Focusing on what matters
is it in the buy-side’s interest to concentrate its flow with fewer brokers?
There appears to be a growing sense among
buy-side firms that their sell-side counterparts need a reality check.
Despite being plagued by an adverse trading
environment for the best part of four years, brokers have largely attempted to
maintain the broad range of services they offered pre-crisis. This is despite
continued downward pressure on the commission pot available to the buy-side,
caused by both low equity trading volumes and greater use of electronic trading
Moreover, some buy-side firms, notably
Aviva and Scottish Widows Investment Partnership, have switched from active to
passive trading styles, which generally includes more algorithmic and program
trading that is many multiples cheaper than the active investment styles.
In light of this declining environment, many
institutional investors see the current models offered by some brokers as
unsustainable and in need of a refocus.
The crisis isn’t the only reason to revisit
broker lists and concentrate flows with fewer brokers. Last week’s trading
glitch at US-based Knight Capital, which caused a US$440 million loss and has
required the broker to look for refinancing, has only exacerbated fears.
Moreover, recent scandals at J.P. Morgan, MF Global and Peregrine Financial
Group – the latter two of which included improper segregation of client funds –
mean now more than ever, buy-side is keeping close tabs on its sell-side counterparts.
surely some brokers must have changed business models following the fallout
from the financial crisis?
There are some brokers which have scaled
back their equity businesses following the crisis, with ICAP opting to focus on
execution rather than a full-service offering, and RBS exiting cash equities
altogether earlier this year.
A more recent trend has been for brokers to
combine high- and low-touch service offerings. Citi and Credit Suisse have been
among the brokers undergoing an integration of sales trading and electronic
In the agency brokerage world, low volumes
have meant there is simply not enough flow to maintain an execution-only
business. This is evidenced by the recent disposals of CA Cheuvreux and CLSA,
the respective European and Asian agency brokerage subsidiaries of Credit
are the practical challenges of consolidating broker lists?
The lack of meaningful unbundling in Europe
– the practice of splitting up commissions paid for research and execution –
means it is difficult for the buy-side to figure out which brokers offer the
best results for specific types of trades.
This makes determining which brokers to
concentrate flow with a challenging task. Brokers are likely to try and offer
bundled services for as long as possible, thereby forcing buy-side clients to
purchase more services than they require.
Buy-side firms also have to consider
whether they have a penchant for agency brokers or full-service houses. The
former do not offer risk or facilitation services, valuable for firms that want
to trade blocks of stock, while the latter are finding themselves under
increasing pressure to reduce budgets and headcount.
The best bet for buy-side firms may be to
keep a core list of fewer counterparts, with a longer ‘tail’ of smaller or
specialist brokers that they can use infrequently for trickier, more
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