The Rise of the Buy Side
If one word described the evolution of the buy side’s relationship with the sell side in the past decade, it would be “empowerment.”
Since the 2008 credit crunch, technology, competition, and regulations have driven institutional investors to be more self-reliant than they had been in prior decades.
Buy-side traders are making more decisions regarding how, when, and where to trade rather than handing off their parent orders to their brokers’ sales desk. Asset managers also have inched closer to becoming liquidity providers as many have backed buy-side-only liquidity venues, such as BlackRock did with Aladdin in 2012 and buy-side consortium did with the Luminex dark liquidity pool in 2015.
“The term ‘execution consultant’ was barely on anyone’s radar 10 years ago,” said Spencer Mindlin, an analyst at industry research firm Aite Group. “Now sell-side firms are redefining themselves as execution consultants and are helping the buy side navigate the complicated markets as well as understanding upcoming regulation and market fragmentation.”
Fueling this evolution has been a trifecta of increased competition, enabling technology, and regulation, he noted.
Low volatility in the equities market combined with low-interest rates have made many asset managers take many of their easy-to-execute trades in-house instead of paying sales traders a three-cents per share commission.
This, in turn, has led broker-dealers to step up their holistic analysis of each client’s profitability.
“Regulations on how much sell-side firms can extend their balance sheets has forced the sell-side to pull back on its resources,” noted Mindlin. “At the same time, the buy side also is feeling competitive and cost pressures. It has led them to consolidate their relationships while trading more with fewer counterparties or eliminating counterparties that are not offering real value.”
The only way that the buy- and sell side can improve their respective efficiencies, and ultimately “do more with less,” has been through embracing, developing, and deploying the latest technology.
The rise of algorithmic trading and advancements in OMS/EMS technology have driven a fundamental transformation in how the buy side and sell side interact, according to Jonathan Clark, CEO of Luminex Trading and Analytics.
“When you think about transaction costs, you can see how the US equity markets going electronic has greatly improved value,” he said. “But it has also required the buy side to evolve. Now the tools that buy-side traders use are virtually on par with those of their sell-side counterparts.”
Although regulatory regimes like Basel III, The Dodd-Frank Act, and MiFID II have increased the cost of doing business for the buy and sell sides, Midlin viewed them as secondary drivers in the evolution of the relationship between the counterparties.
“Regulation definitely causes shorter term in the momentum pushing the industry in a way in which it is going anyway,” he explained. “The industry continues to figure out how to deal with regulation but the realities of the industry getting more competitive, automated, and technologically enabled is a longer-term driver in what shapes the industry. It might change lanes, but it is going the same direction down the highway.”
Mindlin also attributes the natural generational turnover within the industry accelerating the changes in the relationship as those who traded on the floor during the 80s and 90s and relied on relationships retire and leave the industry to those who entered the business during the rollout of Regulation ATS and Regulation NMS.
“That is when technology started to blend into the business and began disrupting relationships, but business was still done via relationships,” he said. “Those who are coming in now on the buy and sell sides really do not have an allegiance to traditional relationships. It is now about the techie on the buy-side trading desk talking with the techie on the sell-side trading desk.”
Whether these changes will benefit institutional investors, Mindlin declined to comment.
“I am not going to make a judgment call,” he said. “It just is how the relationship has changed.”
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