While the far-reaching structural changes of the last 12 months undoubtedly mark new territory for the financial markets, other developments simply mark the difference between a bull and a bear market. Any shift in the relationship between the buy- and sell-sides in the equity markets reflects both a necessary adjustment to new market realities and the growing influence of existing factors.
For almost a decade, the world’s leading stock market indices have trended relentlessly upward, with volumes rising in step as investors sought to achieve competitive levels of return. In this period, hedge funds moved firmly into the mainstream. Because they typically traded more actively than traditional fund managers – and across a wider range of instruments – hedge funds were courted keenly by brokers. As the sell-side poured resources into chasing large hedge fund commissions, many introduced tiering structures that often left less commission-intensive clients feeling somewhat second class. Some argue that large fund management groups had pushed commissions down to such wafer-thin levels that brokers had no choice but to seek alternative sources of income. Nevertheless, tensions were mostly eased by benign market conditions.
Of course, 2009 looks very different. Trading volumes have not yet hit the lows, nor hedge fund bankruptcies the highs, predicted by market pessimists, but a downward-trending market does depress trading activity and focus attention of value for money. This has resulted in some fund managers actively managing commissions up to guarantee service levels from brokers. But at the same time, buy-side concerns about counterparty risk and quality of service have left bulge-bracket brokers more vulnerable to competition, both from established agency-only brokers and second-tier firms that have ramped up their execution capabilities. Is a bear market also a buyer’s market? Miranda Mizen, principal at TABB Group, the research consultancy, suggests the buy-side’s hand has been strengthened. “The buy-side is now looking at the sell-side in the same way as the sell-side has been looking at the buy-side,” she says.
This shift in the balance of power is also reflected in TABB Group’s new annual study, ‘European Equity Trading 2009: Counterparties, Capital and Control’, based on conversations with 53 buy-side traders from asset management firms dealing in European equities across 12 major EU countries. Although Europe’s buy-side has so far stuck with its core brokers, existing suppliers are under much greater scrutiny. “A lot of people were rattled by the events of last year. The field is more open, but we won’t see wholesale flight to agency brokers,” says Mizen. The TABB report sent some clear messages on selection to the sell-side. When asked “what matters most when considering brokers as counterparties?”, buy-side traders ranked risk profile (60%), service (21%) and liquidity (17%) most highly. And 46% of survey participants cited access to liquidity as a key criteria for new suppliers looking to get onto broker lists. “When it comes to quality of service, robust capitalisation and experience in the market, second tier banks and brokers will now step more firmly into the space traditionally occupied by larger banks. In particular, some will leverage their agency status for the most neutral and widest liquidity reach,” Mizen observed in the report.
Minimal capital availability, shattered balance sheets, reductions in service levels and high-profile defections are among the issues that may fracture existing relationship between fund managers and brokers. But while risk capital will inevitably return, the balance in the relationship between the buy- and sell-sides may evolve to diminish its importance.
The buy-side’s growing independence from the sell-side has been accelerated by the events of the last 12 months. Europe’s buy-side traders were already using more third-party technology, acquiring more sell-side skills and personnel, and exercising more discretion over their trades. The temporary absence of capital has meant that the buy-side has had to handle more ‘tricky’ trades in house rather than offloading them to sales traders. The increase in self-directed trading and growing separation of payment for research and execution services are trends that pre-date last year’s financial tsunami. But over the past 12 months, Mizen says a third factor – access to liquidity – has played its part in making Europe’s buy-side more discerning. “A year ago, you didn’t need smart order routing to access European liquidity effectively; now you do,” she says. The ability of brokers – agency, bulge-bracket or otherwise – to meet the buy-side’s routing demands could be the key ingredient to securing buy-side mandates in 2009 and beyond.
Click here to vote in this month’s poll