Trading for Alpha 2011: CSAs in US and Europe

Transparency and quantitative metrics not only dominate the regulatory landscape in the US and Europe, but they dominate buy-side trading desks and buy-side portfolio managers’ desktops. Yes, traders and portfolio managers use market data, historical data and research analysis as inputs into their trade and investment decision-making, but they are increasingly making use of a new data set – the relative contribution of any sell-side firm to the total bottom-line of the fund. And they are translating that value directly into their commission payments to their sell-side partners.

Buy-side firms are closely tracking the relative value of their sell-side relationships. Through alpha-generating ideas and insight, brokers and independent research providers contribute to the absolute returns of the portfolio. Through best execution tools and analytics, brokers contribute to the efficient implementation of those investment decisions. When it comes to paying for alpha through superior trading services, the asset manager has a new tool that matches commissions to value with precision. That is the commission management agreement, or CSA.

In both the US and Europe, buy-side firms are concentrating their business in the hands of a few core brokers. Further, they are concentrating their CSA relationships with those very same core brokers. As they put an increasing percentage of their order flow through CSAs, they can pay for both third-party and proprietary research and ideas at the end of every month if they chose. Lastly, they allocate an increasing percentage of their commission rate to the alpha-generation component of the relationship as executions services become increasingly commoditized. While pressure on the execution allocation of the commission continues, core brokers nonetheless gain market share in the element of the relationship they value the most – order flow.

Buy-side and sell-side trading desks are shrinking as technology and electronic trading grow across regions and asset classes. It takes fewer traders on either side of the Street to manage trading activity in equities, futures, options, FX and soon standardized swaps. It will take fewer broker relationships to deliver the requisite suite of full-service coverage to the buy side. The global investment banks can offer research, analyst time, corporate access, the investment banking calendar. They can offer internalized liquidity, state-of-the-art algorithms and smart order routers across asset classes and regions. And they are happy to offer CSA programs, portal technologies and support personnel to help buy-side traders manage commission allocations across products, accounts and providers.

So as technology allows trading tools and trading desks to get smaller while at the same time increasing their capacity, the irony is that, on the sell side at least, the big get bigger.

Trading for Alpha 2011: CSAs in US and Europe

For this outreach-based report, TABB Group spoke with a total of 121 institutional equity management firms, including 68 head traders in the US and 53 head traders in the UK and Europe. They manage an aggregate of USD $12.9 trillion and EU €13.5 trillion. Discussions covered core broker relationships and their market share; the number of CSA brokers for both US and European clients; the drivers for choosing CSA brokers; the percentage of total commissions allocated to CSA accounts; and the breakdown of payment for execution vs. payment for research. They also examined the impact of unbundling and CSAs on overall commission wallet and commission rates. And they highlighted the most frequently mentioned core brokers and CSA brokers in both the US and Europe.