearly the key drivers. It’s not too surprising to see why. Companies succeed or fail largely due to the quality of the people they manage to attract and retain. However, for smaller and start-up employers, attracting the right people can be difficult. Good people are typically attracted to the idea of working for a house-hold name brand, they look for job security and are enticed by comprehensive employee benefit packages and high salaries that are unaffordable by most smaller companies. Employee share schemes are an effective way for smaller companies to compete in the job market against larger companies, with that potential for a massive/significant upside.
However, at this challenging time, it’s not all about money, keeping people focussed and motivated during the pandemic is at the top of most employers’ worry list. If you choose the right scheme, equity sharing encourages employees to align their motivations to that of the long-term success of the business, over the immediate or short-term gains. And, right now, that is perhaps worth more than anything.
If you’d like to get into the detail then check out our guide to employee share schemes.
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