Specialisation “resonates” with traders as competition pressures mount

Banks and asset managers are being forced to learn to live in a world of greater specialisation, as unbundling of research and execution drives greater competitive pressure on costs. That is probably a good thing – but it will take the buy-side and the sell side in different directions, according to speakers at the TradeTech conference in Paris this week.

“The term that really resonates for me is specialisation,” said Phil Allison, chief executive at KGC Europe. “As a buy-sider, you may see your broker list come down from 100 to 50. Maybe you only need 15 executing brokers. At the same time, new research houses are emerging, and that is very good for the industry. The real trend is towards specialisation, and that’s how I see the industry evolving.”

Allison added that the rise of new research-only houses is part of a growing trend in which providers focus on a particular niche. Where brokers previously used fees from big cap stocks to subsidise research on small and mid-caps, they are now being replaced by a business model in which asset managers will simply pay for mid-cap research according to its value, he said. Other speakers such as Simon Steward, head of European trading at Capital Group, pointed to the growing use of independent research in recent years.

“It’s a challenge for the sell-side,” he said. “The bulge bracket banks will be OK, but the real problem is the mid-tier banks. Buy-siders want high-quality specialist research and not everyone’s got the depth. The days of brokers trying to be everything to everyone are going to disappear.”

Part of the threat to existing business models comes from regulation, which is arguably hurting the ability of the mid-tier sell-side firms to compete. The European Commission’s MiFID II legislation is an attempt to force a greater proportion of trading activity back onto primary trading venues such as national exchanges, in the name of transparency. But some observers argue that these measures will simply undermine competition and consumer choice.

“Liquidity will be concentrated on primary venues, leading to less competition and fatter spreads, which will favour larger brokers,” said Arjun Singh-Muchelle, senior advisor of regulatory affairs at the Investment Management Association. “On equity research, ESMA’s proposals can be made to work for equities if we group clients together for investment goals.”

Singh-Muchelle added that further challenge to financial services business will be provided by the arrival of non-traditional players, including companies such as Nutmeg and Google. For example, Google could open up markets in Europe which have previously had relatively closed distribution of funds. That could force buy-side firms to up their game, and may cause some to struggle. “Captive systems do cause consumer detriment, so it’s a good thing,” he said. “But it will cause competitive pressure for buy-side firms selling funds in Europe.”

Other panellists were more negative about the impact of cost pressures, regulatory change and liquidity constraints. Antioine Buisson, head of execution at Exane BNP Paribas, suggested that brokers will have to exit some businesses such as prop trading. Business models will have to readjust and downsize to cope, while some players will not be able to survive.

“At the bottom end of the spectrum, unless you’ve got the technology you’re not going to make it, so some smaller players will be marginalised or forced to leave,” he said. “The winning equity business model will be smaller and leaner, better at providing transparency, keep its costs under control and most importantly it will be more focused on the value proposition. If you’re going to do something, specialise and be the best at it, otherwise don’t bother.”