Commission Sharing Arrangements Proliferate Among Big Institutions, But Slowdown in Payments Could Pose Cash-Flow Problems

According to the results of the latest Greenwich Associates U.S. Equity Investors Study, independent third-party research providers saw their share of the institutional research pie drop to 11% of overall equity research commission payments in 2009 from 18% in 2008 (as reported by institutional portfolio managers participating in the survey). That 2009 proportion represents a considerable $845 million out of almost $7.7 billion paid by institutions to compensate brokers for research in 2009 and $13.7 billion in institutional equity brokerage commission fees overall.

Independent research providers captured a growing share of institutional commissions for several years following the 2003 Wall Street Research Settlement. That share flattened out in 2007-2008, however, before dropping in 2008-2009. Meanwhile, after losing commission share in prior years, the Bulge Bracket investment banks and global banks maintained their 56% share of institutional research commissions from 2008 to 2009. "There has been a lot of attention paid to high profile analysts that have left the Street to launch independent research firms," says Jay Bennett. "We wish them well, since our research suggests they are entering into a very competitive market. There is still a high degree of dependency between U.S. institutions and the major banks, investment banks and broker-dealers, as these large institutions have the resources needed to meet institutions' growing demand for direct access to analysts, as opposed to published research."

The largest and most active institutional equity traders in the U.S. are looking to maximize the value they receive for their equity commission dollars by making more use of commission sharing arrangements (CSAs) as a means of obtaining research and advisory services from broker-dealers and independent providers. Across the entire U.S. market, the share of all institutions using CSAs was unchanged at about 48% from 2008 to 2009. Among institutions generating more than $50 million in annual equity brokerage commissions, however, the share of CSA users jumped to 63% in 2009 from just 46% in 2008. At the same time, institutions that use CSAs have been steadily increasing the share of their total commission payments routed through these arrangements. Institutions paid out 25% of their equity commissions or some $3.4 billion through CSAs in 2008-2009, up from 16% last year.

Executing brokers typically pay out about half the commissions on CSA trades to third-party research providers, including 29% directed to other brokers and 21% passed on to independent providers without investment-banking capabilities. The portion of the commissions retained by the executing broker includes about 33% retained for execution service and 17% retained as compensation for their own proprietary research.

In 2008, more than a quarter of institutions ordered their brokers to distribute third-party commission payments at the time of trade; in 2009, that share fell to just 2%. Over the same period, the share requesting that their brokers distribute third-party payments on a monthly basis was flat to slightly lower at 30-31%, while the proportion of institutions asking their brokers to distribute these payments on a quarterly basis jumped to 60% from 47%. "In light of concerns about counterparty risk with broker-dealers and cash flow delays to receiving brokers/firms, it is surprising that there has not been more push-back about the slowdown in CSA commission distributions," notes Greenwich Associates consultant John Colon.