Unbundling debate: Participants
JT, ClientKnowledge Unbundling’s aim is transparency of pricing. Nirvana in that context would be a world in which you undertake your execution on a pure best execution basis. You pay for capital commitment as an explicit element, for standard research supply, for Bloomberg screens, for consulting, ideas generation, model building, all as separate explicit fees. That would be a logical conclusion for full unbundling. How close are we to that?
MS, SLI We’re close. What you describe makes complete sense, and I think we’ll get there. But I don’t think it will deliver much more added value than the commission sharing agreement (CSA) process. From the Financial Service Authority’s point of view, unbundling needs to deliver transparent information to the client, and protection for the client. The key enabler of that is the complete freedom of the trading desk to place every order where they wish on a best execution basis. If anything achieves that, then it’s met the number one deliverable from unbundling. The CSA process does that. So would complete disaggregation, but, it’s just adding another one or two percent to something which is 97% delivered.
Execution
JT, ClientKnowledge Mention unbundling to most people and the debate centres on the fundamental value of research services. But perhaps the most profound change is that making the cost of research explicit will reduce the amount of money the buy side will be prepared to pay for it, which in turn means that the sell side need to focus on flow to recoup lost revenues. Are we seeing this?
TT, Morley Almost every investment bank I’ve spoken to about unbundling seems to think it’s about execution rather than research. This may reflect the internal politics of investment banks these days – trading is everything. But it seems that flow is very valuable to them, even though flow is the ultimate commoditization. It’s nothing more than capturing some big pool of money. Is trading the be-all and end-all for the investment banks these days and is that view what drives their approach to unbundling?
JQ, Citigroup Not in our case. By the end of this year we will cover 800 stocks in Europe, that’s up around 25% over the past few years. We’re making a big investment in our research product, and in the areas where we're getting some traction with the clients. This may be in emerging markets such as Russia, in specific special areas such as accounting or in strategy. These are areas where we’re making significant investments. Clearly we recognize there is a value to flow and we want to participate, but flow isn’t everything. We still consider our clients to be clients, not counterparties.
CJ, Henderson Well, when we say to brokers, ‘We’re going to pay you with a CSA cheque’, they tend to say, ‘No, no, we want execution. We’ll take the flow.’ Clearly £1 worth of commission on execution is worth more to them than £1 written on a cheque and given to them. There’s a big land war going on amongst the top ten, or 15 brokers. They want that flow, and they know if they don’t get it, they’re gone.
JS, Schroders A number of broking firms claim they’re losing a fortune executing our business, wanting more reward for it. But equity trading must be profitable, because everybody’s trying to do it. We think the flow is hugely valuable.
CJ, Henderson There is certainly a group that has aggressively saying they want 20, 30% of our execution business.
EM, Lehman As people become unwilling to pay an explicit payment for research, then the currency of payment will increasingly shift towards volume. So volume has value, and that value will vary from bank to bank. As volumes continue to rise, and as explicit payment for research goes down over time, obviously one should make sure that they’re in a dominant trading position. It doesn’t mean that they de-emphasise their research operation, but if you ask them how they would like to get paid – cheque or trade, they’ll say the trade.
CJ, Henderson Flow is more points of contact, so more opportunities to do business.
EM, Lehman I’d just like to add for clarity that we don’t believe the value research generates for our clients is declining. We think the value of intellectual capital in general is becoming increasingly important as our fund-manager and trading-desk clients deal with larger assets or run more complex market structures. However, the explicit payment for that research, the explicit commission rate or aggregate amount of money that’s paid for that research, will decline and that is what changes the currency of payment I mentioned.
MS, SLI This takes us back to the question of where liquidity and execution might go. One radical possibility is a logical extension of the importance of flow and unbundling, and relates to the number of houses used to execute. In the past we have used a large number of counterparties as reward for all the services that they give us. Now we have the freedom, we don’t have to. They’ve been unbundled, they’re separate payment streams, so we take this intermediary step of appointing a number of key counterparties to handle our execution and use them to pay a much wider list for research. A logical extension of that, based on the value of flow, would be to appoint one organization to handle all your execution, to get the maximum benefit of flow and you could still reward everybody from the CSA process for research. You could also negotiate the cost, and I don’t mean the commission, I mean the impact, the entire cost of execution, with that counterparty in advance. We’re better off, you’re better off, you’ve got the flow, you pay everybody else for research.
