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The changing role of the broker – The global financial crisis has triggered a global revolution of the buy-side/ sell-side relationship

By Ofir Gefen
Is the financial turmoil of recent months driving change in the brokerage model faster than ever? ITG’s Ofir Gefen believes the role of the broker is changing in an irreversible way, and that geographic differences are becoming less relevant to the brokerage model as the more pressing concerns of high volatility and trading costs, counterparty risk and business ownership come to the fore.
Recent turmoil in the financial and investment banking industry at a global level is pushing sweeping changes to the brokerage model across the board. Despite fundamental differences in market structure and buy-side behaviour between the US electronic trading world and that of Asia, the financial crisis is now creating convergence at a quicker rate than anticipated. Both buy and sell-side are being forced to adapt, prioritise and focus on costs, risk and efficiency. As the role of the broker changes, market boundaries are deemed less relevant as trading costs, volatility and counterparty risk move centre stage.
Having spent many years working in both product development and sales in the US, when I moved to Asia I expected to encounter similar challenges to those we had already gone through in the US. I soon realised it is easy to underestimate the issues created by the diverse market structures, regulations, cultures and trading behaviours across the Asia Pacific markets. As such, I prepared myself for a relatively slow evolution before the buy-side here would use brokers in a similar way to their US counterparts. The US market was characterised by a highly diversified range of electronic trading tools, mechanisms and providers, where the market had evolved in response to a range of demands from the buy-side, but operated within a homogenised market structure.
In Asia the range of brokers and the services they offer have generally been less differentiated, with markets gradually opening up to DMA and the adoption of algorithms, crossing networks and alternative trading venues still in the comparatively early stages. A 2007 Greenwich Associates report focusing on the US market looked at the evolution of electronic trading in response to sophisticated segmentation of liquidity, while at the same time talk in Asia was more at the mechanical level of developing connectivity and adoption of electronic trading.
As we move towards the second quarter of 2009, similar reports have a very different tone. The December 2008 TABB group study ‘US Institutional Equity Trading: Crisis, Crossing and Competition’ states: “These are tumultuous times… Trading becomes a treacherous affair, with all previous metrics of volatility and transaction costs going right out the window. Both asset managers and brokerage firms are in uncharted waters. The implications for the relationship between the buy-side and sell-side are far reaching and many of the assumptions we hold about that relationship will be overturned”. This is as true for Asia as it is for the US.
Moving beyond old-style equity execution
The traditional value of the sell-side broker has often been intrinsically linked to the provision of stock research, access to IPOs and capital commitment. In an environment where markets are swinging wildly based on high level economic and social factors, IPO pipelines have dried up and capital commitment is now too risky to offer, the traditional sell-side brokerage model is called into question. This has been compounded by the collapse of Lehman Brothers, the acquisition of some large investment banks and the recategorisation of others to commercial banks. Some asset management firms and hedge funds are now stuck trying to reclaim commission credits from the bankrupted Lehmans and counterparty risk is no longer just the concern of compliance officers. Its effects are now directly relevant to the buy-side trading desks. Simply put, asset managers are needing to move beyond the old methods of equity execution and reduce their dependency on traditional counterparties, wherever in the world they are trading.

In Asia Pacific, the variety of market structures, the lack of any common regulatory framework and the logistical challenges buy-side trading desks have faced in establishing trading across the region have dominated the evolution of electronic trading. Traders have often experienced different challenges in finding liquidity than their US counterparts. Nevertheless, buy-side adoption of DMA, algorithms, dark liquidity and crossing has been steadily growing, helped by the commitment of firms with different types of brokerage models to bringing new electronic options to the region. In the past few years, not only have the investment banks invested significantly in developing electronic trading tools for the region, but innovative agency brokers, crossing networks and, imminently, MTF-like structures have brought new opportunities to the market.

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