Unbundling and CSA use set to rise

Buy-side firms in Europe and the US will continue to split research and execution services, through the increased use of commission sharing agreements, a new study has revealed.

Buy-side firms in Europe and the US will continue to split research and execution services, through the increased use of commission sharing agreements (CSAs), a new study has revealed.

The report from consultancy TABB Group found that 70% of buy-side firms use CSAs to pay for research and execution, a trend that is set to rise. Moreover, 42% said they use CSAs to pay for independent research bills in particular, highlighting the shift from bulge bracket to specialist research.

While 56% of buy-side firms questioned plan to increase CSA activity in 2013, 20% are waiting for more clarity regarding impending regulation. 

“Research is being decoupled from execution as the search for alpha means portfolio managers are turning to specialty research and maximising CSAs to pay for it,” the report, authored by TABB Group Europe senior analyst Rebecca Healey, read.

Healey believes increasing automation across the industry in particular would help firms cut costs and boost efficiency.

“Recent trading losses have highlighted the need to develop streamlined businesses that reduce costs, control risk and deliver performance over the longer term,” she said. “Brokers need to maintain investment in technology or they risk being maneuvered out of the game."

The findings are part of TABB's fourth annual buy-side equity trading study and are based on interviews with 60 head traders at asset management firms and hedge funds in Europe and the US between August and October.

The report comes in the same month UK regulator the Financial Services Authority (FSA) stepped up pressure on buy-side firms to unbundle research and execution services from the sell-side, to avoid conflicts of interest.

The FSA released a report highlighting the shortcomings of the industry in tackling the issue after a thematic review found only two of 15 firms adequately complied with current conflict of interest rules. The FSA sent letters to CEOs of asset management firms, which are now required to attest their company’s practices are in line with current regulation by the end of February or face penalties. 

In the US, the unbundling of services to avoid possible conflicts of interest has not emerged as a priority for regulators steeped in Dodd-Frank Act implementation.

Matt Samelson, a director at consultancy Woodbine Associates, which has published its own report into commission payments, said his findings suggested the practice would likely continue in the short term.

“In the States it’s a time honoured business practice. There’s a lot of latitude given to the money manager to classify services in order to bundle them together and it comes out of the assets of the plan sponsor of mutual fund shareholder,” Samelson said.

The practice has its roots in the very foundations of the US financial system. The Buttonwood Tree agreement of 1791, a precursor to the creation of the New York Stock Exchange, laid the groundwork for the practice as brokers agreed on minimum fixed commissions as they bundled services together to attract clients.

When fixed commissions were outlawed in the 1970s, a clause was added to one of the Securities and Exchange Act of 1934 Section 28(e) – one of the country’s bedrock financial laws – creating a ‘safe harbour’ for bundled commissions.

“The safe harbour permits investment advisors to pay trading commissions over and above the cost of execution for certain bundled services without being in breach of fiduciary duty,” Samelson said, adding that the strength of lobby groups would added difficulties in changing the laws. 

The report, titled Soft Dollars and Bundled Services: Practices, History, and Controversy, examines the history of service bundling and use of CSAs and client commission agreements used by money managers to pay for research with trading commissions.

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