CSA opponents stage comeback
Commission recapture firms are fighting back, following a decline in their global business in the wake of the UK's Financial Services Authority's (FSA) new disclosure requirements.
The FSA's Disclosure Code was issued in January this year, and the industry was given six months in which to implement it. The code aims to increase transparency in brokerage commissions, by mandating and standardising reporting. Unbundling commissions, breaking out execution costs from ‘soft dollar' expenditures on research and other services, may lead to lower costs overall.
Commission recapture firms are dismayed in that the FSA seems to have favoured Commission Sharing Agreements (CSAs) over commission recapture as a way of unbundling commissions. The FSA disclosure form includes a facility to report CSAs, but not commission recapture. As a result, the Wall Street full-service brokerages have pulled out of the commission recapture correspondent networks for London trades, a move that benefits the brokers but not their clients, say the commission recapture firms.
"The brokers are dropping out of a business that is good for the people who pay their salaries," said Bill Conlin, COO of Abel/Noser, speaking at a recent roundtable in New York on the future of commission recapture. "And where's the money going? Out of the pensioners pockets and into Wall Street."
Although both commission recapture and CSAs unbundled the price of trading, there are key differences between the two. "On the surface, CSA.s and commission recapture are not that different," said Stephane Loiseau, co-head of electronic trading at Société Générale. "The main difference is who controls the flow of cash."
With commission recapture, the plan sponsor or fund receives a rebate from the broker after the commission is paid, so that the plan effectively pays only for the execution of the trade, and not for any other services, such as research. The plan does so by working with a commission recapture broker, which can claim the rebate from any brokers in its correspondents network, and then pay back the plan (less a fee of around 25%). The leading commission recapture brokers - Lynch, Jones & Ryan (a subsidiary of Bank of New York), Frank Russell, Abel Noser - have a global reach, with correspondent brokers in exchanges around the world. According to Greenwich Associates, in the US in 2005, commission recapture amounted to $790m (€613m), or around 7% of equities commissions paid to brokers.
A CSA is an agreement between a plan or its investment manager and a broker, with no third-party intermediary. The broker itemises the cost of the trade and isolates the amount available to spend on research, to be purchased either from the broker or from a third party. This enhances transparency and means that research can be purchased from the best source. However, nothing is remitted back to the plan, and this, according to leading commission recapture brokers, is a major flaw. And significant funds are at stake in the UK - the FSA estimated between £105m (€154m) to £125m of soft dollar spending on research.
"CSAs give away the manager's control over commission as an asset of the fund," said Todd Burns, president of Lynch, Jones & Ryan. "The difference between CSAs and commission recapture is the same as with soft dollars - CSAs separate execution and research, but the benefits go to the broker, not the plan." Burns pointed out that there is no audit trail and rarely is there any firm arrangement about what happens at the end of each quarter to surplus funds that may remain after spending on research. Bill Conlin of Abel Noser put it more succinctly: "CSAs won't reduce costs."
David Rothenberg, director of Russell Investment Group's implementation services division, which provides commission recapture and management, agrees. "While disclosure and unbundling are good, only commission recapture is a proactive engine to manage assets spent on research. Commission recapture exerts a checks and balances force on the spending of soft dollars."
Burns also expressed concern that CSAs could lead to consolidation in the industry. "We have heard that the big brokers are leaning heavily on the managers to open CSAs and to open only a limited number of CSAs."
In fact, the big Wall Street brokers are no longer accepting commission rebate relationships in the UK.
Although the full-service Wall Street brokerages have pulled out of the correspondent networks, the commission recapture brokers have been actively expanding their correspondent networks. "We've been aggressive in signing new brokers," said Carey Pack, president of BNY Brokerage, a subsidiary of Bank of New York.
" The challenge is to convince the plans to move away from the big full-service houses."
Rothenberg of Frank Russell has also been expanded the firm's correspondent network. "We've enlisted more regional brokers, looking at less traditional avenues, and we've seen a leveling of capabilities."
Even though their correspondent networks may be growing in numbers, both Frank Russell and Lynch, Jones and Ryan have experienced a decline in their business following the withdrawals of the Wall Street full-service brokerages. Burns of Lynch Jones & Ryan noted that around 50% of his firm's clients have money in the UK, and that there is a spillover effect on its US business. Frank Russell has had the same experience: "We've seen a decline commensurate with the departures from the network," said Rothenberg.