'Full Unbundling' Rules to Hit European Brokerage Model, Says Research

Proposed rules on banning the use of brokerage commissions to pay for equity research and advisory services could lead to radical changes in the European brokerage business model, according to research firm Greenwich Associates.
By Joe Parsons(2147488729)
Proposed rules on banning the use of brokerage commissions to pay for equity research and advisory services could lead to radical changes in the European brokerage business model, according to research firm Greenwich Associates.

The process, known as “full unbundling”, would mean firms would have to pay for the majority of the research with their own money, as opposed to brokerage commission payments generated from securities trades within their funds.

The process, put forward by the European Securities and Markets Authority (ESMA) in the revised version of the Markets in Financial Instruments Directive (MiFID II).

This goes one step further than the rules introduced in June this year by the U.K.’s Financial Conduct Authority (FCA), which banned the use of equity trade commissions to pay for “corporate access”.

“Not only did this ruling put the U.K. at odds with the United States, where commission payments for corporate access are permitted, it could also presage a more radical change in the business models of European equity brokers,” the research says.

Since the passing of the rules in U.K. many firms chose to adopt commission sharing agreements (CSAs), where a portion of the commission charged by the broker is segregated into a client account.

CSAs are largely now relied on as a primary revenue source by many small research providers. But when MiFID II comes into force in January 2017, not only could it lead to the CSA model being eliminated, but could also upend the entire business model for full-service brokers.

“If implemented in current form, investors would have three choices: 1) cut a check to research providers and absorb the cost, 2) pay providers and pass along costs to customers via higher management fees, or 3) stop buying certain research and services altogether,” says John Colon, managing director, securities & trading, banking & capital markets, Greenwich Associates.

According to the research, approximately 60% of all brokerage commissions paid on trades of European equities are used to pay for research and advisory service. These payments amount to around €1.5 billion annually.

UBS and Morgan Stanley were ranked as the two leading providers of European equity research, followed by Deutsche Bank, Bank of America Merrill Lynch and J.P. Morgan.

Similarly, research group TABB and tech firm SunGard published a white paper earlier this year which argued European regulations will have significant cost implications for smaller, boutique asset managers.

It suggested while the larger firms will be able to deal with the “full unbundling” rules, for smaller managers it will be harder to survive.

“When you are a boutique it is very difficult to write any sort of check for research,” adds one UK boutique asset manager.

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