Fewer sell-side broker relationships may become the trend
http://www.thetradenews.com/Asia_Agenda_Archive/Fewer_sell-side_broker_relationships_may_become_the_trend.aspx
The buy-side may enter a phase of fewer sell-side relationships, driven by lower volumes and increased regulatory responsibilities.
Gabe Butler, an executive director of Morgan Stanley in Hong Kong, believes that the industry is approaching a time when the buy-side may move towards a more minimalist approach to its sell-side providers.
“In the last year we’ve seen a number of buy-side shops start to cut down their algo brokers’ list. They feel it might be better if they confine themselves to understanding a smaller number of algo suites more deeply and they partner with the providers who have most money to invest in their algorithms’ performance and customisation.”
In addition, Hong Kong’s Securities and Futures Commission (SFC) is currently in the process of applying more regulation to algorithmic business. One result of is that the buy-side is going to have to attest to understanding the algo offerings of all its counterparties. That is an incentive to trim the list and look for assistance from those sell-side relationships that are maintained.
“Bigger firms tend to do well when markets become more regulated, as they have more scale, experience and can navigate through the additional regulation,” says Butler. “As one of the bigger firms in the market then, additional regulation is not a huge concern to us, but we’re well aware of the effect it has on the rest of the marketplace and on our clients.”
He believes that for an asset manager to stay high on the list for a particular broker has become harder and harder. To keep broker service at a very high level, the buy-side has to maintain their relevance to those brokers and put business their way. Until volumes start seeing some massive upward trajectory, as we saw in 2006/2007, Butler thinks this is the environment will persist.
“We’re definitely seeing a shift from a time that there was a rapid expansion in the number of brokers that were being used, perhaps towards a convergence where a user might use five or six, or cutting back to a list of about that number,” says Butler. “Those firms that are starting out now, they’re also likely to be looking to build to a list of about that size. That number still incentivises the brokers to continue to do their best in helping generate performance.”
A recent illustration of market demand for a bigger roster of sell-side brokers came in Asia after the 2008 bankruptcy of Lehman Brothers, when hedge funds who had previously felt comfortable using one prime broker, started to think that in order to avoid concentration risk, they needed more, preferably at least one from Europe and one North American.
“Now, if a hedge fund is starting out, they might feel they don’t need that many prime brokers, though if they have three, they’ll likely stick with them. We do see a degree of consolidation there and a lessening of the rationale from five years ago that they need at least one US prime broker and one European one.”
So, which sell-side firms will ultimately prevail? Is it necessarily the case that convergence will simply favour large firms? Butler summarises.
“You can be big and that would put you in a position to take advantage, but if there’s convergence, you’d have to service more clients, in an environment where there is still cost pressure with sell-side personnel salaries, and requiring expensive investments in operations and technology. Those firms that can afford to do it, and then actually do spend the money on IT budgets, should be the ones to win, whether or not they are necessarily big or small today.”
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