According to a Reuters news report Macquarie Group Ltd (ASX: MQG) is set to shutter much of its cash equites trading businesses outside the Asia Pacific region. Recently Deutsche Bank also flagged that it will shut down its cash equities operations in Australia and other parts of the world.
Cash equities businesses provides market matching, research, and derivative trading services to institutional and high net worth clients, but have come under regulatory pressure in Europe to the Markets in Financial Instruments Directive (MiFID) II.
This key piece of market-facing financial services legislation in Europe has forced the unbundling of research fees from commissions paid to sell side operations like Macquarie's cash equities desk.
MiFID II effectively meant cash equities' desks clients on the buy side would have to pass on the cost of research to their own clients or unit holders if they wanted to 'pay' for it. Unsurprisingly, most buy side fundies didn't want to pass on the cost when they have their own in-house research functions.
MiFID II has also placed more emphasis on demonstrating 'best execution' on the cash equities desks of investment banks, whereas previously the duty tended to be placed on the buy side. This has also resulted in more compliance costs.
More generally the forced 'unbundling" of execution fees has placed a lot of fee pressure on the cash equities desks of groups like Macquarie.
This is conceptually similar for example to a real estate agent being forced to 'unbundle" fees like marketing, legal, advertising, hours worked, auctioneering, etc, for selling a property, rather than just charging a flat 3%.
If the agent were forced to do this, the more valuable the property the better deal the vendor would get.
Other dubious aspects of 'bundling' of equities sales desks targeted by regulators include the 'entertaining" of buy side clients at sports events or lunches for example.
In fact equities sales jobs at desks like Macquarie used to be among the most sought after in the City of London due to the high pay packets and legendary socialising involved.
For equities sales desks it looks like MiIFD II and its 30,000 pages of regulation or 1.5 million paragraphs means the fun times are over for some.
How to respond?
Fortunately for shareholders Macquarie is a pretty nimble organisation versus its big four peers and has pushed deeper into the asset management and syndicated lending spaces in Europe over the past few years.
Evidence includes the $4.3 billion deal to buy the UK's Green Investment Bank.
While in its latest operating update it flagged Q2 FY 2020 would see a $1.6 billion increase in capital expenditure across its annuity style businesses including in the infrastructure, renewables, and technology sectors.
Most of the capital will be allocated by its Macquarie Asset Management and Macquarie Capital principal or syndicated investment style businesses.
Just last month Macquarie raised nearly another $1.7 billion in capital to suggest it sees plenty more profitable investment opportunities ahead.
It can now be viewed as an asset manager or investor that does some investment banking or capital-market facing work on the side.
It will hand in its interim profit report this Friday with a forecast for 10% profit growth on the prior corresponding half.
Value
The stock is challenging to value for even the world's best banking analysts due to the amount of one offs via asset sales and acquisitions going through its P&L at any given time. Moreover, it's a deliberately secretive organisation in part to wrong foot competitors and avoid unnecessary 'attention' from regulators.
If we assume it can grow earnings by an average 8% over the next 7 years with a conservative 0% terminal rate and moderately aggressive 11% discount rate the stock is worth $121.74.
However, any valuation depends on inputs with analysts recording an average share price target of $133.02 according to the Wall Street Journal. These valuations will all be updated next week after it hands in its results.
I'd still rate Macquarie a much better growth prospect that the likes of Commonwealth Bank of Australia (ASX: CBA) or Westpac Banking Corp (ASX: WBC).
