New York – Over the past several weeks we have been hearing an interesting story developing on the CSA front. It seems that one major CSA broker in Europe is about to implement the practice of paying interest on research commissions to its clients. This is of interest because it suggests that the debate about who the research commission pool belongs to (i.e. the money manager) has been finally decided. In addition, the practice indicates just how aggressively the CSA brokers are trying to increase or maintain market share as transparency-induced margin compression continues.
There are two types of CSAs, the pooled CSA and the individual CSA. The individual CSA has been around for some time and reflects an agreement between the executing broker and the research provider. These are also known as directed commissions. Pooled CSAs are more recent. These are the CSAs that are currently under the spotlight in the commission transparency push in both the UK and the US. A pooled CSA is an agreement between a broker and a client. Typically, the research provider is left on the outside and is covered by only a “participation letter”, which it signs with the broker.
We have already discussed on several occasions that the practice of pooled CSAs tends to concentrate the execution of equity transactions with the bulge bracket firms, leaving the mid-sized broker dealers under threat of diminished flow. At the same time, the fact that the CSA relationship dos not really include the research provider leaves the research provider in a weaker position than under a direct relationship. Further this leaves the research provider’s payment dependent to some extent on the execution/research split negotiated between the broker and his client.
Another question is at what point in the process does the broker receive payment for its proprietary research? If the model is consistent with recent studies about 20% of the commission is retained for proprietary research. It is also clear that unbundling does not allow for this research to be accounted for on the execution side of the negotiated split. Given that some negotiated splits are 50/50 arrangements then, does this imply that the research pool available to pay the third party providers would be 30% of the total commission.
One impact of interest payments on research pool balances would be the tendency of the money managers to delay the payment to the research providers so that they could collect a little more interest income. Granted, this is a bit of a stretch, but many RPs have already reported a lack of timeliness in receiving payment and some have reported non-payment since these programs were implemented.
Overall, the impact of commission transparency and the separation of the execution and research commission expenditure alongside the increased use of CSAs has had the effect of compressing margins and forcing trade flow toward the CSA brokers. The recognition that the “advisory” commission pool belongs to the money manager and that the fact that CSA brokers are prepared to pay interest on those accounts, reflects the growing competition among the brokers to increase or at least maintain their current trade flow and execution based commissions. Whether this turns into a very aggressive war among the CSA brokers, or it remains a tug-of-war only time will tell.