European equity buy-side firms tell TABB Group they’re struggling to pay for research by order flow alone, with nearly two-thirds saying research will eventually be paid from management fees, forcing radical change to research payment models.
According to TABB in their annual European equity trading benchmark study, "European Equity Trading 2014, Part I: Get Set for Innovation," optimism over the future of Europe has returned, leading to a 16% increase in average daily volume from the sample set of firms interviewed, but only a 9% increase in commissions.
Long-only asset managers in particular warn of a further decline in commissions payable in 2014 as the industry becomes increasingly low touch.
Slowing fund flows, reduced commissions and a persistent shift from developed markets dramatically changed the rules of engagement for many buy-side firms in 2013, in order to ensure their survival.
Rebecca Healey, senior analyst, TABB and the study’s author, said: "With 96% of the buy side anticipating continued use of algorithms in 2014, the ‘juniorisation’ of the sales trading role offers little incentive for firms to continue to pay full service rates, with increasing numbers opting for greater levels of automation."
As access to quality sales trading declines further, she adds, buy-side traders say they are struggling to maintain their relevance to a resource-stricken sell side. While traditional brokerage services remain highly valued by the TABB study participants, as brokers reduce products and services, the European buy side are turning to a local-regional specialist as one of their top-five brokers in commissions paid.
The situation will intensify as asset managers across Europe anticipate a further reduction in their executing broker lists in 2014. The continued concentration by both the buy and sell side risks propelling equity trading to major industrialisation.
Healey added: "The ability to access small and mid-cap names will become limited to an exclusive club of brokers and asset managers which will have wider negative repercussions for Europe."
TABB interviewed 58 head traders of equity-management firms across Europe, the UK and the US, including 49 long-only asset management firms and nine hedge funds, managing 14.6 trillion in assets under management (AUM).
Conducted during the fourth quarter in 2013, interviews covered the cumulative impact of declining volumes and commission wallets; adjustments to order allocation; the value of the high-and low-touch trading channels; views on today’s market structure; and block trading and risk requirements and execution developments in Emerging Europe.
Due to the depth and extent of TABB’s findings, the study is being published in two parts, with Part II – focused on electronic, low-touch trading issues, e.g., algorithms, dark pools, order flow allocation, next-generation transaction cost analysis (TCA) and the impact of regulatory issues – being released mid-February.
Key findings from Part I include:
- 52% of head traders decreased allocation to sales traders in 2013; only 4% anticipate increasing order flow to sales trading in 2014.
- Traditional brokerage services remain highly valued by 68% of the firms; the most critical services include access to capital, liquidity and in-depth knowledge.
- As brokers reduce products and services, 61% of the traders are turning to a local-regional specialist as one of their top-five brokers in commissions paid.
- This situation will intensify as the relative value of being a core broker increases; 54% of asset managers say they anticipate a further reduction in their executing broker lists in 2014.
- As bulge brackets continue to retrench their activity in certain business areas, over 50% of the buy side anticipate a new broker moving into their top five.
- The shift to automation for the full cycle of the investment process as well as the execution process is not solely dependent on action by any individual regulator – a new economic reality for many.
- Greater transparency in the research process will finally break the relationship between turnover of assets under management and the generation of research, impacting not only the total commissions paid, but fundamentally altering how research is bought, accessed and consumed, redefining the fragile ecosystem between buy and sell sides in the process.
TABB believes that European dealing desks are now in a unique position. Previous experience from MiFID I will provide the valuable opportunity to capitalise. Trading teams have already been redefined, providing a framework to build a sustainable future for a new era of execution. With research and payment models set to undergo a similar evolution and across the asset classes, further innovation will emerge that should benefit smaller players as well as those who have been able traditionally to dominate.
Healey added: "The continued concentration of the industry – sell side to buy side to the underlying investments – has focused on a one-size-fits-all approach, which will no longer suffice. A new era of European specialisation is emerging."