Despite a squeeze in commission payments by Asian buy-side institutions to brokers last year, the average number of brokers used for execution increased as fund managers sought to broaden access to the region's equity markets, according to John Feng, consultant at Greenwich Associates and co-author of its ”2010 Asian equity investors' study, released last week.
The study reported that the typical Asian-based institution reduced commission payments to brokers by 10% in 2010 compared to 2009 levels. The pool of commissions paid by institutions was relatively flat from 2009 to 2010, despite strong market performance that drove the MSCI Asia-Pacific index to a two-and-a-half year high in Q4 2010. On a per capita basis, commissions declined year-on-year.
Feng notes that the typical portfolio manager reported using an average of 16 brokers, a number that was unchanged from the prior year. “In terms of the number of brokers that institutions use for execution, there were signs that the list was actually expanding, and this is a reflection of the fact that some of the funds are increasingly looking at certain country markets that in the past they may not have paid attention to. Some started to use electronic trading in the last couple of years and they are going to deal with not only the full-service firms, but some of the electronic trading specialist firms,” he said.
A slowdown in trading activity at the start of 2010 led to a decline in commission payments that left some institutions short in terms of the amounts available to pay for research-related services. It also limited their ability to allocate trading business beyond their existing broker list, which is expected to impact up-and-coming brokers the hardest.
“There is still a debate on what different brokers really bring to the table,” observed one head of Asian trading at a global investment. “We saw the entry of many execution-only brokers a few years ago but they didn't really succeed and a few actually closed down.”
The study reported that in 2009, electronic trading channels captured 18% of Asian equity trading volume. In 2010 that share dipped to 16%. The pull-back from e-trading was more pronounced among hedge funds, many of which had been heavier users of e-trading than their long-only investment manager counterparts. This was partially offset by a modest uptick in e-trading
volume from 12% to 13% among long-only funds. Institutions that participated in the study predicted that by 2013 electronic trading platforms will capture 23% of this business, including 10% of Asian equity trading volume expected to be executed through algorithmic trading strategies, 8% expected to be executed through direct to market trades/smart order routing, and 5% through crossing networks or dark pools.
The study also found that institutions in Asia place a high value on the research services and products they receive from their equity brokers. Asian institutions on average use just over 60 cents of every dollar in commission payments on trades of Asian stocks to compensate brokers for the provision of equity research and advisory services, sales coverage and access to corporate management teams. That tops the 58 cents out of every commission dollar that institutions in Europe spend on research in domestic equities and 53 cents in the United States.
“In Asia, a very high percentage of commissions is set aside to compensate brokers for research and sales, and corporate access type of services,” said Feng. “It's approaching about two-thirds of the total commission pool. So if the total pool is not growing, it ties the hands of the institutions somewhat in terms of diversifying the provider list.”
The study also noted that in Europe and the US, about half of the institutions have adopted commission-sharing arrangements (CSAs), and some use electronic trades to compensate brokers for the provision of research by applying a higher commission to trades executed electronically through brokers with whom the institutions have CSAs in place. The practice has not caught on in Asia, where only about 30% of institutions use CSAs.
“In Asia, we see the use of CSAs growing but at the fairly modest pace. The adoption level is relatively lower than the rest of the world,” Feng observed.
However, both the slowdown in commission payments and electronic trading are only thought to be temporary. The study also ranked brokers in terms of their business with institutions, with CLSA Asia-Pacific Markets and Credit Suisse both taking a 9.5% share of Asian equity trading. CLSA also accounted for the highest share of Asian equity research/advisory services with an institutional voting share of 10.3%.
Greenwich's study was based on interviews with 259 Asian equity fund managers and analysts, 107 buy-side trading desks and 84 users of equity derivatives products at institutions based in Asia.