Brokers battle over agency versus full service

Yesterday saw a pair of agency brokers take on their full-service competitors in a debate over the assertion that the agency broker has replaced the full-service broker as the buy-side's broker of choice.

The debate was held at a Fix Protocol conference in Hong Kong and was moderated by Pierre Rousseau, CEO at BNP Paribas Securities Asia, whose opening question, asking the debaters to define what they do, led quickly to verbal punches.

John Fildes, managing director at Instinet, says agency means the broker does not advise a client, nor does it trade on its own account; but he stresses that an agency broker can be large and can offer bundled services such as research.

This means the focus is on best execution and avoiding conflicts of interest, adds Peter Twist, CEO of IND-X Securities.

The full-service side fired back that what the buy-side wants is good service regardless of who provides it. Harvey Twomey, managing director and head of prime brokerage sales at Deutsche Bank, adds that prime brokers are necessary service providers to young hedge funds.

A clash immediately ensued, with Fildes arguing that trading desks are not, therefore, using brokers solely for their execution skill, particularly in Asia, where there is no regulation such as in America or Europe that requires brokers and buy-side clients to seek best execution. He accused full-service firms of not engaging in best execution, and called the commission-sharing agreements now common in markets like Britain "a critical issue" for Asian investors.

The full-service side argues, however, that best execution can be broadly defined, although their arguments conflated execution with service. James Donovan, executive director of Asia regional sales trading at UBS, says full service includes block trading, information on global trade flows, global compliance, a global IT structure, and so on. Twomey adds in the case of prime brokers, best execution could mean offering custody, leverage, capital introductions and technology platforms to clients.

Most controversially, Donovan says full-service brokers offer a facilitation desk that requires capital, which agency brokers don't possess -- which Fildes attacked as a conflict of interest, in which client information can be used to front-run trades (although Fildes didn't explicitly say this; he said the client information would be used "to the detriment of the client").

IND-X's Twist poured it on, arguing that full-service brokers' global platforms simply meant 'commoditised' and hence low-touch. "Best execution requires market intelligence, and full-serviced brokers' service levels have come off."

Agency 1, full service nil.

Moderator Rousseau intervened, which is probably good for the full-service guys, who seemed to be struggling to respond. The next round, however, gave them a chance to score a point by asking the debaters what services could be bundled in with execution.

The agency chaps argue that by bundling service, fund managers end up getting goodies such as road trips to meet corporations that, from the perspective of asset owners, is not a good use of their money.

Twomey says, however, that in the current environment, pension funds seem focused on manager performance, not their commission structures. And for fund houses, the services that brokers provide are meant to add to their investment returns.

Agency 1, full service 1.

Full service followed its jab with a hook over the issues of counterparty risk.

On the one hand, say the agents, a full-service broker offers so many extra services, touching the buy-side in so many ways, that this creates more counterparty risk, and who knew what was going on inside the likes of Bear Stearns and Lehman Brothers -- but at least with agency brokers, you know what you get. As for prime brokers, the exodus away from players such as Morgan Stanley and issues over re-hypothecation of assets ("a posh word for 'stolen'", says Fildes) shows the dangers.

Very scary, but Fildes undermined his own argument by acknowledging that Instinet, for example, is owned by Nomura, a full-service broker in its own right which now also owns the European and Asian bits of Lehman's. Twomey put this one to rest by noting that the big financial institutions in the US and the West are now implicitly guaranteed by governments; the challenge is not whether they pose a counterparty risk, but whether they have the resources left to maintain good service.

Before the full-service lads could make a clean getaway, however, Twist landed a final blow, noting that in this era of new risks and a demand among investors and regulators for simplicity and transparency, agency brokers seemed, on the whole, to meet this demand better than full service.

The antagonists having battled to a draw, Rousseau then suggested that both models serve different needs and could happily coexist. Awww. But one did get the sense, listening to all of this, that the full-service brokers are on the defensive, and that while agency brokers will not replace them, momentum is on their side.