As brokers and asset managers gathered for the Extel awards — dubbed the “City Oscars” — last week, one topic took centre stage.
New rules on stockbrokers’ commissions are set to usher in one of the biggest industry shake-ups since the Big Bang reforms in 1986.
So-called “unbundling” is a key part of new regulation that is overhauling Europe’s trading landscape. From 2017 asset managers will have to separate out the payment of research from trading commissions, which has big implications for the funds and the brokers who service them.
“Unbundling is going to happen and it is happening properly,” Steve Kelly, head of Europe at WeConvene Extel, which hosted the awards, told the audience. “The buyside will become more selective and discerning of what research they want and what it is worth for them.”
The changes come as active asset managers are under pressure from the threat of passive investing. They are having to cut their management fees to compete, which in turn means reducing the commission paid to their brokers.
For their part, the brokers are facing permanent, structural changes: lower trading volumes, pressure on fees and better technology.
This combines to form a “perfect storm”, says Glenn Poulter, a director at consultant Stratevolve Financial Services.
“There is a lack of preparedness among the brokers,” he says. “They are facing structural and strategic challenges that they are not equipped to deal with.”
Many brokers and asset managers are adopting a “wait-and-see approach” ahead of the final Mifid 2 rules. One adviser to the securities industry says: “There has not really been any dynamic change in the market. This is a fair amount of bury your head in the sand.”
London’s brokers offer three main activities: research, execution and corporate finance/corporate broking. The sector is cyclical because of its reliance on equity capital markets activity for fees.
While there were casualties and mergers after the financial crisis — including Cantor Fitzgerald’s acquisition of Seymour Pierce in 2013, and Stifel Financial’s acquisition of Oriel Securities a year later — a number of firms have been saved by a rising tide of initial public offerings or were bailed out by institutional buyers. This looks set to change.
“There will be some significant casualties over the next 18 months where people capitulate and pull out or consolidate,” says Patric Johnson, head of securities at Panmure Gordon, which is in talks to buy the securities division of rival Charles Stanley Group. “The economics don’t stack up.”
UK equity markets have recovered since the crisis but equity turnover has not. The FTSE 100 is up 53 per cent since 2008 and the value of trades executed is still down 45 per cent. Pan-European commissions are down 59 per cent from the peak and are forecast to be $5.5bn-$6bn in 2015, according to Stratevolve.
Neil Scarth, a principal at Frost Consulting, a research adviser to asset managers, says: “The total revenues that asset managers pay to research providers will go down and they will probably choose to have fewer relationships. This will force brokers to create research in areas where they have an actual competitive advantage.”
Brokers such as Panmure Gordon and Westhouse Securities have been reducing the sectors they cover to try to make their business models more focused.
“If you’re a top-five rated broker you will get paid, but it you have an analyst who is rated 13th in the sector, you probably won’t,” says Mr Scarth.
As secondary commissions have fallen, brokers are increasingly focusing on winning primary business.
Mark Brown, executive chairman at small and mid-cap broker Westhouse, which delisted from Aim in September, says: “The only way to make money now is by doing deals and looking after clients well. In the past you could cover overheads with secondary commissions and corporate retainers; if you did deals, it was the icing on the cake.”
The junior market — the small and mid-cap brokers’ stamping ground — is also facing greater regulatory scrutiny, following a series of public relations disasters on Aim. These have included Naibu, the Chinese sports shoe maker that in February was forced to admit it had lost all contact with its chairman; Quindell, the controversial insurance claims processor that last month sold most of its business; and troubled stockbroker Daniel Stewart, a one-time nominated adviser to Naibu and Quindell.
These examples and others have renewed corporate governance concerns about Aim companies and the Nomads that look after them — and could prompt a further shake-up of the sector.
“As the regulatory environment gets tougher and more expensive, firms need to get bigger to shoulder the cost, and there will be more consolidation,” says Richard Killingbeck, chief executive at WH Ireland.