New York – The complexity of payment options is one reason why equity research is such a tough business. Research providers are faced with a variety of payment vehicles: commissions paid through Commission Sharing Arrangements or Client Commission Agreements (CSAs/CCAs), commission paid through traditional soft dollars, commissions paid direct (if you have a trading desk), and plain old cash, aka, hard dollars.
We are told by CSA/CCA brokers that volumes have been booming, as asset managers who have the agreements in place are putting more transactions through. The impetus has been to take advantage of ‘cost plus’ commission fees, reducing overall commission expense. Asset managers with CSAs/CCAs in place negotiate an execution fee based on electronic trading and then add an amount that can be set aside for research payments as part of the commission pool generated by the CSA/CCA. The payments are then used to pay for other brokers’ research, and for alternative research.
We assume that the bulk of the savings is coming from reduced ‘full service’ commission fees, which have typically been 4 to 5 cents in the U.S. CSAs/CCAs allow investors to pay for brokerage research at rates that significantly lower, anywhere between 20% and 40%. This helps to explain why brokers are saying that commission revenues are down 30% to 40% this year, even as volumes and security prices have rebounded.
Confusingly, we are also hearing from research firms which have their own trading desks that their volumes are up. We would have thought that with CSA/CCA volumes up, the volume of direct trading with mid-sized and smaller research firms would decline not increase. Again, cost may be the answer to this paradox. Although CSAs/CCAs save money on full service commissions, they are still more costly than direct trading.
So now we are seeing the ironic situation of research firms setting up their own trading desks, or beefing up existing capabilities. This wasn’t the way it was supposed to happen. CSA brokers were aggressively promoting CSAs as a way to reduce the number of trading counterparties (and consolidate more trading volume to the CSA brokers.) The Lehman bankruptcy changed that, at least for now. Counterparty concerns slowed the movement toward consolidation.
Will consolidation resume, or is the land grab over? The trend in financial services seems to be toward greater fragmentation (along with specialization), away from the universal banking models. If this is the future, we suspect that payment options will continue to be a labyrinth that research providers will have to navigate.