The ability to manage change on behalf of the buy-side is becoming an increasingly important differentiator between core US brokers, according to Ian Domowitz, managing director and author of the ITG Broker Edge Universe survey at agency brokerage and technology firm ITG.
The ITG Broker Edge Universe report judges US brokers against each other in terms of cost savings and value added for US equity trades. Reports are then tailored for brokers so that they can assess performance against their counterparts in specific areas.
With electronic tools now a key component of trading in the US, Domowitz notes that changes in the classifications of brokers in the survey reflect a shift in brokerage offerings. Business models have changed to keep up with a fragmented market, he says.
“We used to split up brokers by full-service, execution-only brokers and boutiques,” says Domowitz. “Several brokers that were once classified as execution only, for example, have expanded their operations to the point that they actively compete with what are termed full-service providers in the execution space.”
The survey evaluates the value added (in basis points) by US equity brokers, on large (50,000 + shares), medium (10,000 to 50,000 shares) and small orders (less than 10,000 shares). It then examines more specific components, particularly execution costs and analyses how more difficult and illiquid trades are dealt with compared to liquid stocks.
As the electronic market structure continues to come of age, Domowitz says buy-side firms are increasingly aware of the impact of transaction costs and slippage on returns.
In turn, costs and value added by brokers have decreased, which are shown in survey results through the years. Domowitz notes that in Q4 2003, for example, market impact costs were 19 bps compared to 16 bps in Q1 2008.
While trends in the survey show that lay costs have fallen for the buy-side, Domowitz believes that some initiatives arising from the formation of electronic marketplaces and electronic access to markets have not worked out as intended. “Electronic trading has not improved large block trading,” he says. “You can see that in the size of executions in US dark pools.
The average order size has decreased on the displayed markets and in most dark pools.”
Domowitz says core brokers need to be able to provide fundamental and transaction cost research across the whole breadth of the market. “Core US brokers need to have good transaction research because this is what the buy-side is demanding,” says Domowitz. “They also need a global reach across as many stocks as possible because these days there are so many global lists available for trading.”
However, to really excel, Domowitz claims the core brokers that have ranked highly in the survey are those that have adapted to changes in regulatory issues, market structure and technology - notably connectivity. To illustrate this, he points to the impact of MiFID in Europe and the lack of clarity buy-side traders currently face when having to report transactions or look for liquidity.
“The attitude in Europe from the buy-side is, we now need to go to six different places to get our market data and we need brokers to go and do that for us,” he says. “Fragmentation necessitates electronic solutions to manage the expanding list of destinations. The buy side is turning to brokerage firms to help them manage what has become a very complex function.”