European regulators’ efforts to unbundle payments for research from commissions paid on equity trades could have potentially significant negative consequences for both the buy side and sell side, suggests a new report from Stamford, Conn.-based Greenwich Associates.
The European Commission (EC) is preparing new rules that aim to modify, or even eliminate, so-called “soft dollar” arrangements that institutional investors have traditionally used to compensate brokerage firms for equity research, the Greenwich report notes. The most radical reform would be full unbundling, which would require investment managers to pay for research and advisory services with “hard dollars.”
Yet, any rule change would have a significant impact on large U.S. investors, many of which have significant global operations, the report notes. Furthermore, it warns that even a modest decrease in commissions or broker trading revenue could have a meaningful impact on sell-side provision of research.
“At the very least, we are likely to see a narrowing of coverage, with sell-side resources flowing to those investment managers most willing and able to pay,” says John Colon, managing director of Greenwich’s market structure and technology practice as well as the report’s author.
The reform proposals are a “solution in search of a problem,” Colon suggests. “The current system of ‘broker votes’ by which institutions allocate trading volumes to research providers and commission management programs bring structure to valuing and paying for research while also affording investment managers with a high level of access and flexibility and protecting the interests of their clients.”
Greenwich estimates in the report that large U.S. institutional investors pay about US$6 billion a year in trading commissions as compensation to brokers and other providers of research. And it warns that pushing the industry towards more explicit pricing may harm both firms and clients.
“Given the inherent difficulty of predicting exactly where value will be derived, an a la carte structure is not in the best interest of brokers, investment managers or investment managers’ clients,” the report argues.
“Nevertheless, in light of these discussions, many U.S. institutional investors are reviewing their policies and practices to ensure that expenditures efficiently support their investment processes and are in the best interest of their clients,” Colon adds.