Asian buy-side firms review broker relationships

A sharp fall in commission payments last year meant institutions had less equity commission from which to allocate costs for sell-side research and services, says Greenwich Associates.

Asian institutions use nearly two-thirds of their equity commission to compensate brokers for providing research, sales coverage and access to corporate management teams. That is nearly 10 percentage points more than the research allocation of equity investors in North America, Europe and Japan, according to a Greenwich Associates Asian equity study released last week.

A sharp fall in commission payments last year forced Asian institutional investors to adjust their approach to broker relationships, in order to retain the best sell-side research and advisory services, says the report.

Following steep drops in equity asset values in late 2008 and early 2009, and increased use of electronic trading in Asia, the amount of equity commission fell by 15% last year. It stood at $2.2 billion in the fourth quarter of last year, down from $2.6 billion in same period in 2008.

As a result, institutions devoted about $1.7 billion to sell-side research in 2007-2008, but in 2008-2009 that number dropped to roughly $1.4 billion. "Amid these cut-backs, institutions tried to maintain the amount of commission paid to their top research providers," says Greenwich consultant John Feng.

The most common response from both institutional traders and portfolio managers was to increase the amount of trading business allocated to brokers that provided consistent relationship coverage during the crisis. The second most popular measure taken by both groups was to cut the total number of brokers with which the institution maintains relationships. Moreover, around a quarter of portfolio managers say they tried to reduce their reliance on sell-side research and services altogether.

The survey findings also point to increased concern over counterparty risk. Last year, 43% of Asian institutions cut back on the number of brokers with which they trade equities. Around the same proportion say they increased the amount of trading business they do with brokers with the strongest credit ratings, and almost a quarter reduced the concentration of trading business they did with any single broker.

"The fact that concerns of counterparty risk actually permeated into decisions about cash equity trade allocations demonstrates the level of fear in the market last year -- even in Asia, which was somewhat removed from the large-scale failures of Bear Stearns and Lehman Brothers," says Greenwich consultant Jay Bennett.

(Concerns over counterparty risk have not been helped by the fact that Asian firms feel they lack clear information about potential moves to introduce central clearing systems for over-the-counter derivatives.)

Meanwhile, the Greenwich equity study notes that one factor contributing to a smaller commission pool has been Asian institutions' gradual adoption of low-cost electronic and portfolio trading systems, among which competition is growing in the region.

The share of trading volume executed as self-directed electronic trades increased to 18% in 2009 from 15% in 2008. (Portfolio trades captured a stable 4-5% in both years.) That puts Asian institutions slightly behind their peers in Japan and Europe, where the proportion is 20% in both markets, and well behind the US, where it is 35%.

By 2012, Asian institutions expect to reduce 'high touch' trading -- done via broker sales trading desks -- to 68% of total equity trading volumes, from 78% in 2009. They envisage self-directed electronic volume growing to 28% and portfolio trading staying flat at 4-5%.

The survey also covered institutions' use of derivatives, with half of respondents saying they are active users of flow equity derivatives and 70% planning to increase their use of such instruments in 2010.

"Although Asian institutions intend to increase their use of derivatives, there has been a 'back-to-basics' element to their practices over the past year," says Feng. "While most continued their use of flow options, futures and some swap products, only a minority remained active in more exotic products."

Greenwich Associates conducted interviews between July and September with 265 Asian equity fund managers and analysts, and with 89 traders and 58 users of equity derivatives products at institutions based in Asia.

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