Concentration of Equity Commissions with Core Brokers Reinforced by CSA Increase
Well-equipped trading rooms on both sides of the Atlantic have been shrinking as highly efficient electronic trading technologies continue to manage ever larger amounts of business, using algorithms, smart order routers (SORs) and real-time decision-support tools to trade not only equities but futures, options, foreign exchange (FX), bonds and swaps, according to the Tabb Group.
Long-only asset managers at these buy-side firms tell the Tabb Group that they’ve been concentrating their trading business and commission-sharing agreements (CSAs) with fewer core brokers. The 80/20 rule is now the 70/30 rule, whereby just over 70% of total order flow generated by traditional long-only managers goes to a shrinking list of brokers in the US and Europe.
According to Laurie Berke, a Tabb principal and author of the new benchmark research study, ‘Trading for Alpha 2011: CSA in the US and Europe’, for 2010 and 2011 in the US alone, about half of the buy-side firms are pushing 100% of their CSA commission allocations through fewer than 10 CSA brokers, with an average across all buy-side firms of 9.3 brokers. Across the UK and Europe, the average is slightly higher at 10.2 brokers.
The economic significance of the increased commission concentration is, Berke wrote, “the elephant in the corner of the equity trading room.” As such, Tabb estimates that the total equity commission pool generated by these long-only asset managers in the US and Europe combined in 2010 shrunk to US$13.2bn, nearly an 18% decline year-over-year in the US and a minus 23.5% compound annual growth rate (CAGR) since 2008 in Europe.
Based on this shrinking broker landscape, the power to dictate the terms of the business relationship is now more evenly balanced between broker and client. Although brokers and banks have had highly detailed, cross-product, cross-regional profitability analyses on their customers, it’s the buy side that’s meeting them head-on with similar data. When both sides sit down at the end of the quarter or for a year-end roundup, Berke said, the traders and portfolio managers on the buy side of the table stand their ground, armed equally with hard statistics quantifying the value delivered. Broker votes, analyst votes, performance tracking on recommendations and transaction cost analysis from the trading desk are providing them with the ability to compare Broker A to Broker B on a range of metrics previously unheard-of.
It’s the full-service players who can penetrate the buy-side organisation by delivering investment insight and analysis, cross-asset, cross-currency trading and trade processing, Berke said, who will likely gain even greater market share at the expense of the mid-tier player who has only one or two core capabilities.
“In the end, though, that old sell-side question – ‘What have you done for me lately?’ – is forever going to be a two-way conversation. Brokers who just can’t compete or merely deliver mediocre services will lose market share rapidly,” said Berke.