What, another study of commission sharing arrangements? Hot on the heels of the Greenwich Associates/Frost Consulting report we discussed last week comes another study of CSAs by Woodbine Associates, a Stamford-based consulting firm just up the road from Greenwich Associates. There must be a consulting opportunity here someplace.
Unlike the brief Greenwich/Frost report, the 44-page Woodbine study traces the evolution of soft dollars, and views CSAs as a form of soft dollars. According to Traders Magazine, the report concludes that CSAs benefit institutional investors and brokers more than the asset owners, and bemoans the lack of transparency associated with soft dollars.
“The world is crying for transparency, yet there is no movement toward a truly unbundled world,” Woodbine’s principal, Matt Samelson, said.
While it is true that most proprietary research provided by investment banks is still bundled with execution, at least in the U.S., CSAs represent a form of unbundling because they separate the execution component of commissions and use the remainder for payment of research. For this reason, the growth of CSAs represents an increasing amount of research being purchased with identifiable amounts of commission. According to the Greenwich/Frost report, the share of commissions going through CSAs in Europe has grown from 22% in 2008 to 41% in 2012, and from 18% to 34% in the U.S.
The Greenwich/Frost report focused on the growth of CSAs and predicted structural changes to equity markets, including more pension fund scrutiny of commission payments for research. The Woodbine report takes a darker view, seeing little progress in improved transparency:
“There is no political will among legislators to demand from brokers or the buyside what are the true costs or research and that those costs are clearly stated,” Samelson said. “These services are valued without any continuous guidance from regulators as to what and what doesn’t constitute eligible broker services in the CSA. A lot of discretion is left to the money managers and how it benefits their investment decisions.”
We find it remarkable that CSAs are flourishing despite regulatory neglect, powered primarily by asset managers need to stretch their shrinking commissions further. It is likely that CSAs will continue to grow as commissions remain an increasingly scarce commodity. The marketplace is enforcing a level of transparency without regulatory intervention.
Nevertheless, Woodbine is absolutely correct that the payment process for research remains arcane, convoluted and largely opaque. Although many independent research providers have defined fees for their research, independent research represents less than 20% of the research market. Moreover, as we have noted in the past, some of the most successful independents have found it economically rewarding to add trading desks so they can be paid on a bundled basis.
As the Greenwich/Frost report pointed out, the growth of CSAs has not reduced the number of trading counterparties, a finding which is counter-intuitive. We think this points to another aspect of the commissions opacity: payments for IPO allocations, and other grey areas where commissions provide benefits other than execution or research.
For Woodbine the commissions landscape is a glass half empty, whereas for the Greenwich/Frost report it is a glass half-full, and on the verge of significant change. Our view is that market pressures — mainly shrinking commissions — will drive more growth in CSAs and more unbundling. However, full transparency in commission payments will require greater regulatory scrutiny than is currently evident. Perhaps all these CSA studies will generate increased regulatory interest, but more likely it require some examples of egregious abuse.