Two big investment banks are refusing to accept orders routed from fund managers in London using ITG’s Triton execution management system because of a row over interpretations of the Financial Services Authority’s rules against soft commissions.
The two Canary Wharf investment banks, both leaders in electronic trading, allege that the system of charges, which requires them to pay a percentage of the value of trades executed, effectively subsidizes the cost of Triton to ITG’s clients. They allege that this would be in breach of the FSA’s rules against the use of soft commissions.
ITG has rubbished the claims and dismissed them as a negotiating tactic by rivals unhappy with the success of its front-end execution management system, which has been adopted by some of the world’s largest fund managers. Triton is now used as the front-end trading application of 25 fund managers with collective assets under management of $6.5 trillion. The average assets under management of Triton users is $400 billion.
At the heart of the dispute are the charges that brokers receiving orders from clients are required to pay. These are levied for the use of ITG’s communications network, ITG Net, which is a separate company from its execution management system, with a separate P&L and management team. However, some investment banks competing against ITG’s brokerage business, a leader in advanced electronic execution, see these payments as nothing more than a clever way of getting around the rules against soft commissions – the use of commissions to pay for services that fund managers themselves should pay for, such as technology.
Network charges based on a proportion of the value of trades executed are quite common for technology companies. Although similar to commissions, these charges are paid by brokers to technology companies and not by fund managers to brokers.
"The principal behind the FSA regulation is that commissions should not be used to pay for the asset manager’s technology," says the head of electronic trading at one of the investment banks that has refused to sign with ITG. "What ITG is doing exactly replicates what happened with softing. The buy-side manager chooses to use ITG as its EMS and the sell-side firm receiving orders is obligated to pay ITG an explicit percentage of client commissions. ITG appears to represent that this is separate from their brokerage, and is a network usage charge. Our compliance people struggle with this, as neither the fund manager nor the sell-side firm have any discretion about the network: it is ITG’s network and is bundled with their EMS. If we could choose, we would gladly route the orders through any of several other networks that have cost structures not based on commissions which, obviously, is market practice in the network business.
"By compelling brokers to pay ITG a percentage of the commissions earned from trades received by fund managers using Triton, rather than charging the fund managers themselves, ITG is effectively transferring the cost of using Triton from its buy-side clients to the sell side, which we believe is against the FSA’s principles. We’d be happy to pay ITG for their services, but not on a clients’ commissions basis, as our understanding of the FSA’s guidance says that regulated fund managers are not permitted to use their commissions in this manner. It’s softing all over again, with the simple difference that we haven’t set up a soft dollar account. It’s hard to imagine that, in a principles-based regime, this is what the regulator intended."
The head of dealing at a London-based fund manager with $260 billion of funds under management says: "We are completely comfortable with our arrangement with ITG. Triton provides a service to both us and brokers so it makes sense that they should pay. We pay for it with cash and we pay ITG commissions for certain types of research and for trades executed with them. Brokers are getting business from us that they would not otherwise be getting and a payment based on the value of trades executed is no different from a lot of other tech companies."
Alasdair Haynes, CEO of ITG International, says: "As a company we also supply an independent network to brokers that allows them to connect to all our Triton clients. We do not in any way have a contract with buy-side Triton clients asking them to pay for Triton via the network. Our charging structure for brokers is based on a percentage of the value executed through our network with them. We think this is the fairest way of charging for its use. We have held discussion with the FSA and we and our clients are fully comfortable with our approach."