With money managers’ commission-sharing balances frozen at Lehman Brothers’ European unit, the industry is rethinking the critical payment mechanism.
“This is an absolute wake-up call for folks in terms of whom they have their CSAs with,” Ray Tierney, global director of equity trading at Morgan Stanley Investment Management, said at a conference last month. “I think there will be a push toward a consortium with some type of insurance wrapper.”
Lehman Brothers International, the European division of Lehman Brothers Holdings, is under the administration of accountants PricewaterhouseCoopers, as per U.K. bankruptcy law. Any balances in LBI’s commission-sharing-arrangement accounts are frozen, and the account holders are being treated as unsecured creditors. It is uncertain how long this will remain the case. The unraveling of the large unit is expected to last until 2018. Nomura Holdings did acquire Lehman’s European and Middle Eastern investment banking and equities operations. Sources opine Nomura will accept those CSA balances as its own.
In the U.S., some money managers tried to transfer their client-commission-arrangement balances out of Lehman, but were unsuccessful. In at least one case, a bulge bracket operator of CCAs, refused to accept the transfer of the balances, citing legal prohibitions.
Because of the problems, U.S. trading executives on both the buyside and the sellside are exploring ways to safeguard credit balances of client commission arrangements, the U.S. equivalent of the CSA. These are the monies held by brokers for eventual payment to the money managers’ research providers. Legally speaking, the accounts are the property of the broker-dealers, not the money managers.
Client commission arrangements account for about $2 billion of the total $12 billion commission pool, according to estimates by Greenwich Associates. Balances in individual CCA accounts held for the larger money managers can range from single-digit millions of dollars to double-digit millions. Funds come in after trades and go out when it comes time to pay research providers.
“The machinations around how CSAs are conducted and paid and where those balances are held will change,” Tom Wright, head trader at Sanford Bernstein, said at last month’s Traders Magazine conference.
One old idea being dusted off is that of a consortium. Rather than maintain CCA accounts at several different brokers, money managers would maintain an account at one entity that would deal with all the brokers.
The idea has been around for a while, but has never taken hold. Proponents say a single pooled account is easier for the buyside to manage than multiple CCA balances. Opponents say it results in a loss of control that could lead to information leakage.
Some aggregation already exists. In the U.K., both Goldman Sachs and UBS run their own CSA programs and pool other brokers’ accounts, as well. In the U.S., the idea of an independent operator of a centralized escrow or trust vehicle has also been tossed around. Cogent Consulting, which offers a software product to the buyside that consolidates their various balances into one virtual account, is sometimes mentioned in this regard.
Robin Hodgkins, Cogent’s president, said his firm has heard interest from the buyside on the subject of protecting balances, but has not received many requests to manage their funds. The firm has done research into the subject, though, Hodgkins said, and is willing to operate such a facility if enough demand materializes.
There would be a cost, of course. “Depending on the legal issues, it would cost between a modest and a large amount of money to set it up,” Hodgkins said. “Those costs need to be borne by someone.”
In any case, getting all the operators of CSA programs to agree to a consortium would likely be difficult. “Trying to get a consortium together is like trying to herd cats,” Mike Plunkett, former president of Instinet, told Traders Magazine. “I wouldn’t expect that to happen tomorrow.” The broker already operates a consortium-type arrangement called T*Shares that aggregates multiple CCA balances.
Another idea is to somehow segregate the CCA account from the broker-dealer, but within the bank that owns the broker-dealer. “We are looking into the legal/regulatory viability of whether a separate and distinct bank account for CCA balances can be created to protect those balances,” said Mark Conforti, Credit Suisse’s global head of client commission arrangements. “That would take that account out of the [broker-dealer] entity. Does that accomplish anything? Does it protect the client money? That is, of course, a legal question. But we are asking.”
UBS, which already functions as a sort of consortium in the U.K., pooling its own CSA balances with those of its competitors, is also examining the issue.
“At the very least, there will be some contracts written that protect your money if your commissions are sitting in another broker,” Bob Harrington, UBS’s head of cash equity trading, said at last month’s Traders Magazine conference. “There have been discussions internally as to how we are going to approach it.”
He added: “People want to be clear that if you are the holding bucket for the commissions, those are your dollars, not the entity’s dollars. So we will have to figure out how to structure that legally. And we will learn what will happen to Lehman International.”
MSIM has already taken steps to protect some of its balances. Tierney told attendees at the Traders Magazine conference: “We have already been able to establish insurance around a firm we had some concerns with. We moved some balances around internally to protect ourselves should another event occur.”
For some money managers, the easiest way to protect their balances is simply to pay them down faster. To spread their risk around, they will keep balances at 10 to 15 different brokers, for instance, and instruct those brokers to pay their research providers every so often. That way, balances never build up. Payments are typically made quarterly, Cogent’s Hodgkins said, but can extend to every six months. “Rather than pay them down once every six months, he said, “why not pay them down every six weeks or four weeks so it doesn’t really get to be so large?”
That money managers’ CCA balances could be at risk is not an idea that has generated much discussion in the past. With the Lehman bankruptcy, that has changed.
“This is all virgin territory, but we have to look into it,” Credit Suisse’s Conforti said. “Ultimately, the most important thing is protecting client money.”
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