At stake is the lucrative but opaque system under which fund
managers pay brokers an all-in commission on every trade, charged to
the fund's clients, which covers not only the execution of the deal
but research and other services.
Total spending is estimated at 2 billion pounds ($3.4 billion) in
the UK and about $10 billion in the US.
The asset managers are already reining in spending in the wake of
new UK curbs on charging clients for research sometimes deemed
"questionable" and company visits, traders say. A ban proposed by
European markets watchdog ESMA on charging clients for research -
though not yet final - is also seen eating into brokers' profits,
pushing them to merge or cut costs.
Advocates of new rules say such changes will lead to a healthier and
more transparent financial market, though for the industry it means
another hit to trading profits in a post-crisis world where bank
risk-taking has been curbed and trading activity has yet to recover
"Brokers have already cut enormously, even the big ones, but equity
markets have been difficult," said Neil Scarth, a principal at Frost
Consulting. "We think that (new) research budgeting is going to
cause them to cut further."
Traders say the bundled commission system helps grease the wheels of
equity trading and allows brokers to be more than just "dumb pipes"
into the stock market, but critics argue that there is no price
transparency for clients and that a culture of one-payment-fits-all
has led to excess spending and little scrutiny.
"In no other industry do you see such a bizarre way of delivering
and paying for a service," said Richard Balarkas, consultant and
former head of electronic trading at Credit Suisse.
Both brokers and asset managers are likely to be under pressure to
restructure operations or cut costs, analysts and investors say, as
trading houses will find it much harder to fund large research desks
while asset-management firms will struggle to persuade clients to
pay much higher fees.
"The trend is clearly going towards an increasing amount of research
being paid for out of the asset manager's profits," said Arnaud
Cosserat, fund manager at Comgest in Paris. "For us it will not
dramatically change things as we have developed in-house
research...But those in the middle will be squeezed."
Industry associations are lobbying against the ESMA proposals and
have warned that trading volumes and market stability are at risk;
investment-fund body ICI Global said at a recent hearing that
unbundling would be a "major challenge".
"It is inevitable that there will be a decline in equity market
volumes and a rise in price volatility (if unbundling goes ahead),"
said Robert Buller, a spokesman for Paris-based broker Kepler
Cheuvreux. "Less availability of research will mean less
transparency on the correct pricing of stocks."
[to top of second column]
Advocates of unbundling argue that fears are overdone, accusing the
brokerage industry of supplying too much research of too little
value that is paid for by the end client.
One assessment from Morgan Stanley analysts is that the financial
sector could cut up to $2 billion of excess costs from research.
"The industry is spending more on research than investors are
willing to pay for," they wrote in a 2014 report.
While detractors say this will unfairly harm coverage of small
companies, some see constant demand for good research.
"Firms will have to make a choice as to whether they are a pure
trading business or whether they are providing research... This will
affect the big investment banks too," said Balarkas. "But quality
ideas in overlooked companies will always be in demand."
Traders worry that traditional relationships built up between broker
and fund manager may fall apart without the incentive of access to
research and other services.
"It's a big preoccupation for us," said a London-based trader who
declined to be named. "If clients have to pay a check to access bank
research regardless of how much trading volume goes to that bank,
why will they trade with that bank?"
The head of trading at a global asset manager, who declined to be
named, said he had already begun discussing with one of his brokers
about how unbundling might lower trading business.
For advocates of more transparency, this is an important step that
will in the end benefit the client even if it skims some of the
frothy profit from broker relationships.
"Asset managers are going to have to choose the things they want and
only buy those," said Frost Consulting's Scarth. "It will take
probably some of the excess profitability out of the relationship."
(Reporting by Lionel Laurent; Editing by Toby Chopra)
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