Shining a Spotlight on the Client Commission Costs of CSA/Soft Dollar Aggregation Platforms across Asset Owners, Asset Managers, and CSA brokers

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Commission Sharing Arrangement (CSA) aggregation platforms offered by brokers and some technology firms are a well-accepted solution to the management of multiple CSA/soft dollar trading relationships.  However, most of these solutions are characterized by excessive, unpredictable, and opaque client commission costs, leading to volatile and unnecessary charges on client commissions, asset manager resource allocations and CSA broker revenues.

CSA’s and Aggregation Platforms:

CSA’s allow asset manager to generate trading commissions for the payment of third-party research.  They are a very significant portion of the buyside equity commission wallet, and most industry estimates peg CSA’s at over 40% of total buyside commissions.   4 out of 5 buyside firms have CSA’s in some capacity, and over 50% of CSA program volume is executed electronically.   The number of CSA brokers each buyside firm works with varies greatly, from a mere handful to close to 50 brokers.

CSA aggregation platforms are administrative services, utilizing technology and broker to broker communications to manage CSA trading commissions across multiple brokers, track credit balances, and submit research payment requests in one place.    These platforms are a unique element of the patchwork CSA regulatory landscape as client commissions are utilized to pay for them, yet they are not technically either trade execution or equity research.  In other words, client commissions are being spent to pay for this service which is not directly involved with the investment decision-making process.

History

Section 28(e) mandates that a broker dealer providing research be involved in “effecting” the trade.   The 2006 SEC soft dollar interpretive release clarified these terms and declared that the 28(e) safe harbor is available to an asset manager when two brokers share a commission, if both those brokers are involved in effecting transactions and one or both are providing research.   CSA brokers fulfill the “effecting” requirement by executing, clearing, and settling trades.  The SEC articulated a 4-prong functional approach to allow the CSA aggregation broker to also fulfill the “effecting” requirement, the most popular prong being “monitor and respond to customer comments concerning the trading process”.    When sharing a commission for “providing” research, that term was expanded to include brokers who “pay the research preparer directly”.  This affirmed the aggregation model, as CSA aggregators are not creating research, but simply paying a third-party research provider directly upon instruction from the asset manager.  

Economics

CSA aggregators share the execution component of a CSA trade with the executing CSA broker.   Rates vary depending on several factors (client, trading channel, trade volume, etc.), but the range is typically 4 mils per share (.0004 cents per share) up to 10 mils per share (.0010 cents per share, or 1/10th of a cent per share).  For example, on a 4 cent CSA trade with a 50/50 execution/research split and a 7 mil “toll charge”, the CSA executing broker keeps 1.93 cents per share, the CSA aggregator receives .0007 cent per share, and the asset manager receives 2 cents per share in their CSA credit balance to pay for research.    On international trades the average toll charge is ¼ bps.  

These “mils” can add up…fast.   If that particular asset manager is executing 10 million CSA shares per month with that CSA broker, the CSA aggregator is paid $7000 per month, or $84,000 per year.    Multiply across 15 CSA brokers (assuming identical trade levels) and the commission revenue for the CSA aggregator from one client is a staggering $1,260,000 for an administrative function that is the same regardless of share volume. 

Crucially, these client commissions are taken directly from the CSA broker, reducing asset manager revenue and service levels, including research and trading allocations.  

The Problem: Excessive Client Commission Costs

The problem with this model is excessive costs and overpayment of client commissions.   Payment to the CSA aggregator increases as CSA trading volume increases, in some cases dramatically.  However, the operating costs of administering the CSA program is essentially the same.  The payment to the CSA aggregator can quickly grow out of proportion to the costs associated with managing a client’s research payments, sometimes by hundreds of thousands of dollars.   

In a declining margin environment for trading equities (especially using electronic venues), the expense of the current CSA aggregation pricing model is unsustainable.  A 5 mil aggregation fee on a 50 mil electronic trade is 10% on every share.   In addition, the opaque nature of the current pricing model leads to cost uncertainty, lack of transparency, client inconsistency, regulatory risk, and unnecessary volatility across time.   

The Solution: Bring CSA Aggregation Cost Back to Reality

At S&P Global Market Intelligence, we provide a best-in-class CSA aggregation platform, free to the asset manager and with a flat annual CSA broker connection fee that does not increase based on trading volume.    Our platform is supported by a consortium that includes Bank of America, Barclays Capital, Citigroup, Goldman Sachs, and UBS Investment Bank, along with other large leading broker-dealers.  

This platform is directly tethered to the actual cost of managing a CSA aggregation system, including offering discounts for low volume CSA brokers.   Our pricing model can slash CSA aggregation costs across the board, and in certain cases by up to 90%.    S&P Global Market Intelligence is not a broker-dealer and we cannot compete for order flow.  

Reducing the excessive cost of CSA aggregation is a triple win as it benefits asset owners, asset managers, and CSA brokers together. 

Research unbundling has delinked research costs from trading volume, and it is time for the unbundling of CSA aggregation costs from trading volume as well. 

Finally, to stay ahead of future regulatory developments or industry sweeps, it is important for the buyside to review their spending on these CSA aggregation platforms to confirm they are not overpaying with client commissions.  

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About Author

Mike Mayhew is one of the leading experts on the investment research industry. In addition to founding Integrity Research, Mike is on the board of directors of Investorside Research Association, the non-profit trade association for the independent research industry, and a frequent speaker on research industry trends and developments. Mike has over thirty years of research industry experience. Email: Michael.Mayhew@integrity-research.com

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