Commission-sharing arrangements are leading to shorter broker lists.
Trading desks at money management firms are paring back the number of brokerage houses with which they trade as they take advantage of new research payment schemes by large brokers.
“We are likely to put more of our eggs in the bulge basket,” Bill Stephens, the head of global trading strategy at Franklin Templeton, told a gathering of traders recently. “That’s where we think we get the most overall value. It’s hard to find the value in leveraging commissions with smaller firms.”
Franklin Templeton manages about $300 billion in equities.
Last summer, the Securities and Exchange Commission issued new guidelines governing the use of commissions for the acquisition of research and trading services.
The regulator’s latest interpretation of Section 28(e) of the 1934 Securities Exchange Act made it possible for money managers to use commissions to obtain research from a brokerage but not trade with it. The SEC’s move has freed the buyside to trade with whichever broker they choose.
And with this new freedom, money managers are sharply cutting back the number of sellside trading desks they use. Facilitating this are the commission-sharing arrangements established by most bulge firms and large agency brokers.
CSAs permit the money manager to direct its commission payments to the bulge shop, which will then keep a portion for executing the trade and pass on the rest to the firm that provided the money manager with research. The process reduces the number of orders sent to smaller research-providing broker-dealers.
Lehman Brothers, for one, has sharply boosted the number of brokerage houses it incorporates in its CSA program. According to Brian Fagen, U.S. head of electronic sales at Lehman, the firm is paying about 300 brokerages for research on behalf of its trading customers. Last year, the exec told the crowd at TradeTech USA, that figure was 100.
Brazos Capital Management, a $500 million Texas-based money management firm, is another buysider taking advantage of CSAs.
Head trader Mike Crockett told the TradeTech crowd his broker list has gone from 197 relationships in early 2005 to 10 today.
“The number of relationships our firm had was ridiculous,” Crockett said. “There was no way best execution was being achieved. With commission sharing, I can pay for research without being beholden to a smaller firm that doesn’t necessarily have the best execution capabilities.”
Not all of Brazos’ trading partners are bulge-bracket firms, Crockett noted.