Cost cutting can only go so far.

Agency brokers are increasingly under scrutiny from their institutional buy-side counterparts to provide more and more transparency. Also, the buy side wants to know about costs and how the brokers can either explain their charges and/or reduce them. Historically, this has focused on order handling and dark pools chosen but now, Weeden & Co. has shed light on its costs incurred during the normal of business.

Andrew Upward, head of market structure at Weeden & Co., wrote in a client note that its larger institutional clients recently asked it to make a full accounting of its execution costs so that they could better understand the true potency of their commission dollars. After reviewing its costs and seeing how the information was appreciated by its clients, the firm noted that brokers’ costs (including its own) are increasingly concentrated in areas where it has little control or flexibility.

“They’ll continue to deliver marginal efficiency gains, of course, and will scale up – or outsource to those with scale – to help keep fixed costs low,” Upward said in his note of the brokers. “But generally speaking, their costs will remain relatively high as a percentage of total commission revenues for the foreseeable future.”

Upward examined the trade process – which he dubbed “the execution spine” that traced costs from their inception when the buy-side trader sends the order via OMS to the broker routing it to a particular venue to clearing – either done at a clearing broker or via another utility. He noted that his focus was only on the variable and semi-variable costs incurred when a broker executes a customer order as agent.

He did not include fixed costs, like market data and exchange connectivity charges, or intangible costs like the risk of an error.

“In some cases, brokers have enough flexibility and leverage to keep costs low,” he noted. “Execution fees are a good example: if prices are too high at a given venue, a broker can sometimes – though not always – route its orders somewhere else. In other cases, such as with connectivity fees, brokers have less flexibility. Not surprisingly, we believe that asset managers are getting better value for their commission dollar in areas where the forces of competition are robust enough to keep costs low.”

Weeden first looked at connectivity costs, both for FIX connections and OMS/EMS providers. If an order is sent electronically, the broker pays $250-500 per month to a FIX network provider. Also, some OMS and EMS providers require specific FIX connections.

“For bigger clients, FIX costs aren’t meaningful when broken out on a per-share basis,” Upward explained. “Consider, however, that a $500-per-month charge amounts to six mils ($0.0006) per share for a client that trades 10 million shares with a broker over the course of the year. And in cases where the asset manager needs multiple connections to be able to send orders to different desks within the broker, the costs can double or triple – though not all providers charge for each connection.”

When it comes to the OMS and EMS fees, brokers are often left in a precarious position. The buy-sides’ workflow is usually very deeply embedded in these systems and are reluctant to switch vendors, especially when traders are comfortable with a vendor’s system.

OMS and EMS vendors typically charge brokers a fee for every share sent through their software that gets executed. The fee tends to range between three and twelve mils, though it can be higher or lower than that.

“Broadly speaking, then, brokers are left to haggle with vendors alone over a fee that can’t be easily tied back to any tangible product or service,” Upward said. “ A broker that takes too hard a line in these negotiations risks complicating its relationship with both the asset manager and the vendor. Given the competitiveness of the broker-dealer industry and the buy-side’s low tolerance for operational friction, complicating its relationships in that way just isn’t worth it for most brokers.”

In terms of execution fees, when a broker routes an order to trading venue or crosses it internally the costs are cheap. For example, Nasdaq charges 1.8 cents to report an agency cross to the FINRA/Nasdaq trade reporting facility, for example. To be clear, the rate is 1.8 cents per trade, not per share – and the broker’s bill is capped at $135 per day across all of its trades for all of its clients..

“External executions are more costly,” Upward said. “Taking liquidity on an exchange can cost as much as 30 mils per share, though taking on an inverted exchange can generate a rebate of 10-15 mils. Similarly, providing liquidity on an exchange can generate either fees or rebates. Based on our own experience, as well as on comments our competitors have made, we estimate that exchange fees and rebates end up costing most brokers a few mils per share on a net basis.”

Overall, Weeden estimated that the blended cost of execution across exchanges, dark pools and internal executions ranges from two to five mils per share for the average broker. This costs can change depending on algo used, venue traded at and if the trade gets done at the auction close on an exchange.

When it comes to clearing, there are two separate instances to consider.

First, if a broker doesn’t self-clear it uses a clearing broker. There are fees paid for this service on a per share basis. There are also a fee charged for the proper handling of delivery and money. Lastly, there can be a special handling charge for those trades not settled on the normal settlement date.

If a broker self clears, then it doesn’t pay for clearing services on a per share basis. However, Upard pointed out that a broker does incur financing costs when short-settling a trade, and it does pay a host of fees to the National Securities Clearing Corporation and the Depository Trust Corporation.

“The DTC, meanwhile, charges a host of account maintenance, securities processing, corporate action, custody and failure-to-settle fees,” Upward said. “We highlight these fees to illustrate that even if executing brokers can shop around for better prices from clearing brokers, the clearing brokers themselves are constrained in how low they can cut prices.”