While UK-based asset managers will need to take a more careful approach to research payments, the Financial Conduct Authority’s (FCA) work on unbundling has the potential to transform brokerage businesses.
Why is the way the buy-side pays for research so important to the sell-side?
For most brokers, especially the bulge bracket, research is a significant proportion of the service they offer their buy-side clients. With the cost of execution being driven down over the years due to advances in technology, maintaining a large in-house research team has become a vital way of continuing to attract commission, as well as being a way to connect more directly with buy-side firms that increasingly access the sell-side via a screen.
The bundled nature of commission payments mean that, even as execution costs fall, many clients may not see the benefit, with their commission payments remaining the same and they simply contribute more to research, regardless of how much research they actually get (or read).
What effect will further moves toward full unbundling have on the sell-side?
If the cost of research was properly split from the cost of execution, many buy-siders may notice that the amount they are paying for research services is not necessarily reflective of the value they get from it. If you execute more, then you pay more. Similarly, if you execute with a particular broker, you’re likely to receive its research activity, which you may not even want.
Clearly the FCA feels the asset management industry as a whole pays too much for its research and thus, if this cost is to be managed more critically in future, the overall revenue of the research side of the business will fall, resulting in firms scaling back their activities or exiting the market altogether.
So if research brokers stand to lose, who are the likely beneficiaries?
A number of parties could benefit from this change in the market. FCA chief Martin Wheatley said that one of this key aims is to create a competitive research market and ensure firms that would not survive in such a market are not able to keep on going due to the broken commission payment model.
This is likely to be good for independent research firms, which have struggled to get buy-siders to pay for their services in the past as they are used to paying for them through commissions. It will also be good for the smaller brokers that are specialising in execution as they will be able to clearly differentiate their own costs from any independent researcher that an asset manager might use.
Of course, it’s also good for the asset manager and its customers, because the former will be able to demonstrate they are taking more care of their clients’ cash, while the latter should enjoy better returns with less of their money being spent on unnecessary research.