Smaller commission pool to squeeze e-trading

Asian managers may have to direct more commission dollars to fewer sell-side brokers and shift to high-touch sales trading if trading volumes do not grow this year, says Greenwich Associates.

A recent report* by the US research house reckons that commission volumes in Asia could have shrunk by 20-30% across 2012. That would translate into $2.32 billion paid during the year for trading Asia cash equities ex-Japan and Australia, from $2.66 billion in 2011.

The forecast was made based on a 13% reduction in the total commissions paid to Asia-based sell-side brokers in the 12 months to end-August.

A slowdown in the number of IPOs, declining equity turnover and the global shift to fixed income and cash amid a general 'risk-off' sentiment on the buy-side last year have combined to squeeze the commission pool.

“The trading slowdown could mean hard decisions for institutions,” says Greenwich. "Pressure will begin to build if trading activity does not rebound in the coming year, and we would expect to see institutions forced to concentrate more of their business with their top brokers."

In 2012, trading volume on some Asian exchanges fell 20% year-on-year. Hong Kong's stock exchange, the leading bourse by IPO funds raised in 2010 and 2009, saw that figure drop 65.4% (to $11.6 billion) last year, with 36% fewer companies listing.

In the US there was not a big enough commission pool to satisfy all brokers, so buy-side institutions there were forced to concentrate on fewer counterparties, says Fion Tan, a consultant at Greenwich in Singapore.

Such a trend is not yet evident in Asia as the region's equities market had been growing consistently until 2012, she tells AsianInvestor. But that may change if last year's sluggish trading environment extends into 2013.

Meanwhile, last year some Asian buy-sides were diverting trading volume they had self-directed through electronic connectivity (such as direct market access or DMA) to high-touch sales traders.

Although this cost them more, they wanted to ensure their brokers were paid enough to maintain their equity research, advisory and corporate access service. These services represent a kind of fixed cost that buy-side institutions must factor into the equation when allocating commission to brokers.

“Globally when it comes to a decision by the portfolio manager on which brokers get paid what, equity research, advisory and corporate access is still the main driver of how the equity business [in these buy-side institutions] is run,” says Tan.

Greenwich finds that up to 66% of the commission allocation is driven by these research and corporate access services, with 26% driven by sales trading and agency execution with a view to getting price improvement and reducing market impact. The rest covers broker’s capital commitment and other areas.

The report shows that for the eight months of 2012, the share of total Asian equity trading volume done electronically remained flat from a year ago, at 21%, comprising algorithmic trading strategies, DMA/smart order routing and crossing networks. High-touch sales trading of single stocks was also flat at 74% of total volume.

Respondents said that in the next three years they expect the high-touch sales trading figure to drop to 66%, electronic trading to grow to 29%, with the remaining 5% comprising portfolio trades.

*The study was based on interviews conducted between July and September with 265 Asian equity fund managers and analysts and 114 traders at institutions in Asia.