U.S. brokerage firms could be facing a substantial drop in equities commission trading revenue this year, predicts the latest research from Greenwich Associates.

From 2008 to 2009, the amount of commissions paid by U.S. institutions to their brokers for domestic stock trading grew by 12% to US$13.7 billion, according to new research from Greenwich Associates. However, it also reports that sell-side firms are projecting a 23% decline in overall U.S. equities commission revenue and a 32% drop in hedge fund commission payments this year.

The firm explains that last year’s surge in commission revenue was driven in part by forced selling in reaction to the market turmoil, and the process of hedge fund deleveraging; trends that are now largely over.

“While the rebound in U.S. stock prices in the second quarter is likely to mitigate the resulting decline in commission payments, any significant reduction will be a challenge for brokers that are counting on client-driven capital markets businesses for revenues following the collapse of mortgage and sub-prime businesses,” said Greenwich Associates consultant Jay Bennett.

Greenwich Associates suggests that the decline in commission revenue could lead to cutbacks in sell-side equities sales coverage and research/advisory services.

“These reductions would come at a difficult time for U.S. institutions, which are still coming to terms with huge declines in portfolio asset values and in many cases are looking to outsource aspects of their investment and trading functions to the sell-side as part of their own ongoing cost-cutting efforts,” it says.

One way that institutions have cut their trading costs is by switching to electronic trading. Last year, the share of volume directed to electronic platforms increased to 36% from 32%, Greenwich Associatets reports. As a result of this shift, average commission rates declined to US2.9¢ a share in 2009 from US3.2¢ in 2008.

Also, when they do use high-touch trades, institutions are increasing the amount of commission that is used to compensate brokers for research and advisory services, and directing fewer commission dollars to pay for sales and trade execution, it notes. As a result, they are also increasing the workload on their internal trading desks, Greenwich Associates says.

“Institutions are being quite aggressive in their cost-cutting efforts, but they must be careful that they do not go too far,” said Greenwich Associates consultant John Colon. “Shifting trading volumes to electronic platforms can reduce trading costs, but it also increases the work-flow pressure on the institution’s trading desk. The shift also reduces the amount of commissions that the institution has available to obtain support from the sell-side in the form of sales coverage and research/advisory services. Taking this step while also reducing headcount on buy-side trading desks could prove problematic.”