The Changing Sell-Side
In a time of fundamental shifts across the sell-side, Adam Toms, CEO Instinet Europe, examines the causes, and consequences, of change.
To what do you attribute the fundamental changes underway in Europe?
Equity businesses have been in quite a severe amount of distress of late. Profit margins are being compressed and trading revenues through commissions are challenged given low market volumes. And with the global slowdown in trading by institutions, the commission “wallet” through which the buy-side pays for the products and services they consume has been shrunk considerably. If, as a bank or broker, you are not adjusting your cost base in response to that, you obviously end up with quite a severe economic problem, so we are consequently seeing a number of substantial moves to address the over-capacity currently found in our industry.
This capacity reduction can come in numerous forms. Some firms have shuttered certain businesses and product lines entirely. Others have more specifically defined what they are going to offer and to whom, perhaps servicing only a subset of their former clients in a more substantial manner. And still others have pursued a strategy of merger, acquisition or strategic alliance with rivals.
Is this a new trend or has it been underway for some time?
All of these things have been happening over the last few years, but the pace has quickened over the last six to nine months. However, regardless of the strategy a firm is going to pursue to deal with the slowdown, they have to first and foremost analyse whether they believe we’re simply in the middle of a cyclical challenge or whether a longer-term, secular change is underway.
If it’s determined that it’s cyclical, then managing it probably means reducing some PE expenditure, trimming variable expenses and hoping things start to turn around soon. But if one thinks it is secular, then that really calls for substantial change to the business model and all that goes along with that.
How do you come down on the cyclical versus secular question?
These are conversations we’ve been having at the Nomura Group for some time, and after significant internal debate, we’re firmly in the secular camp. Unfortunately you can only sit there for so long and say: “No, it’s just cyclical. If we just hang in here for a little bit more, the market is going to get better.” That approach will gradually end up compounding the problem, limiting options to correct the position.
What makes you think it’s a secular shift?
We do not think it is one factor but more a number of factors which in unison will result in permanent change, be it the associated equity asset class impacts from the global recession and debt crises through to new areas of focus for global regulators and even taxation initiatives.
Take the French financial transaction tax as an example. From the government’s and regulator’s perspective, it’s natural and appropriate to seek to minimise industry and economic risk through all of the tools available to them. But given the potential for unintended consequences, you hope that laws and regulations take into account their impact on the markets and institutions’ ability to effectively trade for end asset owners.
So how are you adjusting your business in response?
The Nomura Group, with its independent Instinet subsidiaries and its Nomura branded broker-dealers, had been running two distinct execution services groups for some time. When the businesses were competing on a different basis — Nomura a full service broker dealer and Instinet a more execution-only provider — we were quite happy with the structure. But once the group came to the conclusion that we’re in the midst of a broader secular change, it was important to identify a solution that would allow us to extract synergies, innovate and bring the two groups together.
We had a very clear decision to make: take Instinet into the bank, or move parts of the bank into Instinet. We believe our move to extract the cash trading channels from Nomura — essentially consolidating into Instinet — is the right decision. Instinet is preserved as an independent agency brokerage that places clients front and centre of our strategy, which is very different to other models and well-aligned to how we see our clients and the market evolving.
Coming to that conclusion presents quite an opportunity. First, there are significant savings to be had by consolidating onto a single platform, the vast majority of which are through the elimination of duplicate infrastructure costs such as algorithmic engines, connectivity, technology and vendor licenses, exchange memberships, etc. Second, it allows us to pick and choose the best components of each platform. And third, it allows us to take a step back and look at exactly how equity execution services should be provided in today’s markets. All in all we are targeting a bigger and more complete business, and when you consider the impact of aggregating the liquidity of both the Instinet and Nomura platforms, we feel this will differentiate our European business going forward.
We hope to complete the transition by spring 2013.
What about the pending regulations you mentioned? Does that play a role in this new strategy?
Yes. When you consider where regulation is headed, this model makes a lot of sense as well. First, there is a pressure globally to provide more transparency by segregating risk capital from agency execution, which this clearly does. And second, by moving execution to Instinet and keeping research as a stand-alone business within Nomura, we are effectively internally unbundling our offering, which is very much aligned to how regulators are encouraging our clients to think also.
Is there a downside to the new strategy?
While Nomura’s broker dealers can commit risk capital, Instinet cannot. But when you look at the cost of providing capital, it’s a tough game in low-liquidity markets like today’s. So, if you think you can differentiate yourself through an agency-only offering that marries the best of high-touch trading with a suite of electronic tools, we believe we can compensate for any loss due to a lack of risk availability.
How, if at all, will Nomura research clients feel the change?
The biggest change will be in terms of how clients pay for content services, as the execution services groups that existed within the Nomura broker-dealer units to monetise research and other services will be moving to Instinet, with Japan being the notable exception. We would obviously prefer that clients of Nomura research compensate for it by trading through Instinet, who will then direct a CSA payment or similar to Nomura. But Instinet needs to provide a compelling trading service alongside best execution in order for this to happen and we believe the strength of our offering delivers this.
How common are CSA payments in Europe? In some jurisdictions, like Japan, they are virtually non-existent.
It’s true that CSAs are not as prevalent in Japan and various other locations, but the landscape is continuing to evolve. In general, CSAs are well-understood and embraced in most jurisdictions globally. Specifically in Europe, securities regulators have attempted to foster transparency and choice by helping the buy-side embrace more of an unbundled model. But there is a vast difference across Europe in where that process actually stands. For example, in Sweden clients are currently unable to use commission sharing arrangements, but this is set to change shortly allowing CSAs to become an operational reality.
Instinet has been one of the earliest and most vocal champions of the CSA model, and as a result now has nearly 900 different brokers and independent research providers within its global commission management network. In fact, with this migration, Nomura will in some ways become another research provider in that network — it just happens to be one of the larger ones.
Are there any new business segments you may explore once this new model is set?
There are definitely some areas we’re exploring, some of which are made easier given Instinet’s independent model. I can see Instinet, in addition to continuing to service its core institutional clients, progressing its service offering to the sell side, essentially building on many of the execution services we provide to banks and brokers today. It could be commission management administration, core technology development or other white labelling solutions.
What has the response been from clients to this new model?
The response has been positive. Clients recognise that a firm cannot be all things to all people in these markets, and appreciate that we are being transparent in how we’re structuring things to do so. Most feel that this model provides a distinct value proposition while at the same time being sustainable for the long term.
I also think that clients like that Instinet will be able to continue providing a specialised offering. Many other firms, given pressures in their equity models, have attempted to move to more of a generalist coverage model to reduce costs. Conversely, we have staffed our organisation to be able to primarily provide a specialised service offering across high touch sales trading, program trading and electronic services.
More than anything, however, I think this will put to an end the questions over the future of Nomura and Instinet. The Nomura Group is keeping Instinet as an independent company that is segregated from the Nomura-branded broker-dealers. Yes, the Nomura Group is Instinet’s ultimate owner, but Nomura management also recognises that Instinet’s value is tied to its agency-only model, which is predicated on independence. It will do nothing to jeopardise that status.