Institutional Equity Trading 2012/13: The Paradox of a New Paradigm

Executive Summary
Institutional equities are about to be restructured. Commission budgets have been falling year after year, yet investment managers demand the same level of services from their brokers. That dynamic is unsustainable. Today, many sell-side firms have reached the breaking point and are in the process of determining how to generate the same amount of revenue with less overhead. Brokers will begin putting together the pieces of their services in a new way to sustain profitability while trying not to alienate their clients.

Buy side traders acknowledge their brokers’ need to present new coverage models but according to TABB’s most recent research, they are concerned that consolidation of services may lead to degradation in quality and the loss of anonymity between the high touch and electronic desk.

Buy-side traders admit they want to keep services separate because they trust each desk as a separate entity, yet that trust dissipates upon hearing the idea of the two roles merging. They also fear that relationships that have taken years to develop will be diluted by an effort on the sell side to reduce costs. Brokers have a tough road ahead in reconciling where that trust gets lost in the idea of merging the low-touch and high-touch coverage aisles should they choose to do so, and this will take constant and open dialogue.

Equities market structure continues to be another major buy-side concern. More specifically, the level of off-exchange trading has caught the attention of equity traders. Today, a third of US equities volume is traded off-exchange, and participants express concern that market quality is being impacted. In addition the buy side’s trust in the dark venues has been challenged by recent regulatory investigations of several dark pool proprietors. Despite that concern buy side traders know to access liquidity they must keep sending order flow into the dark.

This year, we also saw the same trends from the past two years continue to haunt the industry, only to be exacerbated by weak volumes and lack of inflows. Shrinking commission wallets, declining rates, and a cut in broker lists have found no relief. However, the buy side has battened down the hatches and is fully prepared to weather the storm. On the buy side, there has been continuous preparation for a slowdown in business. They have already shortened broker lists, had difficult conversations with their brokers and addressed which services they need and how they will pay for them. By the time the buy side nears the end of its broker vote there is often little order flow left to distribute from the commission wallet.

Equity markets are about to reach another inflection point. This time the catalyst is not the typical bursts of technology or new regulations. This time the changes will be driven by an attempt to reconcile the reality of a prolonged period of contracting volumes, commission wallets and revenue with the optimism and growth embedded in the very concept of the equity markets. Being amongst the top ten brokers on a list has never been so critical. Smarter algorithms and block trading products will keep the buy side engaged, but it is the new balanced regime that will determine the market standards.
However, it has never been harder to strike that balance between relationships and – profitability, liquidity and anonymity, and expertise and efficiency -, and it has never been as important to find the resolution.

US Institutional Equity Trading 2012/13: The Paradox of a New Paradigm
For this year’s buy-side trading study, TABB Group spoke with 66 head traders of US institutional equity management firms. They manage an aggregate $15 trillion in AUM.   The interviews were conducted during August and September 2012.  We included in our conversations the cumulative impact of declining volumes and commission wallets; adjustments to order allocation; the value of the high- and low-touch trading channels; potential changes to broker coverage models; views on today’s market structure; algorithmic providers and product needs; and block trading and risk requirements.