Monday, June 7, 2010 Stamford, CT USA — Commissions paid by institutional investors to brokers on trades of U.S. equities are falling far short of projections to this point in 2010.
The results of Greenwich Associates' latest U.S. Equity Investors Study reveal that the amount of brokerage commissions paid by U.S. institutions on trades of domestic equities decreased 13% to an estimated $12.1 billion from Q1 2009 to Q1 2010. Despite that falloff, U.S. institutions entered this year predicting that commission payments would surge in calendar year 2010 in step with expected strength in both stock market performance and trading volume. Buy-side traders at U.S. institutions projected a 15% increase in their commission pool for 2010, with hedge funds predicting a 20% increase in the amount of commissions paid to brokers on trades of domestic stocks.
"As we passed the mid-way point in the second quarter of 2010 it become evident that, not only will equity commissions fail to reach those growth targets, the commission pool might actually be contracting," says Greenwich Associates consultant Jay Bennett.
A contraction in institutional commission payments indicates two things: 1) Trading volumes have fallen off significantly, and 2) Resource-constrained U.S. buy-side institutions are doing everything possible to reduce trading costs. There's little doubt that the first factor was in evidence earlier this year: Consolidated trading volumes in NYSE listed stocks in the first quarter were off significantly from Q1 2009. As for the latter point, the average "all-in" commission rate paid by U.S. institutions to brokers on individual trades of domestic stocks dropped to 2.78 cents-per-share in 2010 from 2.90 cents in 2009, in part due to the fact that institutions continue to shift trades from traditional "high-touch" execution to lower-cost electronic and portfolio trading platforms.
"The fact that actual institutional commission payments are falling short of projections will create obvious pressures for equity brokers, but there will be ramifications for institutions as well," says Greenwich Associates consultant John Colon. "Specifically, they will have less commission currency than they had expected to pay for sell-side research and other services."
The 2010 report on the Greenwich Associates U.S. Equity Investors Study includes detailed analysis of institutional use of and payment for sell-side research and execution services, electronic trading systems and commission sharing arrangements, as well a separate analysis of institutional trading of small and mid-cap stocks.
Shift to Electronic Execution
Contributing to the decline in average commission rates over the past 12 months has been the continued drive among U.S. institutions to shift trading volume to electronic systems. U.S. institutions executed 37% of domestic equity trading volume through electronic single-stock trades in 2009-2010, up from 36% the prior year. Among larger commission accounts the proportion of trading executed electronically reached 44% of volume.
After the failure of many algorithms during the historic volatility of the global crisis many institutions pulled back from using the strategies. The share of U.S. institutions using algorithmic trading strategies declined in 2010, falling to 74% this year from 76% in 2009. Despite the decline in usage, algorithmic trading strategies accounted for a steady 18% of trading volume among all respondents and as much as 25% of volume among the most active users of the strategies.
Over the next three years, institutions expect traditional ¿high-touch¿ trades to decline to less than half of overall trading volume, with portfolio trades gradually moving to 8%, non algorithmic single-stock electronic trades increasing to 10%, crossing networks/dark pools growing to 13% of total trading volume from the current 10%, and algorithmic strategies increasing to 20%.
Institutional Research Spend Hits $6.4 Billion
The 53% of total U.S. equity commission payments allocated to sell-side research and related services represent approximately $6.4 billion. Institutions used about 27% of that amount to compensate sell-side firms for direct analyst service, 19% to reward brokers for the facilitation of access to corporate management teams, 14% to compensate sponsors of research conferences and 12% to pay brokers for sales service.
"Institutions are now using a combined one-third of their research commissions to compensate brokers for directly arranging meetings with company management teams or for running conferences that provide opportunities for face time with corporate management," says Greenwich Associates consultant John Feng. "Hedge funds have upped that share to roughly 40%."
U.S. Equities: Small and Mid-Cap Stocks
U.S. institutions paid equity brokers almost $4.6 billion in commissions on trades of small and mid-cap stocks in 2009-2010, a figure that represents 38% of the total U.S. equity commission pool. Commissions on trades of small and mid-cap stocks made up 35% of total commission payments in 2008-2009.