Buy Side Pushes Brokers on Unbundling
Broker-dealers, increasingly struggling to make profits in the current low-commission environment, are increasingly turning to unbundled commission payment plans to stay afloat.
As equity trading commissions have remained flat – holding at the $9 million to $9.5 million level over the last three years, off 25% from their 2007 -2008 highs – brokers are increasingly moving away from a bundled solution – paying for research with monies added onto their trades. Rather, they are allocating separate money to pay for research via Commission Management Programs, which now account for more than one-third of all U.S. institutional equity commission flows, according to Greenwich Associates.
Earlier this year, the consultancy estimated that the annual pool of cash equity commissions paid by institutional investors to brokers on U.S. equity trades in 2016 to be $9.65 billion. This amount is down more than 30% from its 2009 peak.
CMPs are arrangements that allow institutional equity investors to pay for research and other services by instructing executing brokers to direct a portion of aggregated and separate money to third-party research providers.
Greenwich explained that while the CMP is not new, many executing brokers have historically chosen to keep away from this practice and pushing the buy-side to pay for research out trading commissions derived from in-house trades. But as in-house trading volumes have fallen at many brokers and the buy-side wants more transparency into how it pays for services, they are now willing to engage in other ways, such as unbundling, to keep a buy-side traders business.
That growing acceptance is helping push CMP usage to record levels, Greenwich said.
“Given the industry-wide drop in trading business, brokers today can’t afford to be so picky,” says Richard Johnson, Vice President Market Structure and Technology at Greenwich Associates and co-author of a new report, Commission Management Programs Remain Key in U.S. Equity Trading.
Brokers’ new willingness to accept payments from these arrangements has helped boost CMPs, which had previously stalled out in terms of growth. The proportion of U.S. equity trade commissions directed through CMPs users has risen to 36% in 2016 from 34% in 2015. From 2011-2014, volume executed via CMPs had plateaued at 32% of overall volume, so the growth over the last two years is a significant new trend, Johnson added.
Larger institutional investors are the heaviest users of CMPs. Among institutions with more than $20 billion in assets under management, 42% of commissions on U.S. equity trades are paid via CMPs, up from 35% in 2015. Among these big institutions, the proportion of CMP monies used to pay other, non-executing brokers for research and other services has almost doubled.
At the other end of the spectrum, small institutional investors have actually reduced the amount of commissions routed through CMPs. “This trend reflects the new dynamics of the buy-side/sell-side relationship,” says Kevin Kozlowski, Greenwich Associates Institutional Analyst and co-author of the report. “Larger accounts are able to take more control over their order flow and increasingly break the bonds between research and trading, while smaller firms need to concentrate business with a few brokers in order to remain important clients and protect their access to broker coverage.”
Looking ahead, Greenwich Associates expects institutional use of CMP “aggregators,” which has been on the rise for the past five years, to continue expanding. More broadly, upcoming MiFID II regulations around unbundling in Europe will likely lead to a knock-on effect in the United States and further increases in CMP usage.
Jack Pollina, Global Head of Commission Management Programs at execution broker ITG, told Markets Media that his firm has seen this uptick in the usage of CMPs for both traditional client commission arrangements (CCAs) and commission sharing arrangements (CSAs). Unbundling is catching on, he added, in the last several years as lower wallet spend by the buys-side along with global regulatory changes necessitates more transparency and unbundling of research from execution.
“We’ve seen an increase in the use of CMPs and unbundling – both with our clients and among others in the industry,” Pollina said. “Firms will unbundle everyone versus traditional bundled arrangements and will have leverage as to how much the executing research provider gets to keep for his research.”
So, if a buy-side trader was using a bundled arrangement and has now engaged in a CMP to fully unbundled execution from research, he now can see if he is overpaying for his research and has extra money left over. Any leftover monies are recovered, Pollina said, and can be placed into a bundled account and used to fund other research purchases.
“You (the buy-side trader) can more closely align your trades with your executing broker and measure the value of execution and research you get from them separately as defined and not over-fund/pay for research,” he said. “You can now use excess money to purchase other research.”
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