The link between equity research and trading – long a foundational underpinning of the Wall Street brokerage business – is weakening, according to a report by Greenwich Associates.
Sixty-one per cent of the USD9.7 billion paid by institutional investors to brokers on trades of US equities last year went to providers of research and advisory services.
Given that proportion, it’s no surprise that brokers’ market share in institutional US equity trading traditionally has been tightly correlated to their performance as a provider of research and advisory services. That relationship is now breaking down, the report says.
“Although there is still a relationship between broker’s market share and position in equity research/advisory and trading, those two things are no longer moving in lockstep,” says John Colon (pictured), Greenwich Associates managing director and author of US Equities: Regulations Loosen Bonds Between Research and Trading.
While the leading brokers in US equity trading remain closely grouped in trading share (the top four are separated by only 50 basis points), they are much more widely dispersed in share of the research/advisory vote, with a spread of nearly 400 bps separating the top four. In addition, whereas the leading bulge-bracket brokers’ trading share historically exceeded their research/advisory share, the reverse is now true for three of the four leading firms.
The shifting relationship between research/advisory and trading partly reflects changing dynamics on both sides of the business. Bulge-bracket brokers are becoming less willing to cede research/advisory share to mid-sized/regional firms and independent research providers but are ceding share—particularly in electronic execution. It clearly hasn’t hurt that these mid-sized firms have been free of the regulatory issues impacting several bulge-bracket firms’ dark pools in recent years. Meanwhile, institutional investors are making more use of “tack-on” payments in electronic trading and commission management programmes to pay for research.
Regulations are playing a major role in weakening the link between research and trading, and no rule has addressed the issue more head-on than Europe’s MiFID II. Although the latest MiFID rules appear to stop short of the outcome many feared most—an outright ban on the use of trading commissions to pay for research—institutions in Europe are increasingly responding to the new regulations by moving to a “fully unbundled” model.
“By Greenwich Associates estimates, roughly 30 per cent of institutions drive 70 per cent of the US commission pool,” says Colon. “These institutions are more often than not global and intent on pursuing globally consistent practices.”