Buy-side traders have been trusting more of their executions to agency brokers as a result of the global financial crisis, according to Ian Domowitz, managing director responsible for networking, analytical and research products at ITG.
According to Domowitz’s estimates based on data from TCA clients, trading with pure agency brokers has increased by almost 13% from the beginning of the second quarter through to the end of the third quarter this year. If measured from the beginning of the year, the increase is almost 5.5%.
ITG is a provider of transaction cost analysis services, agency brokerage services, and trading technology such as order and execution management systems.
The shift away from investment banks is not just apparent in the TCA analysis. “We have a lot of anecdotal reports that agency execution has increased,” says Domowitz. “We see in the US, for example, that flow into more publicly-operated crossing systems has certainly gone up.”
The latest stage of the global financial troubles was sparked by Lehman Brothers’ filing for Chapter 11 bankruptcy protection on 15 September, and the subsequent wave of failures, mergers and bail-outs. Global stock markets have been highly volatile since this date, with some reporting record drops and spikes as the market digested all the news.
Domowitz said there are two reasons why the evidence for the shift toward agency brokerage should be regarded with caution. First, it only takes into account what ITG’s clients report to the firm, and so is only a small sample of overall market activity. Second, the figures do not take account of the fact that large investment banks have agency desks. But Domowitz added, “Although those estimates should be taken with a suitable grain of salt at this stage, they do confirm what we’re seeing anecdotally in the markets with respect to movements in the agency direction.”
The shift has partly been caused by fears about exposure to counterparty risk following the collapse of Lehman Brothers, and partly by the rising costs of capital commitment from full-service brokers, according to Domowitz.
“A more highly volatile environment will virtually automatically increase the cost of principal,” he said. “As principal gets more expensive relative to an agency execution, the more difficult it is to do business on the principal side.”
A further reason for the shift, Domowitz contended, is that agency brokers have been largely unshaken by the market turmoil. “Core agency brokers have been able to remain focused on advancing self-directed trading by the institutional buy-side,” he said. “We, as well as others, have not been distracted by issues with our own trading desks or counterparty risk issues that are associated with things like the Lehman collapse.”