According to a report from Greenwich Associates, last year’s surge in equity brokerage commissions was driven in part by the forced selloff of U.S. stocks, which represented one of the few sources of liquidity for institutions in need of funds to cover deteriorating positions in fixed income and other areas of their portfolios. Hedge fund deleveraging also contributed to the trend.
“While the rebound in U.S. stock prices in the second quarter is likely to mitigate the resulting decline in commission payments, any significant reduction will be a challenge for brokers that are counting on client-driven capital markets businesses for revenues following the collapse of mortgage and sub-prime businesses,” said Jay Bennett, consultant at Greenwich Associates, in a news release.
Advisory Services Cutbacks?
The decline in commission revenues could result in cutbacks on sell-side equity sales coverage and research/advisory services.
According to Greenwich, the primary strategy used by institutions to reduce U.S. equity trading costs is to shift trading volumes from traditional “high-touch” trades facilitated by broker sales traders to relatively low-cost electronic execution. The proportion of overall U.S. institutional equity trading volume executed through high-touch trades slipped to 56% in 2008 to 2009 from 60% in 2007 to 2008, while the share of volume directed to electronic platforms increased to 36% from 32%.
The switch to electronic trading generates significant cost savings: The average commission rate on a “high touch” trade has been unchanged at about four cents per share since 2008; the average rate on “execution only” electronic trades declined to 1.6 cents per share in 2009 from 1.7 cents in 2008.
When they do use high-touch trades facilitated by sell-side sales traders, institutions are increasing the amount of associated commissions used to compensate brokers for research and advisory services, while directing fewer commission dollars to pay for sales and trade execution.
Increases in electronic trading volumes increase the workload for buy-side traders and should raise concerns about possible capacity constraints, Greenwich said. Institutions expect to increase the share of their total trading volume executed electronically from the current 36% to 41% by 2012.