The changing role of the broker – The global financial crisis has triggered a global revolution of the buy-side/ sell-side relationship

Driving adoption of trading technology
However, the current financial crisis has exacerbated a lack of liquidity the effects of which are keenly felt in Asia. High volatility and widening spreads have resulted in dramatic increases in the anticipated costs of trading (see chart on previous page), combined with even higher increases in the standard deviation of costs. With risk management and cost control now at the top of every firm and fund’s agenda, an emphasis on efficient execution is more important than ever. This is accelerating the rate of change in Asian adoption of trading technology and the corresponding demands from the buy-side about what the sell-side must provide.
At the heart of the process of controlling trading risk and costs is understanding where and how they are arising. This is driving demand for Transaction Cost Analysis (TCA). TCA is already widely used in the US and Europe: TABB Group projected adoption rates of almost 90% across the US and Europe by 2009 in light of the regulatory requirements of Reg NMS and MiFID. Now Asian buy-side desks need to make cross-market comparisons and determine whether their costs of trading are proportional to market averages, and do not unnecessarily erode fund alpha. This demand for transparency is being reflected onto brokers, who will now need to prove they are providing quality execution and delivering value for their fees. While in calmer markets this has promoted growing buy-side use of ‘low touch’ DMA and algorithmic trading tools which help control costs, in volatile conditions the value-add from an experienced broker trading desk or sales trader is also vital. This is true of any market, but particularly for Asia given the diversity of market structures and interlinked economic and regulatory factors.
Playing CSA catch-up
The focus on costs of execution also means that Asia Pacific buy-side firms are rapidly catching their global counterparts in the adoption of CSA structures that unbundle execution from research. The differences in how the buy-side and sellside interact, and the resulting changes in demand for the various brokerage services is now less defined by geography and more by business model. Agency-only brokers with transparent balance sheets and a business focused solely on Best Execution services are valued counterparties across the globe. Without the natural advantages of IPO access, capital commitment and large volumes of proprietary flow, the traditional large sell-side model is facing serious challenges.

Avoiding a buy-side pile-up
Finally, the relationship between sell-side and buy-side is now developing in more fluid ways as the sell-side adopts an important role in buy-side education and execution advisory services. For many years the buysidehad no choice but to ride on the sellside ‘execution bus’; but as the market has developed every buy-side firm can now access its own ‘car’ to take themselves wherever and whenever they want. This gives the buy-side more control and flexibility over their execution. But without the proper instruction the wrong route can be taken or crashes can occur. Brokers that can continue to add value in helping the buy-side develop and take better control of their trading are more likely to succeed. The balance of power is shifting, and those that can develop an interactive relationship or an advisory role in terms of trading will end up as stronger trading partners.
The brokerage model post-crisis is likely to look very different to before. Those that succeed will have to add clear and quantifiable value to the buy-side, whether through the provision of high quality execution using technology, unique market insight and advice or – most likely – a combination of the two.
I have a first-hand understanding of how different the Asian markets are to those in the US. However, the current crisis has highlighted the fact that business concerns are the same across the globe – and while the mechanics may be different in each region, the role of the broker is changing at a fundamental level everywhere. Independence and transparency have become more valuable than ever, and Best Execution is the top priority as risk and cost management now dominate the buy-side/ sell-side dynamic.