We wrote recently that institutions are no longer paying as much for broker research. But, as the 2016 Peter Lee Australian Equity investors research shows, as a minimum of 40% of all commissions are generated by what are principally research driven factors (known as tags) it is an expectation that institutional broking firms continue to provide the product.
Every institution has a preferred broker list — “the panel”— with whom they deal and, for any self-respecting broker, occupying a place on a panel is the holy grail. Panels generally vary by size and structure according to the quantum of funds managed by an institution. Our research this year indicates the average number of brokers per panel has declined over the past 12 months to 13.3 (previously 14.4) — the lowest level in four years. Whilst that may sound a large number, most panels are pyramidical in structure meaning that the nearer the top of the tree you are the more commission can a broker expect to receive from an account — our research indicates that across the industry almost 50% of all commissions are paid to firms occupying the top three panel positions.
Now, before you jump to the conclusion that that leaves a further 50% of the commission pool for the other 10 firms to fight over, consider this. In 2016 65% of respondents indicated using Commission Sharing Agreements and paying 12% of their commissions in this manner. Additionally they reported paying almost 40% of their commissions via tags — that is for such services as customised research, greater analyst contact, and ESG research — with 90% of that figure being distributed across all panel brokers.
So when you do the maths it becomes apparent that for those firms on panels but outside the Top 3 positions there is not a lot left to share — and then, remember, there are also commissions being paid via tags or CSA’s to some brokers outside the panel. Whilst our analysis does not go beyond this level of granularity it does appear that about 80% of all commissions are split amongst panel members, of which 50% goes to the Top 3. We do know that the fifth most important firm receives 8% and the 10th picks up 3% so the ability to fund a full blown research product becomes more constrained as your position declines. And then you run the risk of it becoming a downward spiral — less commission, less capability to produce the research the institutions want, even less commissions…and so it goes.
So what does that potentially mean for the industry? Unless you are in the Top 3— or at the very least not lower than #5 — it becomes very difficult to see how a firm might survive in any meaningful way. And unless you are happy to rein in costs, produce less product and be prepared to live off the scraps a lower tier firm finds itself being paid, it becomes an almighty struggle.
For many years the Australian broking market has been seen as ripe for consolidation — to date that has not occurred. It is an oxymoron but, as each year passes, given its current structure, the end of the broking world as we know it keeps creeping closer to reality.