Commission management – No One Size Fits All

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By Anita Karppi, Managing Director, Co-owner K&K Global Consulting (K&KGC), and Kristian Karppi, Managing Director, Co-owner K&K Global Consulting (K&KGC).
54 senior buy-side traders across Asia and Europe voiced their opinions about current and future commission management practices in the K&K Global Consulting Ltd’s (K&KGC) Buy Side Perspectives 2014 Commission Management report co-authored with FourFirth Consultants. This follows a long and intense debate between the UK regulator Financial Conduct Authority (FCA) and the European Securities and Markets Authority (ESMA) who advise the European lawmakers about the future MiFID II regulation.
We conclude in the report that there is unlikely to be a single global approach, not even within many of the Asset Management firms, to commission management. There is an opportunity for the buy-side trading desk to refine their role within the firm and the focus will increasingly be around the value the trader can add in the investment process. K&KGC recommend that buy-side firms evaluate the benefits of establishing a formal Trade Management Oversight Committee (TMOC) to oversee commission management procedures. Unfortunately only a few national regulators and buy-side associations are being pro-active and helping the buy-side firms in this process so there is a strong need for buy-side peer debate, collaborating to resolve the common challenges. Examples of top level responses from the buy-side regarding unbundling:

  • 79% say end investors are getting better information on what their commission is spent on.
  • 68% confirm that liquidity provision has not been affected due to changing commission management practices.
  • 53% think that unbundling provide the firms with a competitive advantage.
  • 50% think they receive a cost advantage.
  • 42% have reduced the number of brokers due to CSA’s.

The UK FCA was ambitious and early to implement regulation for unbundling in 2014, far ahead of MiFID II, with their own interpretation of how to treat research and corporate access within dealing commission payments. As the UK based buy-side were forced to unbundle their dealing commissions, 59% of the survey respondents chose to use Commission Sharing Agreements (CSA).
ESMA on the other hand, have deemed the current use and practice of CSA’s as not entirely meeting the objective of decoupling research charges from transactions. Something that subsequent to the UK FCA initiative has given unfair advantage to the largest banks who had such CSA arrangements with the buy-side and are subsequently rapidly gaining market share to the detriment of smaller brokers. The buy-side in Continental Europe were given more time to choose their preferred method of unbundling and the buy-side in Sweden and Germany has alternative means to unbundling which they deem more efficient and less administrative compared to CSA agreements. Various buy-side associations are now lobbying and coming up with alternative solutions for how CSA agreements can remain in use within MiFID II.
The UK buy-side also waved farewell to the use of dealing commissions to fund corporate access services. ESMA is not following suit, being descriptive about the future classification of corporate access. This means that an unfair form of regulatory arbitrage where a fund manager based outside the UK may be permitted to meet a CEO of a listed company in the UK funded by dealing commission charges, whilst a fund manager in the same firm but based in the UK is not.
The European buy-side will, successively as new legislation is rolled out country by country, need to transition to budgeting fixed, instead of relative, amounts of research budgets on a quarterly basis which should not be linked to transactions. The buy-side will apply stronger due diligence of what form of research they are consuming and paying for and if the charges can be passed on to their clients or not. To complicate the challenges further, where bundled dealing commissions have been exempt from value added tax, the European authorities have been unwilling to confirm that the unbundled research component will remain tax exempt. Consequently independent research providers will increasingly be set in a fairer competitive position against research brokers.
With such dynamic changes and inconsistency, the Asia based buy-side are still observing how regulation will emerge, not only in Europe but also in the U.S.A., in order to predict the national Asian regulators next move. The Asia based buy-side have a significantly higher dependency on the relationships with their sell-side partners and are protecting the mutual interest in paying for relatively higher service levels.
More detailed analysis and commentary can be found in the Buy Side Perspectives 2014 report about Commission Management from K&KGC. To purchase the full report, please email editor@fixglobal.com and take advantage of the GlobalTrading readers’ 10% discount.