Capital Markets | Investment Banking

Rethinking The Research Function

2

3

Services Wanted – Sell Side Financial Analysis

Sell-side research services related to our on-going need for input within the global financial markets wanted.

We seek professionals who are considered among the most well respected analytical leaders in their chosen field of expertise. The right candidate will have a proven track record of Alpha generating ideas, insightful information flows, outstanding publishing and speaking skills, be available to service our needs on a moment’s notice, and provide access to industry managements and participants through conference calls, one-on-one meetings, field trips, and conferences where the cost is borne by the sell-side provider. The position will also require members of your team to service our firm by offering sales, service and support as well as trading services guaranteeing best execution and access to capital and your firm’s balance sheet as needed.

In return we offer to engage your services for payment terms to be decided at a later date of our choosing, if at all, based on overall perceived service provided to our firm relative to your peers.

Please note: We expect services to be rendered for free for a period of no less than six months before consideration can be made for payment – there will be no recourse for payments the recipient deems unsatisfactory.

Qualified candidates should contact our Broker Liaison, Mary Smith, at 212 555 1000 or email msmith@anyfirm.com

Sadly this is the state of the sell-side research model as viewed from both the financial buyers’ and providers’ points of view. Of course this does not take into account the entire business case for providing research, namely doing so as a means of supporting other capital markets functions deemed profitable such as IPO fees, prime brokerage, asset and wealth management and trading. Research has always been part of the capital markets value chain and is not likely to disappear. However, the current ill-dynamic between the buy- and sell-side in terms of research service and delivery needs to be addressed.

In an environment where equities margins have been squeezed to near zero and FICC trading could be facing the potential for a similar fate in the longer term, driving value through research should evolve in today’s digital market place in order to not only remain relevant, but also - once again - become profitable rather than a “loss leader”. To this end there are a number of alternatives that need to be explored in the context of helping create a possible optimal business model. These include embracing digital disruption as a potential competitive differentiator as investors continue to consume ever larger volumes of information from digital sources. It also includes the expansion of digital delivery methods, both as an efficient delivery mechanism but also for access control and the potential to better understand consumption for monetization and price discovery. Finally, investment banks have unprecedented amounts of both historical and real-time data which might not be adequately leveraged through advances such as real time data stream analysis, layered analytics, and big data applications for discovering new data correlations to asset prices. The question is: how did we get here and what can be done about changing the business model of research services?

To answer these questions, we first must examine the evolution of sell-side research.

From the sell-side perspective Research services provided to the buy-side were given away for free, both in written form and as a service (i.e. information flow and advisory), in return for what was hoped to be commission flow and IPO underwriting fees at a later date. Imagine taking items and telling the grocer, “I will decide how much utility I gain from your products after consumption and will come back to pay you what I believe is fair later.” While this business model seems counterintuitive, the reality is historically trading and IPO margins more than made up for this fundamentally flawed business model.

From the buy-side perspective The expectation was that investment banks would provide research (advisory) services to help clients better understand the fundamentals of the businesses in which they invest as part of a larger bundle of services which also included trading (brokerage), IPO allocations (new deals), and sales support. Payment for these services is on the “back end” typically through a “vote” process which decides how much business will be directed to each broker. One of the key issues to understand is the fact that the dollars being paid to the brokers comes out of the investors’ pockets in the form of trading commissions tacked on to the price of a security, NOT the management fee(s) paid to the money manager. In addition, buy-side managers are in part incentivized to pay more commission to those brokers with the best equity IPO’s or FICC issues since allocations of said securities are at least in part determined by client ranking (i.e. how much the client pays the broker) at the investment bank.

In the past, research was subsidized by investment banking fees. According to a study by Sanford C. Bernstein in 2004, the annual research budgets at the top eight investment banks averaged between $200 and $300 million during the 2000–2003 period1, of which 40% was covered through investment bank fees.

4

After the internet bubble and the subsequent financial crisis, the capital markets have realized a number of negative fundamental shifts that have altered the profitability paradigm related to providing research services. Research analysts are prohibited, in large part, from the IPO process. Chinese Wall regulations have been created to remove analysts from information flow generated by bankers, and Regulation Fair Disclosure means companies are not permitted to disclose any information deemed material to their business unless it has already been publicly disseminated. This takes away a key “edge” of street analysts who in the past had access to

information unavailable to the general public. Electronic trading and alternative trading services have helped drive trading margins in equities to near zero. As the figure below shows, equity commission rates remain under significant pressure and, in the longer term, the FICC will likely suffer the same fate, although at a slower rate of decline. Against this backdrop, freely available information has grown exponentially due to the internet, as well as the ability to target and analyze relevant data streams. Hence, the ability to gain an information “edge” and to rise above the “noise” is immensely more difficult.

This is also compromising research quality as:

• The amount of research expected from an analyst is growing due to cost constraints (i.e. covering a greater number of securities).

• Given the economics of the business, the best and brightest are no longer attracted.

As one portfolio manager of a multi-billion dollar fund put it, “the average age and experience of sell-side analysts goes down every year. They are getting younger and younger without any real, long-term industry experience or insight.” Of course this trend will also persist until such time as research once again becomes profitable and viewed as a viable long-term career option.

The Paradigm Shifts

Cents-per-share

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Q1 2007 2008 2009 2010 2011 2012 Q1 20142013

4.00 4.00 4.003.80 3.70 3.70

3.53 3.58

3.20 3.21

2.902.72 2.76 2.69 2.692.63

1.30 1.20 1.16 1.07

Normal “high-tough” agency-bundled trades Average “all-in” blended comission rate Algorithmic/smart-order routing trades

Commision Rates for U.S. Equity Trades

Note Based on responses from 271 traders in Q1 2007, 272 in 2008, 290 in 2009, 286 in 2010, 304 in 2011, 316 in 2012, 294 in 2013, and 316 in Q1 2014. Net of rebates and excludes portfolio and electronic trade. All-in blended rate across single-stock, program, and electronic trades, including any commission management program “tack-on” rate. Excludes any “tack-on” rate to pay for research.Source Greenwich Associates 2014 U.S. Equity Investors Study

5

As alluded to earlier, research unbundling in the United Kingdom as mandated by Mifid II to encourage the creation of a hard dollar research market and perhaps in other jurisdictions may alter the economics of asset managers’ business models. This is due to firms being forced to pay for research services from their own profit and loss, rather than costs being tied to the price of securities and therefore paid by investors. The alternative under Mifid II is money managers receiving agreement from investors to fund a research budget, but we doubt this will be much of a factor given cost and complexity. However, these regulations will have significant impacts, both intended and otherwise.

The creation of real price discovery for research is likely to force money managers to scrutinize the research services they purchase. This will lead to more selective consumption and hence a flight to quality, which will negatively impact the “me too” research

providers. This regulatory mandate may be further exacerbated by the fact that managers face their own margin pressures. Long term underperformance of active managers has given rise to unprecedented growth in ETFs and other passive or Index products. Relative underperformance also drives managers to transact with a decreasing number of brokers in an attempt to get more leverage from commission dollars paid to their sell-side providers. However, the one thing that will not change is that money managers may continue to see value in access to unique insights and information, access to capital, and access to deals (IPO’s and primary issues).

Finally, as buy-side firms have built their own research capabilities (especially at the larger hedge and mutual funds), coupled with increased regulatory pressures from compliance and Regulation Fair Disclosure, the ability to generate alpha from sell-side research will continue to become

more difficult. This could be exacerbated by the amount of free and easily obtained information publicly available that was once the domain of the analyst community due to the time and effort involved. Finally, there is currently too much research supply for liquid securities. This is not to say that quality research cannot be adequately monetized as highlighted by examples such as Autonomous Research, an independent provider which has proven successful as noted recently by eFinancialNews.com.2

The Paradigm Begins to Shift For The Buy-Side

Interestingly, slightly more than half of buy-side professionals choose their investment banking relationship based on research, yet 65% also cite price as a determining factor.

However, among buy side institutions, over half either don’t use a service or expect research to be delivered as part of the service bundle. Risk management, best execution, and ability to trade rapidly are cited as service priorities.

In other words, there is an economic disconnect between the research function and revenue. On the one hand, research is cited as an important factor for choosing firms with whom to transact. Yet on the other, it is a service viewed as not requiring paying a premium.

Of course these trends have caused investment banks to explore ways of cutting costs. One strategy has been around outsourcing research functions to low-cost offshore providers. However this strategy has limitations due to proximity and the deep tacit knowledge required of a research analyst to adequately cover a particular industry. It also presents challenges related to analyst availability for customer service and compliance.3 Clients may still believe original research is what they are paying for and any move seen as degrading the process, either due to location or perceived quality, will be met with negative results. Despite these challenges, outsourcing/offshoring of the research function remains a cost effective, viable alternative and should be considered not simply based on cost but rather holistically relative to quality and effective client delivery.

Despite numerous efforts, both on- and off-shore, compensation costs for research have moderated in recent years, but still remain high. For example, an Accenture-sponsored survey revealed the average compensation for research professionals among top-tier investment banks decreased by 8.16%, and headcount by 2.5%, for the 2010-2012 period alone. In terms of geographies, 65% of spending was related to North America, Europe, and Asia. Interestingly, on an average comp basis, North America consistently has one of the higher average salaries across all banks while Australia and Latin America were also “expensive” regions ranging from ~1.0x the average to as much as 1.44x the average between 2010-2012.

So What Do They Pay for?

6

Source YouGov, Accenture ResearchBase 50 Asset or Fund Managers, US and UK 24/07/13 - 16/08/13

What are the four most important factors influencing your choice of an investment bank for a product or service?

Research provided

Ability to tailor appropriate financial options

Trading/execution capabilities

Willingness to finance

Lack of any conflicts of interest

Existing relationship with individuals/bank

Deal execution abilities

Market expertise/knowledge of product or service

Market reputation for this sort of deal

Wide range of service o�erings (one stop shop)

Expertise in a designated region

Clients rated price and research provided as the most critical factors for choosing an investment bank

Least important were a wide range of service o�erings and geographical expertise

Price 68%

58%

48%

42%

30%

26%

26%

24%

22%

22%

16%

14%

Risk management services

Ability to trade rapidly

Ability to trade at best price

Trading advice – when to trade

Post trade analytics

Access to senior corporate executives of the companies that research covers

Ability to execute complex trades

Liquidity management

Assistance with meeting regulatory compliance issues

Access to written research

Source YouGov, Accenture ResearchBase 50 Asset or Fund Managers, US and UK 24/07/13 - 16/08/13

2%

0%

2%

40% 26%

44% 28%

40% 30%

36% 34% 10%

34% 40% 10%

28% 48% 14%

2%56% 34%

4%56% 34%

40% 46% 8%

38% 46% 10%

Fund management clients prioritized risk management services and trading execution capabilities over all other services

Top 5 most important demands

Top 5 least important demands

Not a service we useExpect as basic serviceWill pay a small premium for better serviceWill pay a large premium for better service - Value di�erentiating service

10%

8%

6%

6%

6%

32%

28%

28%

20%

16%

7

As of 1Q 2014 the total commission pool from asset managers showed the first signs of a turnaround in five years. According to Greenwich Associates, buy-side traders predict the U.S. cash equity commission pool will increase 4% on average by year-end 2014 to

an estimated $10.75 billion, with hedge funds (9% projected increase) more positive than long-only funds (3% projected increase). The expected increase is being driven by what appears to be growing demand for overall content. In fact 80% of the commission

wallet increase came from spending on research and other related services; written research, corporate access, market color and analytics. In other words providing insight into where their orders are going and where their executions are ultimately coming from.

Outlook: Opportunities Still Exist

Note Based on random sample of 148 accounts. Direct corporate access includes non-deal roadshows, one-on-one company meetings and conference call needs.Source Greenwich Associates: Demand for Research Drives Uptick In Commission Spend

Proportion of U.S. Equity Research/Advisory Allocation for Research, Sales & Corporate Access

U.S. Cash Equity Comissions -- The Total WalletAnnual Spend into Q1 2014 (in billions)

Q1 2002 2004 2006 2008 2010 2012 2014 Expected Q1 2015

0

2

4

6

8

10

12

14

Total Commissions

Expected

Equity Research or Advisory Services, Sales Coverage and Corporate Access

Sales Trading and Agency Execution

Analyst service26%

24%23%

Direct access to companies’ management19%

22%22%

Research conferences and industry seminars14%

13%13%

Individual company or industry studies10%

10%9%

Other, including global research 2%3%

3%

Customized or bespoke research 1%1%

1%

Expert networks2%

NA1%

Economic analysis and portfolio strategy advice 7%7%

7%

Thematic investment ideas or specific stock recommendations8%

8%7%

Sales service13%

12%11%

12.60

11.30 11.20 10.80 10.9010.30

12.20

13.9013.20

11.6010.90

9.30

9.52

10.34 10.75

6.205.39

6.206.807.00

7.80

5.505.00

5.705.515.605.756.55

4.143.914.704.80

6.206.10

6.70

5.30

5.205.295.605.546.05

Q1 2014

Q1 2013

Q1 2012

Source Greenwich Associates: Demand for Research Drives Uptick In Commission Spend

8

From all this data, Accenture concludes that sell-side research will remain a key differentiated service offering, but it needs to be redefined. Sell-side institutions need to view research as an integral part of the service offering so as to help optimize revenues across the entire enterprise. Sell-side institutions have access to a vast amount of industry expertise and data and need to rethink how to leverage those factors for optimal monetization. The question is: How to earn money with research? Market positioning, content, and delivery methods all need to be considered as pieces of the total offerings for revenue and market share maximization. Accenture believes sell-side firms should consider the following:

Redefining Sell-Side Research

9

Creating the Optimal Business Model

Firms can choose to be a global, one-stop shopping flow monster offering full service across asset classes, with research being a supporting function for the enterprise. Another alternative firms have is to be a boutique or regional firm viewed as having a particular expertise with differentiated views of particular industries or strategies, such as Telsey Advisory Group, Autonomous Research, Arete, or Capital Economics. While it may seem obvious, the choice has significant implications for efficient research access, delivery, which research is commoditized versus value-add, and then framing the operating model, compensation structure, and workforce accordingly. Clients will expect the former to have research depth and expertise for all industries and asset classes, implying significant costs which may not be justified on a stand-alone basis. On the other hand, banks may need to consider the potential synergies created by cross-industry and cross-border coverage that could be otherwise lost. The latter boutique strategy suggests research expertise related to a narrower industry subset, meaning some revenue opportunities may be lost, but the cost/benefit analysis lends itself to being more easily justified. The answer may drive business decisions for building delivery functions that range from simple electronic (i.e. email) delivery and communications to vastly more complicated, and hence costly, solutions such as interactive portals.

Digital Disruption Cuts Both Ways

As the traditional research function continues to suffer from digital disruption, so too can it potentially benefit by being more digital. Investors still use traditional sources of information to make their decisions (e.g. analyst research reports, direct information from companies, and primary research) with their reliance on digital media still being very low despite the growing significance. Blogs, social networks, micro-blogging services and message boards are becoming more important, with 86% of investors recognizing their importance and seeing them as having an increasing impact on their investment decisions.4 This is likely a function of the digital generation (Gen D) population becoming a larger and larger proportion of the workforce, at least partially.5 Not only is the consumption of digital information increasing, contributions in the form of conversations, posts, etc. are on the rise and

having a big impact. Technology allowing for layered analytics, learning which digital contributions are deemed important and credible, and incorporating new data sources, can create customized research offerings based on client directed interests/management styles and demand. Combining attractive data visualization and “live” updates and trading ideas can create a truly interactive customer experience. With advanced data analytics being deployed across the entire suite of research products to leverage multiple research sources, a more holistic view with real time updates could imply better client alignment, but also the need for big data applications. For example, data visualization tools leveraging research inputs from across the enterprise bring a layer to analytics that allow for better and faster trading decisions based on real-time data and current events driving market share. But doing so requires significant computing power, secure storage capacity, and real-time digital delivery methodologies.

An interesting recent example in the use of digital technology is UBS leveraging analyst popularity ratings and fluctuating demand for services. By analyzing consumption and usage data, the bank is creating a model where, based on these rankings, investors pay for research services that could be four to five times higher for the most popular analysts versus their peers. Of course, setting an “auction” marketplace for analyst resources will not be without controversy, but the UBS model could show that leveraging data capture from digital such as feedback loops or scores can create better business models versus today’s research delivery.6

The key question for the future of research services remains: How to have a cost efficient research access and to deliver distinctive value?

Digital Delivery

Not nearly enough is being done to create holistic, full service, interactive digital delivery platforms. While many claim to have “the solution”, most are simply repackaged versions of the old built for purpose silos or binary asset class products rather than creating an opportunity to interact for collaborative engagement. What the buy-side wants is the right information at the right time for global ideas with a local presence. One of the challenges for digital delivery, however, will be competition and rising above the noise by creating mobile, buy-side regulatory compliant

interactive interfaces as a competitive differentiator. This could also be used for post-delivery analytics to better understand consumption patterns and client usage for better research resource optimization.

Another opportunity created through better digital delivery methods will be information flow control and consumption tracking. Many of the current delivery methods employed by the sell-side have little or no access or sharing controls. Once a report or data is transmitted to clients, it can be downloaded, saved, and shared by anyone willing to pass the information to others. By more tightly integrating document and data controls, sell-side firms can better limit the number of people who view their proprietary research information, which in turn may increase its perceived value. Again, we point to Autonomous Research as an example of a firm that very tightly controls the number of investors with access to its data, which in turn could create pricing power through exclusivity.

How to Monetize Research Data?

Finally, sell-side firms have vast amounts of historical and real-time market data, as well as other data streams. Data applications including massive amounts of news, blogs, and other editorial and media content data from anywhere around the world can be quickly integrated into research reports. Also, new data sources, such as social media provide additional insight such as derived sentiments (based on sentiment analysis) from customer messages on Twitter to “following” localized data and subject matter expert inputs (e.g. determining crop yield based on localized weather and tweets from farmers). Applying advanced analytics to better understand how certain events impact or don’t impact asset prices creates an opportunity for trading idea recommendations which in turn could drive revenue.

10

Accenture can help to assess the research value creation process, suggest ways to optimize the operating model towards an efficient research function and can help ensure that relevant regulatory requirements are met. Accenture has strong analytics and technology capabilities and can advise on ways of leveraging data visualization and digital delivery optimization methods.

Analytics: Separate the insights and meaningful information from the vast amount of data noise. Analytics can also automate, streamline and pre-populate a lot of the manually intensive and “boring” parts of research report creation removing the need for some low-skilled analyst input, even if low-cost. Consider just a few of the opportunities:

• To separate the “noise” from the “insights” for research, advanced analytics algorithms allow for better filtering of news, blogs and other research based on the relevance and credibility of the source.

• Leverage Natural Language Processing and text analytics to quickly distill the most important parts of articles and news releases using sentiment analysis to quickly determine potential shifts in investor perceptions.

• Analytics techniques, such as pattern recognition, anomaly detection and utilization of new data discovery and data visualization tools may uncover new insights, such as determining connections and correlations between various stocks or industries that may have not been viewed historically as interdependent.

• Machine learning algorithms can “learn” and speed up and enhance the process of deriving the most useful and unique “insights”.

• With the emergence of new analytical tools and techniques, the research analysts that used to have a generalist or business background working in XLS, would now become a data scientists working in R, SAS or other new environments.

Technology: Internal and external cloud infrastructure combined with Big Data technology platforms can allow for having a single platform for sharing research between research teams creating a holistic (global) research perspective. At the same time new Big Data technologies and real-time capabilities can improve the speed with how news and data is quickly processed and released to the investors.

How Accenture Can Help

11

Copyright © 2015 Accenture All rights reserved.

Accenture, its logo, and High Performance Delivered are trademarks of Accenture. 15-3170

Notes

1 https://warrington.ufl.edu/graduate/academics/msf/docs/speakers/prereading_McMahon_Ward0405FortuneMag.pdf

2 http://www.efinancialnews.com/story/2015-02-11/autonomous-research-the-house-that-puts-a-price-on-exclusivity

3 https://www.deepdyve.com/lp/elsevier/when-outsourcing-is-not-an-option-international-relocation-of-hDTDNHmvo1/17

4 http://www.prnewswire.com/news-releases/brunswick-group-releases-survey-on-investment-community-use-of-digital-and-social-media-188681861.html

5 https://www.accenture.com/us-en/insight-generation-d-europe-investor-survey-wealth-management

6 http://www.wsj.com/articles/new-rules-poised-to-reshape-analyst-research-sector-1423514292?KEYWORDS=ubs+analyst

Contacts

Owen Jelf Managing Director, Accenture Global Capital Markets owen.jelf@accenture.com

Bob Gach Managing Director, Accenture Capital Markets Strategy robert.p.gach@accenture.com

Sigrid Seibold Managing Director, Accenture Capital Markets Digital sigrid.seibold@accenture.com

Chris Brodersen Manager, Accenture Research c.brodersen@accenture.com

About Accenture

Accenture is a global management consulting, technology services and outsourcing company, with more than 336,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the world’s most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$30.0 billion for the fiscal year ended Aug. 31, 2014. Its home page is www.accenture.com.

Learn more about Accenture Capital Markets at:

www.accenture.com/trading

www.accenture.com/investmentbankingblog

@AccentureCapMkt

Disclaimer This report has been prepared by and is distributed by Accenture. This document is for information purposes. No part of this document may be reproduced in any manner without the written permission of Accenture. While we take precautions to ensure that the source and the information we base our judgments on is reliable, we do not represent that this information is accurate or complete and it should not be relied upon as such. It is provided with the understanding that Accenture is not acting in a fiduciary capacity. Opinions expressed herein are subject to change without notice.