Brokers just can’t win these days.

New research from Aite Group reported that the brokers are spending upwards of $1.2 billion to deliver trading solutions to their buy-side clients, who continue to ask for more. Adding insult to injury, commissions paid to the brokers remain flat to slightly lower – meaning they are absorbing any additional costs to provide technology.

As background, Spencer Mindlin, author of the Aite report, titled “OMS in Focus: The Light and Dark Sides of FIX and Client Connectivity,” starts with the premise that brokers often subsidize a significant percentage of the cost of these systems by paying fees to the buy-side’s software vendors for connectivity and the right to receive orders electronically from clients. This practice has been compared to the slotting fees that suppliers pay to retail supermarkets to have their products sold in stores and placed on shelves. Aite Group estimates that brokers paid over US$1.2bn in 2017 globally to vendors and connectivity providers that deliver the software and solutions to asset managers. The connectivity fee model, which is often a complex blend of fixed monthly and execution-based transactional fees has recently come under scrutiny.

“Brokers, their buy-side clients, and buy-side order management systems (OMS) vendors have become mired in complicated compensation structures that include many variables, such as bundled pricing, soft dollars, and blends of fixed and transaction-based fees,” Mindlin told Traders Magazine. “Products and services are sometimes paid for by parties that do not always consume the services but are their sponsors. And now the revenue models for how OMS vendors are paid are under the spotlight”.

Key Findings:

Aite Group estimates brokers paid US$1.23 billion globally in 2017 for client connectivity.

“Brokers complain they are getting squeezed by their buy-side clients through commission compression while the buy-side’s vendors’ fees to the broker have not adjusted commensurately,” Mindlin continued. “Vendors’ profits stay the same while brokers claim they are now trading at cost or at a loss.”

Mindlin writes that the buy-side either has been unaware or has turned a deaf ear to the true costs of its technology, who’s paying for it, and the pressures the brokers are under. Because brokers are captured, the vendors can compete on price with their clients and make up the revenue by charging the sell-side. The buy-side, under pressures of its own to reduce fees to investors, votes with its pocket and has no interest in paying more than it has to.

“Vendors are experiencing pressures too. The technology and solutions they are delivering to both sides of the trade are expensive,” Mindlin said. “Clients expect their vendor to keep up with feature enhancements and provide compliance and regulatory solutions without having to pay more. Brokers and clients expect the network to work when it needs to work, and the costs to keep the lights on don’t change regardless of whether the client trades.”

Constantly evolving regulations create additional pressures, he added. The revised Markets in Financial Instruments Directive (MiFID II) seemingly mandates clients to demonstrate that they know the value of the products and services they are receiving from their partners and know who is paying the bill, and it mandates that conflicts of interest be rooted out and addressed.

“In the U.S., while the conversation around best execution and potential conflicts of interest have primarily been focused on exchange access fees and “maker/taker” fee models, and the potential for conflicts of interest between the asset manager and the broker, the potential for conflicts of interest associated with client connectivity are just as great or greater, and the money involved is certainly consequential,” the report finishes. “Some industry participants have advocated for greater disclosures around connectivity fees, like order-handling disclosures for brokers.”

The full report is available from Aite Group.