09 March 2015

Tabb Forum: Commission unbundling to drive asset manager shakeout

While the transparency resulting from unbundling research and execution may benefit the industry in the long term, changing the payment-for-research structure will guarantee continued consolidation of the asset management industry, creating further challenges for the financial services industry.

Opacity and confusion over costs and fees have convinced some regulators and market participants that the use of dealing commissions to purchase research is fatally flawed. In fact, buy-side trading desks have been slowly realigning internal processes to meet regulators’ requirements to unbundle the cost of research from the cost of execution. While the speed and depth of change may not exactly be in line with the FCA’s expectations, 58% of European firms now have a research budget in place, and 55% intend to switch to execution-only commissions when the budget has been reached.

And unbundling no longer is the domain of just the UK in Europe. The reality is that dealing commissions is yet another area of financial services where the global industry is undergoing painful metamorphosis. Constrained resources and greater accountability already have created demand for an improved understanding of costs versus profitability. The sell side is becoming more selective of what it provides, while the buy side has become more discerning about what it chooses to consume and how to pay for it. Seventy-nine percent of participants in the annual EU equity trading survey now use Commission Sharing Agreements (CSAs) to manage this process.

Rather than this standing as a resounding endorsement of the FCA’s lead in pushing for greater unbundling, however, greater confusion is setting in. Not every European regulator has interpreted the latest ESMA text in the same manner as the FCA, and European MEP’s are of the view that research payments were not part of ESMA’s remit. As a result, 30% of all firms are choosing to wait for greater regulatory clarity as to whether CSAs will be admissible in the final text from the EC. Paying for research from the bottom line would, on the face of it, appear to be a cleaner and more efficient payment structure. Using a bundled commission model, fund managers may or may not receive best execution if they automatically route orders to favored providers of research. Cross subsidization among funds and firms may lead to end investors paying for services they did not use. However, the alternative unbundled model is not without its complications.

If small and large asset managers are to pay equally for research – that is, for research to be paid for via a flat fee – smaller asset managers will be worse off, as the cost of paying directly for research will have a disproportionate impact on their P&L; larger asset managers have greater scale with which to absorb research costs. If the research is subsidized in favour of smaller asset managers, however, this would unfairly penalize larger asset managers. Use of CSAs may penalize existing clients of the funds; if research is purchased earlier in the year and then the firm switches to execution-only commissions for the remainder of the year, any new clients in effect receive the research for “free.”

Full article

© TABB