US equity brokers expect the commissions they earn from institutional trades of domestic equities to fall by 23% and hedge fund commission payments to drop by 32% in 2009-2010, according to the latest equity investor study from research and consulting firm Greenwich Associates.
According to the study, brokers expect the fall despite a 12% rise in the amount institutions paid them for equity trades to $13.7 billion in 2008-2009. Last year’s increase was driven in part by the forced sell-off of US stocks. Hedge fund deleveraging also contributed to the historic trading volumes seen last year, said Greenwich, which has now largely run its course.
“While the rebound in US stock prices in the second quarter is likely to mitigate the resulting decline in commission payments, any significant reduction will be a challenge for brokers that are counting on client-driven capital markets businesses for revenues following the collapse of mortgage and sub-prime businesses,” said Greenwich Associates consultant Jay Bennett, in a statement.
As well as putting pressure on brokers, Greenwich asserts that the dwindling commissions could also hurt the buy-side because it could prompt cutbacks in equity sales coverage and research/advisory services. The firm said these reductions come at a difficult time for US institutions, which are still coming to terms with declines in portfolio asset values and in many cases are looking to outsource parts of their investment and trading functions to the sell-side as part of their own cost-cutting efforts.
The study uncovered a concerted effort from the buy-side to cut costs and maximise the value they get from commissions. The main expense reduction strategy being employed is to shift from traditional high-touch broker-facilitated trades to relatively low-cost electronic execution. In addition, the study noted that the proportion of all US equity trading volume executed through high-touch channels slipped to 56% in 2008-2009 from 60% in 2007-2008, while trades directed to electronic platforms grew to 36% from 32% over the same period.
However, Greenwich added that US institutions’ growing use of electronic trading services increases workload for buy-side traders and should raise concerns about possible capital constraints.
According to the study, institutions expect the volume they execute electronically to increase to 41% by 2012 from the current 36%, but rather than gearing up for this by hiring more traders, buy-side firms have cut back on the number of traders they use to an average of 3.6 in 2009 from 3.9 in 2008.