Nearly two-thirds of European buy-side firms anticipate research eventually will be paid for from management fees not from client commissions, according to a recent TABB Group survey. European asset managers spent less money on brokerage research and trading in 2013 relative to market volumes. A separate survey of U.S. buy-side firms showed a rising share of CSA commissions going to research while the execution portions fell.
Extinction of research commissions?
TABB Group found that 64% of European head traders expect commissions will be paid for from management fees in the future. According to TABB: “Greater transparency in the research process will finally break the relationship between turnover of assets under management and the generation of research, not only impacting the total commissions paid, but fundamentally altering how research is bought, accessed and consumed, redefining the fragile ecosystem between buy and sell sides in the process.”
Will Commissions Be Paid for from Management Fees in the Future?
TABB Group spoke with 58 head traders of equity management firms across Europe, the UK and US. These firms comprise 49 long-only asset management firms and nine hedge funds, managing €14.6 trillion in assets under management (AUM). The interviews were conducted during Q4 2013.
TABB Group foresees liquidity issues arising from a regulatory push to unbundle. Fewer asset managers will have the wherewithal to purchase brokerage research, resulting in consolidation and reduced liquidity for mid-cap and small-cap stocks: “The ongoing concentration by both the buy and sell side will continue to propel equity trading to major industrialization, and the ability to access small- and mid-cap names looks set to become limited to an exclusive club of brokers and asset managers.”
Declining research commissions
Meanwhile, research commissions are getting squeezed. The survey found that European asset managers are allocating a lower portion of trades to high touch research commissions relative to electronic trading. While average daily equity market volume rose 16% year on year, commissions paid to brokerages climbed just 9%.
More than half of the participants cite traditional brokerage services as having the greatest value, yet just 4% anticipate increasing their order flow allocation to sales trading in 2014, with the majority increasing electronic trading. Survey respondents projected a 25% decline in allocations to sales trading in 2014 while allocations to direct market access or algorithmic trading were seen increasing by 52%. As the survey’s author, Rebecca Healey, put it, “Commissions for our sample set may have risen by 9 percent in 2013 after 2012’s dramatic decline of 27 percent, but the reality is that any upturn is unlikely to continue.”
As a result, the research market is becoming more niche-oriented. In its European survey, TABB found that smaller regional brokers were holding their own: “For European-based asset managers that are struggling with depleted commissions to maintain their relevance to a resource-strapped sell side, the response has been to return to local brokers in their search for valuable quality coverage.” This trend was particularly apparent in emerging European stocks: “Seventy-eight percent of participants now regularly trade emerging European stocks, and actively look to trade local stock where possible, enabling local brokers to retake market share.”
In a separate study of U.S. buy-side equity managers, TABB found that Commission Sharing Agreements are being used more aggressively in the declining commission environment. The research portion of the CSA increased from 1.9¢ in 2012 to 2.3¢ in 2013 while the execution component fell from .9¢ to .8¢. TABB believes this helps asset managers route more trades electronically.
Thus, the use of electronic trading does not have as much of an impact on the total commission pool, since bellwether buy-side firms are more comfortable increasing the research component of a low-touch trade. TABB believes this trend will spread and that the rate differential between high touch and low touch will continue to narrow. As a result, it raises the ceiling on low-touch market share that once existed.
Whether research commissions are headed for extinction, they are certainly under pressure. TABB’s surveys show that European asset managers are bearish on the future of research commissions, while shrinking their allocations relative to electronic trading. U.S. asset managers may be less dire in their views, but are also using CSAs to stretch research commissions further, ultimately increasing the electronic share according to TABB.