Funds still spend half of bank trading payments on research

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That is the finding of a large survey by consultants Greenwich Associates, taking in 197 portfolio managers and 178 traders at European institutions, and published on November 22.

It found the proportion of trading commissions spent on equity research is falling, and has gone from 58% to 50% in the past two years. The practice is currently discouraged by regulators, but not outlawed. EU authorities want to completely end the practice by 2018.

The report referred heavily to the EU’s revised Markets in Financial Instruments Directive, which comes into force in 2018 and includes rules banning fund managers from paying for broker research out of their trade execution costs.

They will call for fund managers to cease paying banks and other sellside analysts for their work out of clients’ general funds. Instead, the managers must either pay the costs themselves, or set up a new “research payment account” under which client money may be used, but only if budgeted for and clearly delineated for the purpose, with regular reporting and auditing.

As a result of this, Greenwich’s survey also found that buyside firms expect to use “significantly less” research from global investment banks in the future.

Independent providers of investment research will be the big winners from the new trading rules in Europe, the report said. But Greenwich also said that managers are predicting a “modest downward pressure” on their research budgets, which might hurt all providers.

That may be because if fund managers continued to consume research at the same rate, but had to pay for all of it, the increase in costs might hit their bottom line.

Greenwich Associates consultant Satnam Sohal said it was “questionable how much research expense managers can actually bring onto their own P&Ls”, or profit-and-loss accounts.

Sohal also noted the “unique role” played by global investment banks in helping clients understand market consensus around what drives stock prices.

Greenwich has also published its annual assessment of the market leading banks in European equity research and trading. The two lists are not exactly the same, suggesting some separation of the two functions in the eyes of the buyside – but there was a lot of similarity.

It found Switzerland’s UBS had more than a 10% share of European equity trading, and boasted a 13.9% share of European equity algorithmic trading, making it the top bank in both categories. When fund managers were asked to vote for the top research provider, it was second-placed, behind Morgan Stanley.

Morgan Stanley had the second greatest volume of algorithmic trading, with 9.3%, and placed fourth in the chart for European equity trading, with a 7.6% market share.

And Bank of America Merrill Lynch came fourth in the ranking for research, second in the ranking for equity trading and fourth in the list for algorithmic trading.

But Exane BNP Paribas came third in the research table, despite not featuring in the top six banks for either regular or algorithmic trading, while agency broker ITG, which sold its investment research businesses earlier this year, featured in third place on the algorithmic trading list, with a 9.1% market share.

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