Unbundling likely to have profound effect on profit party
Life is sweet right now for Hong Kong's stockbrokers. With the Hang Seng Index back above 18,000 for the first time in more than six years and the market enjoying sky-high trading volumes, they are making money by the fistful.
For many, however, the party cannot last. As changes in the way big investors pay commissions spread into Asia, widespread job losses within Exchange Square's broking community look increasingly likely.
The trend is already visible in Europe and North America. Since the beginning of this year, Britain's Financial Services Authority has required fund managers to tell their investors exactly how much they pay brokers for executing buy and sell orders, and how much for company research.
In Asia, however, there has been little distinction between the two services. Brokers here generally charge a single bundled commission for execution and investment advice.
That means if a fund manager wants to receive research reports from a star analyst, he has to pay by routing orders through the dealing desk of the analyst's employer, even if its execution is sloppy.
Equally, if a fund manager chooses to buy or sell through a particular brokerage company because of its deft execution, he often pays for its research whether he wants it or not. Inevitably the extra costs get passed on to the fund's ultimate investors.
Now, however, things are beginning to change. Prompted by demands for greater transparency, more big international fund managers are insisting on commission sharing agreements which reward brokerage companies separately for execution and research.
For example, Schroders, which manages funds worth more than US$200 billion worldwide with a sizeable Asian portfolio, has signed commission sharing agreements covering all its Asian trading.
According to managing director Elisabeth Scott, Schroders now allocates its trades on the basis of best execution, while stipulating that the executing broker must pass on about 50 per cent of the commission payments to the fund manager's favoured research houses.
Schroders is not alone. Julian Pickstone, managing director of Asian equities at UBS, says 14 of the Swiss bank's clients have already introduced unbundling in Asia with another eight in the process of switching.
The effects on the stock-broking industry are likely to be profound. Evidence from London suggests most of the execution business will flow to the biggest, most highly capitalised brokers who boast the greatest ability to handle large orders without moving the market.
That inevitably means the big international investment banks with their active derivatives desks and block trading expertise will capture the greatest market share. Second-tier brokers will struggle to compete. 'It is going to be painful,' warns Ms Scott.
Unbundling is also likely to sharpen competition on the research side. Some big fund managers will move more towards employing brokers for execution services only, while building up an in-house research capability. It could also encourage more analysts to set up independent boutiques, pressuring brokerage company research departments.
In the end, the ordinary investor should benefit. With greater transparency, commissions should come down. With better execution, spreads should narrow and the adverse market impact of trading should fall. And with more competition, the quality of stock research could even improve.
But for many brokers, unbundling could take the shine of the current bull market.
