At Westminster Research Associates ( a unit of ConvergEx), we regularly field questions regarding the use of commissions to acquire research. The questions are typically the “What are best industry practices” and “What are my peers thinking about in the space” kind of questions. Recently, however, as regulators around the world examine the use of commissions, the questions are picking up.
As both trading and investment research have continued to become more fragmented, the use of CCAs and CSAs have grown to become established industry practices, now tracked and measured by many consultancies. With this growth has come more regulatory scrutiny and change, designed to protect consumers and further establish market integrity. And as regulators from different markets have provided guidance and direction, some more restrictive than others, we have seen a lot of raised eyebrows as industry stakeholders are wondering what this means for acquiring ‘research’ with commissions in the future.
In light of ongoing changes to the regulatory landscape outside of the United States, we’ve spent some time thinking about what research really is – its role and purpose in the capital markets. We started by asking ourselves two simple questions – “What is research?” and “Who are we trying to help?” We thought that perhaps these two simple questions would help us to stay focused on the matters at hand, as we parsed through past consultation papers, policy statements and comment letters.
Let’s start with our first question, “What is research?”
Wikipedia offers at least two definitions of research that would fit the bill for the investment world and our purposes.
1. In the broadest sense of the word, the definition of research includes any gathering of data, information and facts for the advancement of knowledge. (1)
2. Research is a process of steps used to collect and analyze information to increase our understanding of a topic or issue. It consists of three steps: Pose a question, collect data to answer the question, and present an answer to the question.(2)
This makes sense when we think about the research we undertook in our undergraduate studies or while at business school. Research is not a prepared answer, wrapped up in a report provided by someone who did the analysis for you. It is a process. To a portfolio manager or analyst, research usually means collecting information – ideas and data, perhaps both qualitative and quantitative – from many places and analyzing that information with the goal of finding good investment ideas, ideas that will hopefully help them outperform both their benchmark and their peers.
And the more information from which a portfolio manager or analyst can choose, the better. Most managers are hungry to find new sources of data and information, with data that is differentiated and scarce – or unique – being the Holy Grail.
Regulators on both sides of the Atlantic have carefully crafted rules over many years that address the provision of research and have voiced support for a marketplace where independent research can flourish. Certainly, they have been aware of themanner in which research has evolved and the sell-side has changed. This is no longer a new story. And we are mindful that finding the right regulatory balance is never easy. Too much regulation will slow innovation, new research and stifle competition, yet too little will compromise the necessary safeguards that protect investors.
We all know that once upon a time the sell-side was a defacto oligopoly, with investment research largely controlled by a handful of large brokers. Trading desks were the cash registers used to monetize payment for research, along with other services such as corporate access, capital and sought-after IPO allocations.
But today, thanks to changes in technology, regulation and globalization – research is more fragmented – it comes from everywhere. And with CSAs, research no longer even needs a trading desk or a home within a brokerage firm. To point, most new, innovative research does not come from bulge bracket firms, whose research today seems to be used sparingly.
WRA has offered regulators the following thoughts regarding the marketplace for research:
Much of today’s independent research is comprised of proprietary information and data that did not exist even a few years ago, and the pipeline of new information continues to evolve in unforeseen ways. Research has certainly become a more fragmented and complicated endeavor. With that, it now seems that research is more the domain of the buy-side’s “investment process” than it is a sell-side “offering”. Given this, a more flexible regulatory framework is imperative.
It seems counterintuitive to limit the information that can be acquired with commissions. Certainly, it makes it harder for portfolio managers and analysts to do their jobs. And while firms can use cash to buy research, only a few firms of size might, knowing that moving the industry in this direction would play to their advantage. Smaller players don’t have that luxury. This tells us that money managers who operate in markets with a more restrictive definition of research may well choose to live without the critical information that their peers in the US and elsewhere will still acquire with commissions. And the clients hiring them know this.
Which leads to our second question, “Who are we trying to help?” The answer, of course, has to be that we – brokers, money managers and other service providers – are all engaged in an industry whose ultimate goal is to help the end client whose assets are being managed – help to preserve and grow their assets and create wealth. And if we all pull the wagon in the same direction and have our interests clearly aligned, we come closer to accomplishing this goal.
Certainly brokers, research boutiques and money managers all have their own unique challenges and agendas. Transparency has increased and margins are tighter. Brokers, in particular, have faced challenges from the growth in the number of unique, specialized firms with expertise and client-driven solutions that have replaced commodity offerings that were once a part of the sell-side’s opaque bundle.
In running a brokerage firm that specializes in aggregating and managing CCAs and CSAs, we interact with executing brokers, research boutiques and investment management firms of all shapes and sizes. This provides us with a unique vantage point from which to view the way industry players interact with one another.
It pains us to see money managers overly concerned about the demands of their major brokers – almost working to keep their brokers happy to make sure they get what they need, whether it’s hitting arbitrary commission levels that made sense years ago, or paying for offerings that they don’t necessarily need or want solely because they need to curry favor.
Surely they know that their brokers, no matter how large, are there to be their partners in providing solutions that can help return value to their managed accounts. Is it that hard to say no once in a while? It is not the job of a money manager to make his brokers happy.
And it works the other way, as well. We see many clients win Pyrrhic victories – after driving execution rates to low levels they are suddenly faced with the realization that brokers simply aren’t making enough money to service them properly. You can’t blame the brokers for this.
Fortunately, we see investment managers becoming more mindful that brokers need to earn money too. And major brokers are starting to realize that in an unbundled world, their clients need the expertise of firms and people who are not from the big firms, yet who also need to be paid with commissions. This includes firms providing research, technologies, as well as commission management services critical to money managers.
Money managers know that the ‘client’ commissions which they generate are an asset to be managed and optimized. It is for them to decide how to best deploy this asset on their client’s behalf, regardless of the pressures placed on them by brokers and others. Clearly articulating what services they want and at what price, and perhaps just as importantly, what they don’t want, helps to achieve this. Savvy brokers will listen and know that if they help their clients achieve their goals, they will win in the long run.
In our past comments to regulators we have made the following suggestions: broaden the definition of research and give money managers the discretion to decide what is important, reinforce a framework that allows money managers to use commissions to acquire all research, and address any conflicts, perceived or otherwise, by improving disclosure. This has worked well in the United States.
With unbundling, CCAs and CSAs have become increasingly more important, as they are now the link between two very different businesses, research and trading. It appears that this will be the case for the foreseeable future in the US, and while the rhetoric may be high in other markets, we expect that ultimately, commissions will still be used as the currency of exchange to acquire research, even as the definition of research is tweaked over time.
Hopefully, greater transparency and a communication among all players – brokers and research boutiques, money managers and regulators – will help to move things forward and for the most part, keep everyone on the same page. And remembering that the commission belongs to the client will help.
We as an industry need to work together to find the right combination of regulation, competition and cooperation that will help us achieve the goal of maximizing value for managed accounts. Only then will we have really answered the important questions.
Mr. O’Halloran is co-president of Westminster Research Associates LLC, a ConvergEx Group company. Westminster Research Associates LLC, is a broker-dealer and FINRA member that specializes in the provision of investment research and commission management solutions to the institutional investment community.
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1. Shuttleworth, Martyn (2008). “Definition of Research”. Explorable. Explorable.com. Retrieved 14 August 2011.
2. Creswell, J. W. (2008). Educational Research: Planning, conducting, and evaluating quantitative and qualitative research (3rd ed.). Upper Saddle River: Pearson.
The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community. Please send your comments to Traderseditorial@sourcemedia.com
