Following up on my last blog about commission sharing arrangements and client commission agreements (CSA credits), I wanted to talk about some of the unexpected consequences (or requirements) that fall out of offering these arrangements. Nothing here is bad or problematic, unless you don’t understand it or are ill-prepared to address some additional client needs.
Based on recent news in the trade press and feedback from recent meetings, it appears that commission dollars and volumes for some agency broker dealers are starting to grow again. That’s good news. We think it’s driven in part by the use of Commission Sharing, CSA agreements and the access to new research.
However, this also has another consequence. Clients want to view their unbundled execution costs, seeing how much they are paying for this research as well as having greater transparency into their execution costs. In fact, it’s clear that clients are asking for cost-plus arrangements.
What does this mean? Well, in order to maintain that client, you’ll need to systematically calculate the specific costs of each trade, including maker/taker fees, complex exchange fees, SEC fees and other charges. Clients now expect you to charge them these explicit fees with an agreed upon mark-up. No longer can you charge the typical $0.04-$0.05 all-in commission fee.
The moment you fail to show these explicit costs and verify the mark-up, you’ll lose those clients and commission dollars to the next broker-dealer who can. You’ll have lost a client and wasted the resources that acquired in the first place. Even as commission dollars begin to rise, no one wants to take for granted a client relationship and lose it simply due to their inability to provide transparency and cost-plus billing.
Are you prepared?
Over the past several years, with the market meltdown and the ‘flash crash” last May, overall commission dollars have continued to fall in capital markets. In 2010, commission dollars were down over 20%. There are projections of another ~20% drop in commissions for 2011 as well.
In the years leading up to the meltdown, brokerages had been reducing their execution costs to retain and/or grow revenues. A large shift to electronic trading, algos, and improved smart order routing shaved points off commissions rates and lowered the costs of execution.
However, in the past two years, execution isn’t the only issue. The buy-side is actively looking for “alpha-generating” ideas through better research. It’s been reported that more than 75% of buy-side firms use some form of commission sharing arrangement (CSA) to gain access to the research they need to lure retail customers back and improve the overall picture in capital markets. The other 25% is increasingly moving toward the use of CSAs as well.
Bulge bracket firms continue to invest in research and technology as full-service brokers, because they can afford to do so. The rest of the execution-only brokers will find it increasingly difficult to compete for commission dollars without research and CSAs to entice the “alpha seeking” crowd.
In the past two years, Firm58 has helped some of the leading brokerages create and manage CSA programs through our hosted technology solution. Our Software as a Service (SaaS) subscription model lends itself to institutional brokerages of all sizes because infrastructure and hardware costs are eliminated.
Firm58 is committed to continuing our focus on CSA program management. Recently, we added Mike Plunkett to our Board of Directors. Mike was President of Instinet, a company that had one of the most successful and longest-running CSA programs, ever. Mike’s insight into the market is already translating into actionable solutions for our clients and our company.
How well prepared are you to handle this need for more and better research? Learn more about our CSA/soft dollar offering.