Radical reform needed to sell-side business models

Brokers need to adapt their business models to better reflect the evolving needs of institutional clients and "radically" cut their cost bases, according to a raft of research released this week.

Brokers need to adapt their business models to better reflect the evolving needs of institutional clients and "radically" cut their cost bases, according to a raft of research released this week.

While many have sounded the death knell of brokers, particularly since the financial crisis, economic pressures and the changing needs of buy-side firms mean brokerages will need to reform in order to survive, the reports conclude.

There is evidence that broker revenues are being hit with volumes down considerably on several years ago. Total EMEA volume fell from €1.4 trillion in January 2008 to €706.6 billion in January 2013 according to Thomson Reuters Equity Market Share Reporter. Adding to the pressure, commission spend by the buy-side is also down, with a 2011 TABB Group report claiming 53% of brokers have seen their commission wallet fall by at least 20% during 2010.

With the overwhelming majority of equity market orders now traded electronically, brokers need to reform their business practices to better suit low-touch trading, with execution consultants taking over from more traditional sales traders, according to research from consultancy Woodbine Associates.

However, Woodbine said its research suggests there is a need for brokers to ensure they employ top-notch talent for execution consulting. "It is a cause for concern that less than half of head traders at asset management firms thought that execution consultants can strongly and effectively convey the underpinnings of their broker's algorithmic offerings. These individuals, on the 'front lines' of electronic trading, are in many instances charged with expanding the broker/asset manager business relationship," said Matt Samelson, principal at Woodbine and author of the report.

David Easthope, research director at Celent Securities & Investments, believes brokerages should look to reduce the number of sales traders supporting more commoditised forms of execution.

"There are opportunities to invest in further development of client portals to replace some equities sales traders with cross-asset regulatory and execution consultants who can help navigate the array of execution venues, algorithm types and even ancillary asset classes," he explained in Celent's most recent report.

Time to refocus

Similarly, a white paper published by Olivetree Financial Group, a London-based agency broker and technology provider, has called on brokerages to reform their business models due to changing demands from the buy-side.

Olivetree claims that the time has finally come for the sell-side to alter its business models, partly due to its current reliance on legacy relationships, but also "pressure from clients and regulators for the buy-side to justify fees and limit the costs that are charged to clients".

The white paper said the rise of electronic trading and reduced reliance on broker research - driven by growing competition from independent information sources - means brokerages need to refocus around their IT and aggressively cut costs.

Easthope agrees: "Managers are no longer tolerant of expensive IT supporting a business with disappointing returns. Furthermore, because more revenues are going to be hard to find amidst low volatility, thin margins, and high complexity, we believe radical expense reduction programs have become necessary among not only mid-tier broker-dealers but also the largest broker-dealers."

Calling time

Meanwhile, Steve Grob, director of group strategy at financial technology Fidessa, suggested - in a white paper titled 'Wish you were here' - that the post-trade environment is particularly in need of reform to cut costs for both the buy- and sell-side.

This should include development of industry standards, particularly around the work FIX is doing to support greater post-trade reporting standards, as well as moves towards trade aggregation that have been resisted in the past, according to Grob.

"Achieving the next level of cost reduction in post-trade requires a more collaborative approach than exists at present. This is slowly being recognised and a number of working groups have formed outside the formal trade bodies that exist currently," he added.