The unbundling of research and trading has been a discussion topic for many years both globally and in Asia. While in theory there are many good reasons to unbundle, the practical implications have often made it difficult for asset managers to do so. However now several important business factors are pushing Asia-based fund managers to review their processes and consider how they value research and trading, while using more sophisticated tools to manage and report on who and what they pay.
Asset owners and regulators demanding more transparency from fund managers
It’s no secret that recent years of lower Asian equity turnover and compressed commissions have placed pressure on buyside firms to review the value of services they receive from brokers. However, demand for more accountability and transparency in this area is now also coming from other, arguably more important, angles.
As global funds invest more in Asia, mandates from asset owners to the fund managers come with global requirements – increasingly this includes best execution policies and reports on the use of brokerage commissions. In particular more fund mandates, particularly those from US or UK based pension funds or sovereign wealth funds, may ask for a breakdown of how much commission has been generated by their fund, and how that was spent. Asia-based asset managers who cannot demonstrate clear processes and reporting to their clients on how they select and what they pay their trading and research providers could miss out on winning or retaining mandates.
One of the reasons the mandates are changing is because of increased awareness among those asset owners of best execution regulation – which is now mandatory in many markets – and also corporate governance best practice around how brokerage commissions are used. For example the UK FSA (now FCA) in November 2012 published a review of conflicts of interest for UK asset managers which included the comment: “Firms regularly spend millions of pounds of their customers’ money buying research and execution services from brokers. Only a few firms we visited exercised the same standards of control over these payments that they exercised over payments made from the firms’ own resources.”1 This scrutiny has triggered a review of procedures by many fund managers, reinforcing a focus on this principle which is already written into voluntary codes of conduct for investment managers around the globe, from the US to Australia and many countries in between.
With client and regulatory review growing, the knock-on impact is global: initially the effect on Asia-based asset managers is perhaps most direct on those who have operations across multiple regions – and particularly those with significant UK connections where regulatory scrutiny is highest. However, as with any free market, as those firms raise the bar on the transparency they can deliver to clients, others will need to follow to remain competitive.
Putting the theory into practice – growth of CSAs and CSA aggregation
As these buyside firms look at client and regulatory demands for transparency, there is now a growing trend to have consistent best practice by using a model that will work across different regions. Typically this means applying a ‘highest bar’ approach where the region with the most stringent requirements is taken as the benchmark. The effect for Asia is that, despite little local regulation for fund managers in this area, for commercial reasons the same policies and internal procedures are likely to be applied when it comes to selecting and paying brokers.
Commission Sharing Arrangements (CSAs) are widely used as the mechanism to enable a more transparent approach. With overall adoption rates of commission management programs estimated at over 83%2 in the UK and 76%3 in the US and seeing year on year growth, it is no surprise that CSA adoption in Asia almost doubled from 2011 to 2012, from 22 to 43%4.
As the use of CSAs becomes more prevalent, this has also resulted in the development of CSA aggregation in Asia, led by ITG. This is a service whereby fund managers trade and build CSA credits with their existing CSA brokers, then to simplify the management and administration of the system, those credits are reconciled and pooled centrally by the CSA Aggregator. This reduces workload for the fund manager by outsourcing the time-consuming reconciliation process, and creates a single CSA balance from which to view and manage all payments.
An essential component of this service in the current environment is that it can be used to provide detailed analysis and reporting of commission spend, allocation by research type or provider, and do so in a way that can deliver reporting at an individual fund level, or within a framework that takes into account different global rules on CSA eligibility.
The multi-million dollar question…
Having CSAs and CSA aggregation in place does not in itself solve the industry’s challenge of defining how much research is worth – the multi-million dollar question which will ultimately have a different answer at every buyside firm. However it does provide a highly transparent framework for tracking how much is used to pay for execution and research, what is spent, and as a reporting mechanism in a global environment where a fund management firm’s clients, the regulators and the fund management business itself are asking for more transparency and accountability on commissions than ever before.
1. Financial Services Authority: Conflicts of interest between asset managers and their customers: Identifying and mitigating the risks. Section 3.1. November 2012.
2. Celent: estimate for 2011. Source: Commission Sharing Agreements in Asia, The Right Idea at the Right Time?. P11. August 2011
3. Greenwich Associates 2013 survey of US Investors4. Greenwich Associates 2012 survey of Asian Investors
Clare WittsContributors Head of Relationship Management, Asia Pacific
Clare Witts is responsible for the strategy and implementation of ITG’s interaction with institutional clients, regulators, exchanges and the media across the Asia Pacific region.
She also runs ITG’s Commission Management and CSA program in Asia and Australia.