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Equities: Flight to quality lifts smaller brokers

Relationships count more than ever in the world of equity trading.

The financial crisis and extreme volatility have created an opportunity for second-tier brokerage firms to win market share back from the bulge bracket.

The bulge bracket has transformed its business model the past decade to cope with falling commission rates and unbundling by focusing on automation and cutting back on sales-trader coverage. Large clients have responded by concentrating more of their business with fewer brokers to ensure full service while using commission-sharing arrangements to pay their smaller brokers and research houses.

Now, however, extreme volatility and fears of counterparty risk are turning the tide on the days of broker concentration, and large asset management firms are starting to talk about diversifying their broker lists.

Buy-side traders today concentrate almost three-quarters of their order flow with their core brokers and their biggest complaint is about inadequate sales-trader coverage.

High volatility and lower liquidity put a premium on unique sources of liquidity and high-quality advice, playing to the strengths of regional and sector specialist firms, which cover more than just the top tier of institutional investors and which have always maintained their focus on what are known as high-touch services: sales traders.

The disappearance of top-tier players such as Lehman Brothers and the consolidation of brokers such as Bear Stearns with JPMorgan and Merrill Lynch with Bank of America have also opened up a window of opportunity for competition as clients reassess their relationships with these firms.

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