With Joe Kassel, Global Head of Dealing and Exposure Management, AMP Capital
It is fair to say that Australia has had a unique vantage point to observe the long march towards unbundling and the looming regulatory changes in Europe. These changes will shape how an investment manager’s clients’ commissions can be used going forward. Spared from the entrenched practice of soft dollars in other regions, and their questionable usage of times past, the local industry has effectively adhered to agreed industry norms within a principles based regulatory framework.
It is clear, however, that the Australian market will be impacted by European regulatory changes. The focus now is on what this means for the industry and regulation here as Australia creates its own local requirements. For firms such as ours, with trading operations in Sydney, London and Chicago, the bigger conversation is also about how to respond to requirements in other jurisdictions and whether to adopt local requirements locally or the most onerous requirements globally.
From our discussions with our trading counterparties and with our clients when they conduct operational due diligence on us, it seems clear that European rules will become the effective regulation that global clients will expect Australian firms to adhere to.
Until now, Australia’s response has been to provide increasing transparency to clients in terms of how commissions are used and how much commissions are paid. Buy-sides have been able to demonstrate to clients that commissions are used only for research for their own benefit while absolutely cutting out any questionable uses that might have been a feature under previous norms in other markets.
Perhaps the single most effective measure to demonstrate how seriously we have fulfilled our fiduciary duties in this area has been our proactive regular review and adjustment of commission rates with counterparties. For example, a recent AMP Capital study looked at our weighted average commission rate paid to brokers over the last 25 years and showed that the average commission rate for equity trades over that time frame has fallen by one basis point per year. According to the study, clients have seen a 25 basis point drop in commission rates over the last 25 years.
For an actively managed fund this equates to a 25bp performance boost per annum attributable to lower explicit trading costs. The unbundling discussion aside this is a very concrete outcome for our clients.
The regulators’ role
We believe that it is very appropriate for the regulator to actively review conflicts of interest in investment management as well as take action when a principles-based approach has not worked. What is still unclear, however, are the impacts and steps to implementation of a prescriptive approach to assigning budgeted dollar amounts for particular items of research, and the segregation of anticipated client commissions accordingly into research payment accounts. It is important to our firm, for example, that our clients continue to benefit from our scale and that there is a satisfactorily transparent pricing mechanism for research applicable to all investment managers.
That said, Australian buy-sides are well placed to meet anticipated regulatory requirements and certainly, our firm is. We disclose to clients our trading activity, trade commission uses, commission rates, as well as any services received. Adapting further, though, to a more prescriptive, standardised, itemised, fixed priced research regime is work that still lies ahead for all investment managers.
Will there be a unified global regulation on CSAs and unbundling? Probably not. But in order for fixed budgeted dollar amounts, unrelated to the value of trading, to work, the buy-side needs a standardised solution. As a large firm it is also important that none of our clients subsidise research provided for any of our other clients. As a firm, and for our clients in aggregate, passing on the benefits of our scale in the market and our efforts to negotiate low commission rates ensure that we are not subsidising research provided to other asset managers just because we happen to be the big fish in a small pond.
It is also worth noting, smaller research providers are unlikely to see a negative impact because we see the trend of the percentage of commissions going to specialist research firms continuing to increase.
Smaller asset managers, on the other hand, who traditionally relied on bundled research, will face a number of tough decisions. Increasing internal research capability will be a financial challenge for small and medium-sized asset management firms. At AMP Capital, our ability to generate our own independent research is a definite advantage.
The long term impact will be felt on the sell-side. Already brokerages have downsized research departments, as bulge brackets directly reduce their coverage of stocks in anticipation that a lesser percentage of their commissions will be eligible to pay for that research. As their customer and an investor, we more actively coordinate with our brokers on how we receive research and what research we value most. By providing a clear understanding of our research needs, our clients’ commissions are spent more efficiently.
Further evolution on commission usage should be expected. Sell-side firms cannot afford to maintain prior service levels after unbundling. By reducing their offerings or restricting it to buy-sides willing to pay for it, sell-sides will eventually settle on a balance.
Effects on the buy-side
Whether we view it from the perspective of a regulator or a client, transparency is the goal. That push will not go away any time soon. In the last three years AMP Capital set up trading desks in Chicago and London, in part to be closer to the regulatory requirements in each market and verify – both for clients and regulators – that we are adhering to the highest standards in the markets that we operate in.
Transparency has had and will have many manifestations for trading desks: with whom, how and where we route orders, how we access markets, our ability to access all sources of liquidity, our execution processes, our analysis of trade outcomes versus expectations, the true cost of trading and importantly, our usage of research.
In the past we may have jealously guarded our proprietary research and market insights. These were our intellectual IP – they were our edge . Now, at all turns, we seek to share our insights, processes and expertise with our clients. This transparency is our new edge because that is what will help build trust and understanding with our clients and enable us to better help them meet their investment goals into the future.
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