BUYSIDE INDEPENDENCE INCENTIVISES BROKER SERVICE BATTLE.
Relationships are being renegotiated as services evolve to match new landscape. Dan Barnes reports.
MiFID II has disrupted the relationship between buy and sellside firms more deterministically than any other regulation in history. It has set clear rules around the payment and valuation for sellside services, as well as the review of performance. Additionally, it has segregated trading venues between multilateral and unilateral offerings which overall has fundamentally changed sellside revenue models, and buyside responsibility.
When considering the effect this has had on buy- and sellside relationships, MiFID II should not be viewed in isolation, says Nicholas Greenland, global head of broker/dealer relations at BNY Mellon Investment Management, as relationships evolve over time where capabilities and requirements on both sides are changing. “Whilst unbundling has had an impact on how relationships are looked at, for most firms, this is not the only change that has happened over this period,” he says.
As the changes wrought by MiFID II have taken effect, other rules have been bedding down. Capital adequacy requirements have already reduced the balance sheet that banks can commit to risk trading. Derivatives trading regulations across the European and US markets have imposed margining for both cleared and uncleared trades, to reduce the potential for a systemic impact from default. At the same time, automation of trading has increased across asset classes, albeit with very different levels of adoption, led in part by the maturing of technology and its application. The economics of the asset management business has also been changing, driven by customer and regulatory pressure.
“The buyside is seeing fee compression, loss of assets from active to passive funds, and now in many cases greater pressure on how they spend their own money,” says Mark Pumfrey, chief executive officer at Liquidnet Europe. “So, their focus on getting the best possible value from sellside service has gone up significantly.”
Greater service, tighter bonds
With service divided across two lines, the first thing that changed was budgets. In the research space, that has led to an estimated drop in spend of at least 20-30% this year-to-date, based on consistent industry reports.
For banks the budget reduction is only part of the issue. As research previously had no commercial model, they are having to negotiate new approaches to getting their information into the right hands at the right price.
“The inducements rule means that often research providers have to go to a procurement team rather than individual fund managers,” says Vicky Sanders co-CEO of research distribution platform, RSRCHXchange. “They may have previously worked in broker communications but they might have worked in data procurement and bought market data. So some research firms are finding it very hard to describe why a fund manager might want their research to the procurement team, where a fund manager might understand more easily.”
Asset managers and brokers outside of Europe will also have to assess what effect these rules might have upon them. The Securities and Exchange Commission (SEC) in the US wrote no-action letters in 2017, in order to overcome rules which state anyone paid for research is considered an investment advisor. The overspill for effects of MiFID II outside of Europe is expected to continue.
“Anecdotally, I have heard of some buyside firms planning for the day when the impact of MiFID II is felt more globally as regards how they pay for research,” says Greenland. “The sense is that this will be client demand /commercially driven. For example, from what I can see the use of soft dollars in the USA has reduced steadily over recent years. Financial services are a global business, and with global investors/asset owners, it would not be unexpected to have broader global pressures to adopt some of the practices seen as a result of MiFID II.”
Payment for execution has also changed. Agency broker ITG found commissions paid to brokers for trading fell from 6.9 basis points (bps) in Q4 2017 to 5.2 bps in Q1 2018 in Europe (ex UK) and from 7bps to 5.9 bps in the UK over the same period, during which MiFID II came into force. By Q3 2018 they had fallen further to 4.9 bps in Europe and 5.3bps in the UK.
This increases the competitive pressure on broker/dealers which have consistently cut front office headcount over the last five years, falling by 12.7% since 2013, according to analyst firm Coalition.
Moreover, where sellside firms were once a trusted supplier of buyside execution technology, that service provision has become commoditised, and in some cases even superseded by home-grown tech.“ Some of the more systematic investment managers have even taken the algos upstream and are using a DMA service to get to market, so they are taking control of their execution and only using the sellside for access to the market,” says Chris Monnery, regional head of Electronic Execution Product Marketing, at trading platform provider, Fidessa.
To reintroduce a differentiated service at the point of execution, banks are fighting to offer consultancy and guidance on electronic trading. “Low touch services used to just be about getting access to the algos; there is now a requirement for a higher level of service,” says Monnery. “Now it’s a new battleground with greater customisation and defining, in agreement with the client, how a suite of algos is going to be combined forming how the broker differentiates their offering.”
A new vision of service
Where firms can offer both market access and execution venue, they are using that advantage to link connectivity with the technology and integration with order/execution management systems to provide more colour around low touch, thereby providing a better quality of execution.
Pumfrey says the recent integration of OTAS Technologies with Liquidnet’s frontend, called ‘Liquidnet Discovery’, fits this description, by boosting the capabilities of human traders managing low-touch desks. “If you have a blotter with 200 names on it, that is difficult to manually manage, so Discovery powered by OTAS can alert you to events on individual shares that really matter and will likely cause you to adjust and change trading strategies,” he says.
In some senses, this is taking the same level of automation that occurred in the choice and application of trading strategies across the equities execution in the mid-2000s and bringing it up a notch.
“OTAS technology taps into the indications of interest or watchlists and effectively ‘technologises’ what high-touch sales trading does, with advice and colour around market activity using statistically significant and back tested alerts,” he says.
However, buyside firms are no longer sitting back and waiting to see how their service providers are going to improve business; the considerable pressure to deliver change for all stakeholders is driving a concerted push for efficiency and growth.
“Asset managers, in my experience are being relentless on how to innovate and add value to their clients across as much of the value chain as they can; this is broader than just product returns,” says Greenland. “This means that partner sellside firms who can deliver bespoke and unique services to their partner clients can continue to differentiate themselves and embed themselves ever more deeply.”
For broker/dealers, agency brokers and research houses, faced with smaller budgets and more demanding clients, structural change is inevitable in order to match the new reality.
“I think we’re starting to see an inflection point,” says Sanders. “There will be consolidation and changes in market structure on the sell side, and we have seen some evidence of that happening already, but we are just nine months in. As we hit year end, and firms become clearer in their strategy, we will see some who decide to stop providing research, some who buy other firms. The next six to 12 months will be quite active on that front.”