Buyside adoption of electronic trading tools is putting many sales traders out of work and making the job tougher for those hanging on. The future promises more of the same.
“There have been some firms that have closed down,” said Greg Voetsch, who runs Knight Capital Group’s institutional businesses, including sales trading. “There’s going to be some more consolidation over the next 12 months. There’ll be fewer seats, and competition will be tougher to get a seat.”
Based on research from Greenwich Associates, Tabb Group and Traders Magazine, the buyside’s embrace of do-it-yourself trading is putting downward pressure on high-touch commission rates and share volumes. It is also forcing sales traders out of the business, out of their firms or, at least, out of their comfort zones. Going forward, sales traders will have to work harder and do more business to make the same amount of money. That’s because they can expect to see less high-touch order flow at a shrinking commission rate.
The number of sales traders is on the decline at bulge bracket firms, but on the rise at independent trading houses. But as the buyside does more of its own trading, the overall demand for sales traders will continue to fall.
For starters, a growing amount of institutional order flow will be the low-touch variety, according to a recent study on evolving market trends in U.S. equities by Greenwich Associates, which will mean lower commissions.
Sales traders will see their share of order flow drop to about 58 percent by 2011, compared to about 70 percent today, the Greenwich study said. Specifically, more volume is expected to go through channels that include direct market access, broker algorithms and crossing networks.
Tabb Group estimates are even more aggressive. The consultancy estimates that the commission revenues percentage split in high-touch/low-touch channels by year’s end will be an estimated 57-43. By comparison, the split was 72-28 in 2005, and will be an estimated 53-47 in 2009.
Adding insult to injury, Tabb says, is that commissions for sales traders should shrink, as well. This should occur despite the fact that overall U.S. equities institutional commission revenues are expected to grow to $12.3 billion this year from $11.5 billion in 2007, the report noted.
Also, the average commission rate full service sales desks will see in 2009 will shrink to an estimated 2.88 cents per share, from the 4 cents-per-share rate they saw in 2005, according to Tabb research.
Finally, buyside firms are increasingly using client commission arrangements that trim the number of trading partners they use. This gives the buyside greater leeway in paying for research, while allowing it to better leverage its trading relationships.
In this environment, the sales trading business model balance has shifted from one that played to the strengths of the bulge bracket firms to one that works well at independent, institutional brokerages. And scores of sales traders who once sat at bulge bracket desks have now moved to the “eat-what-you-kill” independents.
With commissions so low, trading equities at the investment banks has been a difficult business. The main problem for bulge shops is because commissions have dropped with the advent of electronic trading, they have had to cut costs by letting sales traders go.
But those who remain are working with more clients and learning how to provide more services. So the firms are branching out into cross-selling more product offerings, including cash, derivatives, electronic trading and prime brokerage, among others.
Despite these gloomy trends, industry insiders said sales traders will always be needed, as high-touch order flow, though on the decline, will never disappear.
“That role is always going to be there,” said Knight’s Voetsch. “And you have to be able to add value by having the experience, being able to handle the liquidity, access the liquidity and some facilitation-type capital.”
These trends have made it critical for sales traders to demonstrate quickly where and how they’ll add value. With commissions shrinking and electronic and buyside trading growing, tomorrow’s sales traders must learn as many trading skills and tools as possible to become experts in low-touch and high-touch arenas.
To begin with, they’ll need to be well acquainted with the kinds of tools that reside on buyside desktops, according to Lance Lonergan, managing director and head of national sales at brokers Weeden & Co. Equally important, he added, sales traders will need to know how to source liquidity for and trade blocks, quarterback a program trade and coach the buyside through using crossing networks and dark pools.
“If a sales trader knows how those three worlds interact with each other, and you leverage each world for different types of orders to achieve best execution, then that sales trader has really got something going,” Lonergan says. “If you have that relationship, and you understand all of the different trading venues and you can help coach your client to achieve best execution, you’re going to get paid.”
And sales traders continue to be very important to the electronic trading client, even as their role is changing, said Will Sterling, global head of electronic trading at UBS. “They now add value by serving as execution consultants,” he said, “by helping clients make strategy and venue decisions, helping to provide context around what is happening with an order and what lessons can be learned post-trade.”
And though commissions have been falling for sales trading desks, volumes will continue to rise exponentially, said Mike Plunkett, president, North America, at agency broker Instinet. So, while the profit margins for sales traders are thinning, the volume scale helps make up some ground on those losses, he said.
One thing that won’t change, Plunkett added, was the need to do right by the customer. “You have to be a sales trader-type-person that knows how to take advantage of the market and its nuances, and how to solve your clients’ problems, and how to create efficiencies for them,” he said. “At the end of the day the clients just want to know how they can do their jobs better.”
