This Infographic on Commission Sharing Agreements (CSAs) in Asia provides a visual representation of just how far unbudling has come in this part of the world. This infogrpahic and the articel below it appeared in our second issue of the Asia Etrader magazine
Please click the image below to see the full size.
Sub: The practice of bundling brokers’ research and execution services together cheats the end investor, finds Dan Barnes.
Asset managers can only demand improved execution performance from brokers if they can threaten to move execution to another broker, should the incumbent underperform. Where execution and research payments are bundled together, and the research is deemed worth paying for, the buy-side is stuck with the execution the broker chooses to provide.
Best execution has become a competitive tool in many developed markets, driving unbundling of research and execution and allowing competition to drive service provision for asset managers. Commission sharing agreements (CSAs), which allow payments to be split between research and execution brokers, have become more popular as a result.
“One of the main benefits of having CSAs is that they would be an efficient part of best execution; as it is standard practice in many Western markets, most of the leading global brokerages want to have it in Asia too,” says Anshuman Jaswal, senior analyst at research firm Celent.
In most Asian Pacific markets, uptake has been slow. Best execution matures in a three-step process. Initially it starts off as fiduciary duty, in a broker doing a good job for his client. Then it becomes a regulatory burden, with something akin to the Markets in Financial Instruments Directive (MiFID) in Europe, or the Regulatory Guide 223 (RG223) produced by the Australian Securities and Investments Commission (ASIC) providing guidelines. Then, once the rules are established, the market has the chance to turn best execution into a competitive edge rather than a function of compliance.
“We are seeing the rise of real-time execution consulting,” says Steve Grob, head of strategy at trading systems supplier Fidessa. “Rather than showing how well a trader is doing his job after 100 trades, he has tools on his desktop that can tell you in real time how an order is being executed. In a more complicated landscape with multiple venues, these tools can advise him to drop a trade in and out of different algos. It’s a more dynamic process than it has been.”
A guiding light
In Asia, such ‘complicated landscapes’ are just starting to emerge, creating the imperative for best execution rules. Japan has seen the proprietary trading systems (PTSs) SBI Japanext and Chi-X Japan increase their share of Japanese equity trading volume from 0.84% and 0.7% in January 2011 to 3.22% and 2.65% in January 2012, according to Thomson Reuters’ Equity Market Share Reporter. The progress may appear slow, but that is not too remarkable; there is no regulatory best execution obligation to route orders in Japanese markets, so although both markets can compete with the dominant Tokyo Stock Exchange (TSE) and smaller Osaka Securities Exchange (OSE) on cost, brokers are under no obligation to use them. These alternative venues are faced with a number of disadvantages. For example, when on 2 February 2012 the TSE halted trading for four hours, due to a technical problem with a market data feed, the PTS’s were also shut down by the Japan Securities Dealers Association, their regulator, while trading on the OSE remained open.
“Ironically Japan is leading the region in the use of alternative trading destinations, but lagging in best-execution legislation,” says Glenn Lesko, CEO of execution-only broker, Instinet Asia. “Many Japanese firms don’t use the alternative venues. They often have the use of the primary market written into their best execution agreements, and if they buy more than 5% of a company’s stock off-exchange they have to make a regulatory filing.”
Australia, which saw competition to the incumbent Australian Securities Exchange introduced last October when Chi-X Australia launched, has specific best-execution guidelines, under RG223, but these are not effective at making the separation between execution and research, Lesko notes.
“Many funds trade with brokers on the fully bundled model and select them on the basis of their access to research for deals; there is often little to demonstrate how trades are being allocated on a best execution basis,” he says. “There are standards for brokers now, but there is room for formal responsibility on the fund side as well.”
Regulatory pressure to deliver unbundling itself is also muted in Asia. Celent says that 76% of US fund managers used CSAs in 2011, as did 83% of British fund managers; both countries incentivised their use following concern over conflicts of interest with brokers. “There is no one strong party who would argue for CSAs in Asia,” says Jaswal. “The greatest pressure is coming from the global brokerages.”
These big players are taking standardised practices from their home markets in the US and Europe and exporting them, he says. “They have not been completely successful; they have the ears of the regulators, and they have got them interested in Singapore and Hong Kong, and also some Asian brokerages are interested,” he observes. “However they have other priorities right now due to the tough market conditions, but there have been agreements to look at this again in the next year or so.”
Rights of the buy-side
Those same market conditions that are dissuading the sell-side may be having the opposite effect on their buy-side clients, asserts Clare Rowsell, head of commission management services and marketing, Asia Pacific for broker and execution analysis provider, ITG.
“There are a lot of business imperatives which are encouraging firms to move towards CSAs,” she says. “At an operational and business level we are seeing increased adoption and interest in how to set up these programmes. In the current environment commissions are much tighter and there is less to go around. Most fund managers are adopting a rigorous evaluation process of the brokers and research providers they use.”
Rowsell says that this is leading to the processes for broker rating and research voting becoming better established, on a quarterly basis with fixed voting procedures and statistical weighting used to deliver improved accountability for what the buy-side is buying.
“Buy-side firms are also trying to reduce the number of brokers on their broker panel, so there is more commission available to reward highly valued brokers,” she notes. “That requires them to work out who they want to carry on trading with, and then add CSA credits onto those trades. If they want to reduce the number of brokers on their panel, the CSA mechanism gives them the ability to still make payments to other brokers who are providing research and value often from one of the smaller or emerging markets.”
The crisis has also meant that larger sell-side firms are often not servicing smaller boutique firms, leading them to look to independent research, while the number of independent research analysts is increasing as banks cut back head count.
“The big sell-side firms don’t have analysts in place so that smaller buy-side firms can just pick up a phone to get a view on what’s happening with a particular Chinese stock today,” says Edward Stockreisser, director for Asia Pacific at Lombard Street Research and co-chair of AsiaIRP, the independent research analyst association. “The more people who get laid off by the banks, the more experienced analysts there are with an independent view.”
Of course where there is opacity there is profit and brokers may well exert pressure the other way if feel they may be losing out. ITG estimates that for a buy-side firm trading US$1 billion in equities, the additional costs for trading in Asia, rather than the US, would be close to US$4.6 million.
There are also challenges to the model, argues Grob.
“Unbundling sounds like a great idea but there are two fundamental problems with it,” he says. “One is, how do you pay instead for research. By the page? By the investment decisions you make? The second is that the buy-side prefer to pay in commission dollars because that comes out of their funds, not their own pockets. And I think the CSA model has an equal problem in that it lowers the incentive for the execution broker, at a time when he’s got to support the kit to keep navigating this landscape.”
Nevertheless, the economics of successful research will win out asserts Stockreisser. “Asia is not one market; an analyst must have so much local knowledge to be effective,” he says. “You can’t have a French Bank, with a recently expatriated English analyst, based in Hong Kong, covering Korea and tell me that his is the best research available for tech stocks. As an investment manager you have to ask how you can get access to the Korean analyst who has been covering his technology sector for 20 years, and work out how to pay him.”