Better safe than sorry.
That’s the new mantra for money managers and broker-dealers concerned about the safety of balances held in commission-sharing arrangements. Both sides of the business are taking steps to protect the buyside’s CSA balances in light of the troubles of last year and the precarious financial positions of many large trading houses.
Money managers are spreading their business around to more brokerages and reducing balances faster. Major banks are segregating CSA accounts away from their brokerage entities.
“A year ago I don’t think any of us were focused on how we protect our money in these CSA accounts,” Greg DeSalvo, Goldman Sachs Asset Management’s chief operating officer of fundamental equity trading, said at a recent industry conference. “Times are different now.”
Behind the move to safeguard balances is the bankruptcy of Lehman Brothers. Many money managers kept CSA balances with the large broker which became unavailable when the firm collapsed. Concerns over the financial status of other trading houses is also prompting the buyside to demand greater protection of its funds.
There are roughly three courses of action industry participants appear to be taking: 1) use more, not fewer, CSA brokers; 2) segregate accounts from the broker-dealer entity; and 3) pay down balances faster.
GSAM is diversifying its roster of CSA brokers and asking its brokers to segregate its funds. “Not every broker is ready for that,” DeSalvo said. “Part of it is a negotiation.” The executive was speaking at this year’s TradeTech USA conference.
Brokers, at least those that are part of large banks, are taking steps to ease their clients’ minds. State Street Global Markets, the brokerage arm of State Street Corp., for example, is in the process of converting all of its customers’ CSA balances in the U.S., U.K. and Europe from brokerage accounts to “actual client accounts,” Robin Howard, chief executive of State Street subsidiary Financial Sockets, told conference attendees.
“We are segregating their assets to ensure they are in the best possible condition in the event of some unfortunate circumstances,” Howard said. The balances are rolled into money markets every night, Howard said, which gives them some protection by the Securities Investor Protection Corporation.
Commission-sharing arrangements are also known as client commission arrangements, or CCAs. They are agreements between money managers and their sellside trading partners that permit the fund manager to trade with one broker and buy research from another. The fund manager typically deposits funds into a CSA account at the trading brokerage upon completion of a trade. That broker then periodically doles out the funds to the money manager’s research providers.
The arrangement has become popular in recent years because of clarifications made by the Securities and Exchange Commission regarding the practice of using one commission payment to obtain trading services from one broker and research from another.
The move toward diversification may be benefiting smaller and mid-tier brokerages. A year ago, many in the industry were predicting that CSAs would hasten consolidation of trading into the hands of a few large bulge bracket firms. That outlook may be changing.
“When we first started to look [at CSAs], the average was about two to four brokers,” DeSalvo said. “The funny part was, you only wanted to go to the big bulge bracket players because that’s where funds would be safest. That’s not so much the case anymore. We are diversifying among those guys, as well as some of the mid-tier brokers. We all anticipated that many of the mid-tier brokers would be hurt by CSAs. In fact, it has been the opposite.”
GSAM is also keeping its CSA balances lower than before by sweeping them out quarterly.
Despite the perception of safety that comes with diversification, the trend of using more trading desks goes against the rationale for CSAs, others point out. CSAs allow the buyside to reduce the number of its trading partners and achieve some economic efficiencies. “Traders want fewer trading partners,” Frank Porcelli, Bloomberg Tradebook’s head of commission management services, told the TradeTech crowd. “Now all of a sudden, if you expand the number of CSA brokers, you are back to where you started.”
Both Porcelli and Howard noted that not all money managers are diversifying. The very large global managers are still seeking to reduce the number of their CSA brokers. “For ease of administration, they want to collapse that all into one centralized bank,” Porcelli said.
Still, DeSalvo warned against putting the eggs into too few baskets. “If you had asked people two years ago where Lehman fit in,” he said, “they would say Lehman was in that select few of CSA brokers. I would caution people that you just don’t know these days. It’s a very different environment.”
Money managers Cohen & Steers Capital Management jumped on the diversification bandwagon in the fourth quarter of last year. “Our worry was that not only would our CSAs have problems,” said Anthony Dotro, Cohen & Steers’ global head of trading, “but that our typical trading partners were having problems. Trading with Lehman, for example, ended up being wasted dollars.”