LONDON - The U.K. government has backed a proposal for a radical change to the treatment of stockbroker commissions that could see money managers footing the bill for transaction costs on client portfolios.
The proposals, published last month by Paul Myners, chairman of Gartmore Investment Ltd., London, also suggest money managers charge plan sponsors a single fee that includes the cost of all transaction and research services.
This is a dramatic change from the current system, in which trustees pay their money managers an annual management fee and, in addition, pay for commissions to stockbrokers for dealing, research and other related services.
U.K.-based plan sponsors, money managers and actuaries broadly welcomed the review and the move toward greater transparency about fees, but they said the proposal needed careful consideration.
Dealers and money managers are concerned the proposal on commissions would discourage money managers from trading and disadvantage small specialist money managers who rely on external research.
It is even possible fund managers might move to making greater use of index-tracking strategies in an attempt to reduce transaction costs, said John Gillies, senior consultant at Frank Russell Ltd., London.
He welcomed the fact that the proposals encourage plan sponsors and money managers to focus on controlling transaction costs.
But Mr. Gillies added: "It would be a pity if we lost the imperative to seek returns due to the fear of transaction costs, which are a second-order priority to seeking returns."
Willing to pay
One investment manager working for a large U.K. plan sponsor involved in the motor industry said he would be willing to pay higher fees so long as they were calculated clearly and were being used to pay for services related to the management of his portfolios.
The proposals on brokerage commissions were part of a government-sponsored review, led by Mr. Myners, of institutional investment in the United Kingdom that also urged abolition of the Minimum Funding Requirement (see related story on page 16).
In the report Mr. Myners said: "Clients' interests would be better served if they required fund managers to absorb the cost of any commissions paid, treating these commissions as a cost of the business of fund management, as they surely are. Fund managers would of course seek to offset this additional cost through higher fees: this would be a matter for them to agree with their clients."
It is still unclear how this proposal will be implemented. Mr. Myners said it is up to the clients to determine what fee and commission arrangements they want from their money managers. He said he would prefer the report's proposals to be treated as a code and that adherence to it should remain voluntary.
"I am an economic liberal; the best decisions are made by people acting in their own interest," he said in an interview.
Chancellor's approval
U.K. Chancellor of the Exchequer Gordon Brown earlier this month fully endorsed the proposals and his department is consulting with the industry before deciding how to implement them. The consultation period ends May 15.
The industry will be given two years to voluntarily comply with Mr. Myners recommendations. If after two years it were felt that voluntary compliance had not been effective, Mr. Brown said he would be prepared to legislate that plan sponsors, money managers and consultants report their compliance with the proposals. The government has not yet decided when the two-year testing period will begin, said Melanie Johnson, economic secretary to the Treasury.
Mr. Myners said the issue of commissions had been raised by plan sponsors who were concerned about the use of "soft commissions," or credits generated by a fund manager by trading through a nominated broker. The credits are used to pay for services the fund manager needs for managing money and include broker research, Reuters screens or fees paid to performance measurers. This practice is regulated in the United Kingdom to ensure that soft credits are not awarded at the expense of best execution and that fund managers disclose these services to their clients.
But Mr. Myners' proposal goes further than just soft commissions and tackles trading commissions, which are included in nearly all stock market trades and generally cost around 20 basis points, according to U.K. money managers. Research by Watson Wyatt Worldwide, Reigate, England, found the typical pension plan with assets of L200 million ($294 million) paid an average fee of 27 basis points to an investment manager and another 15 basis points in brokerage fees.
Changing relationship
Mr. Myners said his proposal would change the nature of the relationship between fund managers and brokers. "In the future, the basis of the relationship between the buy and sell side may not be based on a fee related to transactions; it will be based on the service provided," he said.
He told Pensions & Investments he has no quarrel with so-called "net" trades, as no commissions are paid in these arrangements. (Such trades are meant to be free of commission, but fund managers and dealers say they assume a transaction fee is always included in the spread between the buy and sell price.)
Rather, Mr. Myners wanted to tackle agency arrangements in which the broker charges a commission separate from the price of the share.
He said it is unlikely that spreads on net trades will increase if fund managers stop trading on an agency basis, because spreads are subject to highly competitive market conditions.
But Frank Russell's Mr. Gillies said many investment markets outside of the United Kingdom trade on a net basis, with the transaction cost included in the spread between the bid and offer prices.
"Brokers have to make a profit and there is a cost in the net trade. Unfortunately, it is not possible to disentangle the price of the security from the associated transaction cost," he said.
Sources were concerned that adopting Mr. Myners' proposals would put the United Kingdom out of step with common practice in the rest of the world.
"It would not be sensible to make domestic rules and regulations in an industry dominated by global fund managers and global counterparties," said Paul Manduca, chief executive officer of Rothschild Asset Management Ltd., London.
Supports proposal
William M. Mercer Ltd., London, supports the proposal, said Andrew Kirton, head of U.K. investment consulting. "If a fund manager needs to buy in external research, that is arguably a business expense."
Many money managers already monitor their dealers to ensure they are getting the best value for money. They have to report the cost of commissions to their clients' custodians, but these costs are rarely considered by trustees, because they find it hard to interpret the data.
"The transparency is available, but it's up to the pension fund to demand that information in a more useful form from the custodian," said Frank Russell's Mr. Gillies.
