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London - Regulatory pressure to undo the traditional way brokers sell research alongside share dealing is alarming traders in Europe, who fear a further drop in business and more cost-cutting in an already tough environment.
At stake is the lucrative but opaque system under which fund managers pay brokers an all-in commission on every trade, charged to the fund's clients, which covers not only the execution of the deal but research and other services.
Total spending is estimated at £2bn in the UK and about $10bn in the US.
The asset managers are already reining in spending in the wake of new UK curbs on charging clients for research sometimes deemed "questionable" and company visits, traders say.
A ban proposed by European markets watchdog Esma on charging clients for research - though not yet final - is also seen eating into brokers' profits, pushing them to merge or cut costs.
Advocates of new rules say such changes will lead to a healthier and more transparent financial market, though for the industry it means another hit to trading profits in a post-crisis world where bank risk-taking has been curbed and trading activity has yet to recover fully.
"Brokers have already cut enormously, even the big ones, but equity markets have been difficult," said Neil Scarth, a principal at Frost Consulting. "We think that (new) research budgeting is going to cause them to cut further."
Traders say the bundled commission system helps grease the wheels of equity trading and allows brokers to be more than just "dumb pipes" into the stock market, but critics argue that there is no price transparency for clients and that a culture of one-payment-fits-all has led to excess spending and little scrutiny.
"In no other industry do you see such a bizarre way of delivering and paying for a service," said Richard Balarkas, consultant and former head of electronic trading at Credit Suisse.
Cost pressure
Both brokers and asset managers are likely to be under pressure to restructure operations or cut costs, analysts and investors say, as trading houses will find it much harder to fund large research desks while asset-management firms will struggle to persuade clients to pay much higher fees.
"The trend is clearly going towards an increasing amount of research being paid for out of the asset manager's profits," said Arnaud Cosserat, fund manager at Comgest in Paris.
"For us it will not dramatically change things as we have developed in-house research...But those in the middle will be squeezed."
Industry associations are lobbying against the Esma proposals and have warned that trading volumes and market stability are at risk; investment-fund body ICI Global said at a recent hearing that unbundling would be a "major challenge".
"It is inevitable that there will be a decline in equity market volumes and a rise in price volatility (if unbundling goes ahead)," said Robert Buller, a spokesman for Paris-based broker Kepler Cheuvreux.
"Less availability of research will mean less transparency on the correct pricing of stocks."
Advocates of unbundling argue that fears are overdone, accusing the brokerage industry of supplying too much research of too little value that is paid for by the end client.
One assessment from Morgan Stanley analysts is that the financial sector could cut up to $2bn of excess costs from research. "The industry is spending more on research than investors are willing to pay for," they wrote in a 2014 report.
While detractors say this will unfairly harm coverage of small companies, some see constant demand for good research.
"Firms will have to make a choice as to whether they are a pure trading business or whether they are providing research... This will affect the big investment banks too," said Balarkas. "But quality ideas in overlooked companies will always be in demand."
Cosy relationships
Traders worry that traditional relationships built up between broker and fund manager may fall apart without the incentive of access to research and other services.
"It's a big preoccupation for us," said a London-based trader who declined to be named. "If clients have to pay a cheque to access bank research regardless of how much trading volume goes to that bank, why will they trade with that bank?"
The head of trading at a global asset manager, who declined to be named, said he had already begun discussing with one of his brokers about how unbundling might lower trading business.
For advocates of more transparency, this is an important step that will in the end benefit the client even if it skims some of the frothy profit from broker relationships.
"Asset managers are going to have to choose the things they want and only buy those," said Frost Consulting's Scarth. "It will take probably some of the excess profitability out of the relationship."
