European Unbundling Could Dampen Research

Terry Flanagan

A move by the European regulators to unbundle payments for research from commissions paid on equity trades will have potentially significant and negative consequences for both the buy side and sell side, according to Greenwich Associates.

The European Commission is preparing new rules to modify or even eliminate so-called soft dollar arrangements by which institutional investors currently compensate research providers with commission payments on equity trades.

The most radical change under consideration is full unbundling, which would require investment managers to pay for equity research and advisory services with ‘hard’ dollars out of their own P&Ls or pass costs along in the form of additional fees. Any rule change by the European Commission would have a significant impact on large U.S. investors, many of which have significant global operations.

Given current stagnation in institutional equity commission payments and the related pressures on broker profitability, even a modest decrease in commissions or broker trading revenues could have a meaningful impact on sell-side provision of research. “At the very least we are likely to see a narrowing of coverage, with sell-side resources flowing to those investment managers most willing and able to pay,” said John Colon, managing director of Greenwich Associates’ Market Structure and Technology practice, in a release.

The reform proposals are a “solution in search of a problem,” Colon said. European regulators contend that investment managers are “sloppy buyers” when spending their clients’ money.

“The current system of ‘broker votes’ by which institutions allocate trading volumes to research providers and commission management programs bring structure to valuing and paying for research while also affording investment managers with a high level of access and flexibility and protecting the interests of their clients,” Colon said.

Greenwich Associates estimates that large U.S. institutional investors pay about $6 billion per year in trading commissions as compensation to brokers and other providers of research and advisory services.

European regulators appear to be pushing the industry towards more explicit pricing for individual services. However, given the inherent difficulty of predicting exactly where value will be derived, an a la carte structure is not in the best interest of brokers, investment managers or investment managers’ clients.

Particularly in the case of those brokers providing broad coverage of sectors and companies, giving clients the option to call on different broker resources as their needs dictate provides valuable flexibility.

“Nevertheless, in light of these discussions, many U.S. institutional investors are reviewing their policies and practices to ensure that expenditures efficiently support their investment processes and are in the best interest of their clients,” said Colon.

Featured image via Dollar Photo Club

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