Unbundling trades could hurt European institutional investors

GREENWICH, Conn. — A new survey of European institutional investors and traders indicates that while equity trading commissions have remained low — and on par with their U.S. counterparts — proposed regulations to unbundle trading from research could hurt small and midsize managers because of the costs unbundling would entail.

The survey by Greenwich Associates, Greenwich, Conn., found that European institutions paid out more in overall commissions in the 12 months ended March 31 than in the previous year, while average commission rates were flat at 18 basis points per share. Greenwich analysts said the overall increase in paid commissions was likely a result of the 23% increase in equity assets under management.

Greenwich consultant Jay Bennett said in the report that increasing use of electronic and portfolio trading could drive average commission rates lower. "Many European institutions expect to further increase their use of electronic and portfolio trades, which suggests to us that there will be more downward pressure on average commission rates in coming months," he said.

European institutions currently execute about 25% of their overall trade volume electronically but expect to increase that to 35% within the next year, according to Greenwich. The average commission rate for electronic trades fell to nine basis points in the 12 months from 11 basis points in the prior period.

In addition, more than 75% of those same institutional investors use portfolio trading, according to Greenwich.

As trading costs decline, Greenwich consultants said the impact on investment performance is diminishing, which is increasing the need for high-quality investment research.

"Our research suggests that consistent declines in commission rates have reduced trading costs to a point at which their impact on institutional investment performance is miniscule," Greenwich consultant John Webster said in the report. "But a reduction in the quality or availability of the equity research that institutions use to inform their investment decisions (the result of full unbundling) could potentially have a real effect on performance."

But European portfolio managers are not showing signs of cutting back on research, either in-house or external, according to Greenwich. The percentage of overall equity commissions allocated to broker research and sales — as opposed to third-party independent research — reached 67% in the 12 months ended March 31, up from 58% in the prior 12-month period.

In addition, the Greenwich survey found that because of unbundling, buy-side institutions are hiring in-house research staff and expect to continue doing so throughout the next year. Most European institutions have increased their internal research staffing level to six from five, although institutions with more than €10 billion ($12.41 billion) increased their average analyst roster to 18 from 14.

About 20% of the smaller institutions (with assets less than €1 billion) expect to add more analysts in the next 12 months, while 44% of the larger ones plan to add research staff, according to Greenwich.

Greenwich consultants say this disparity between large and small institutions could be exacerbated by proposed regulations by securities regulators on unbundling of trading and research by European broker-dealers.

"Regulators need to consider how any new rulings with the potential to make it harder for the buy side to access good outside research will affect the investment community," Mr. Bennett said in the report. "Our research suggests that such regulation would have a disproportionate impact on small institutional investors that lack the resources to maintain significant sized research teams.

"Surely it is not the intention of regulators to disadvantage the little guys relative to large institutions and hedge funds," he said.