Nordea has become the first bank anywhere to completely outsource its company equity research. It is unlikely to be the last.
The pan-Nordic bank is to cease its own coverage of stocks in the Nordic region and will instead buy research on 200 regional stocks, including buy, sell and hold recommendations, from Standard & Poor's. This follows a similar deal with S&P last year in which Nordea outsourced all its US, European and Asian company equity research coverage to the US group.
Under the terms of the five-year deal, S&P will establish a 20-strong research team in Stockholm and will be barred from agreeing any similar deal with another bank in the region. Nordea will also get access to all S&P's equity products including its database and industry surveys. In total, S&P will provide research on 1,700 companies. It will be paid a quarterly fee, with a bonus linked to the performance of recommendations.
Although Nordea will outsource all its company equity research, it is also setting up a new internal research unit called Alpha Research Team. The team, which will bring together quantitative strategists and sector specialists, will work with the S&P analysts to generate more value-added research. ?They won't be tied to calendar research,? says Frans Lindelöw, head of equities at Nordea. ?There are a lot of great analysts out there bogged down doing maintenance research and this will give them the chance to do more with the underlying data.?
Making the provision of quality equity research to clients economically viable is a challenge that most mid-tier banks have yet to face up to. ?What we've done is to take the market and regulatory pressure on research and try to turn it into something positive,? says Lindelöw. ?We believe there is a real disconnect between the service that investment banks are providing and what clients really want. Research has suffered from low credibility, poor performance and conflicts of interest since 1999-2000. We wanted a business model that resolves these issues and that makes economic sense for shareholders. This deal is good for both clients and shareholders.?
Bold strategy
Nordea's strategy is a bold one and could prove a model for others. ?Nordea is ahead of the curve in terms of making a move,? says John Meserve, president of BNY Jaywalk, a leading provider of independent research in the US. ?We may see more mid-sized and regional banks outsource some components of their research. Not all models will be like this but a number are interested in buying independent research to expand their coverage or to offer second opinions. There are a number of hybrid models and doing everything in house may not be one that's viable for many in the long run.?
?Hundreds of analysts all over the world cover the same stocks but only the top 10% or so actually get read,? says Julien Hardwick, European head of equity operations at Standard & Poor's. ?There is little difference in the quality of core fundamental analysis and there simply don't need to be hundreds of analysts doing it. Equity research wasn't always done by banks in house. Historically, banks brought research in house because they needed it for their corporate finance businesses, so in some ways outsourcing research is really a ?back to the future' model.?
The possibility of outsourcing all research becoming widely embraced is held back by several factors. Independent providers sell the same product to all their clients but some exclusivity has to be built into any agreement. This naturally limits the number of clients an independent provider could provide with an outsourcing service. Secondly, there are few independent research providers with the size or stature to provide a complete service to a mid-sized bank.
Other models involving several independent providers or involving partial outsourcing could well take hold, however, as the reality of falling margins and competitive and regulatory pressure are not going to go away. Mid-tier and regional banks will have to take decisive action at some point and it seems likely that there will be more back-to-the-future sequels.