CCAs for Fixed Income? « ResearchWatch from Integrity Research Associates

Friday, July 18, 2008

CCAs for Fixed Income?

New York -- A recent article in Advanced Trading makes the argument that there will be increasing demand from buy-side clients for commission sharing agreements (CSAs or CCAs) in fixed income, as well as other asset classes such as options and futures. As more asset managers now look holistically across different strategies, regions, and asset classes, it does seem plausible to argue that commission arrangements in all kinds of trades should offer the same flexibility as CSAs currently offer in equity markets.

The details of these non-equity CSAs are somewhat unclear at this point, as it is difficult to cross-compare commission arrangements in fixed income and other asset classes with equities - one suspects that the implementation of said CSAs may well require the assistance of specialized CSA management system providers like Cogent. However, the article provides a very compelling argument for the adoption of CSA across all asset classes and regions, supplied by Michael Groves, head of trading at New Star Asset Management:

We have an obligation to ensure that we provide best execution for our clients," Groves relates. "At times, when it's not possible to trade through brokers who have provided research due to our best-ex requirements, using CSAs allows the fund manager to reward brokers who generate useful and successful ideas and research," he adds.

"CSAs also help us reduce the number of brokers on our dealing list, which has been pretty extensive," Groves continues. "We are able to list our brokers who provide execution and research and those who just provide research. ... You can still deal where you need to deal and find the best price and liquidity, but under CSAs you can pay firms that are providing 'permissible' services, as defined under U.K. regulation, to the fund managers."

Article link: Client Commission Agreements Go Global and Multi-Asset-Class, Advanced Trading, July 16, 2008

Posted at 11:05 am by Ronit Bhattacharyya


	Bill George July 23, 2008 11:39 AM PDT Some Problems with Client Commission Arrangements The premise for creating Client Commission Arrangements (CCA) was to facilitate investment advisors’ concentration of trading with an executing brokerage firm which claims to provide “best execution” then allocate some excess commissions generated from these trades (with the executing broker) to pay for third-party services. In my mind CCA’s are problematic for a couple of significant reasons: (1) Although execution analysis and execution evaluation has been attempting to identify and quantify “best execution” for more than thirty years there still is no uniform definition of “best execution” and there is no standardized and universally accepted methodology for measuring best execution. (Does one use value weighted average trade price (VWAP), the Elkins/McSherry method, the ITG Plexus method, Abel/Noser’s approach, Gil Beebower’s SEI Model, or . . . .) And, is “best execution” defined as above median performance, the top quartile or the top quintile of all trades executed by the broker, or can a broker claim to have expertise executing trades in a specific capitalization range or industry group. My point: I suspect there are more brokers claiming to provide “best execution” than brokers who can actually prove they provide “best execution” on a consistent basis. (2) The current structure of Client Commission Arrangements (CCA’s) further institutionalizes the historic competitive advantage full-service brokerage firms’ proprietary ‘services’ have enjoyed as compared to third-party provided services. In the current (U.S.) regulatory environment, and as CCA’s are presently structured, CCA’s provide a cover for the continuation of the tradition of bundling and not disclosing brokerage firms’ proprietary services. While at the same time, CCA’s further institutionalize processes that force the specific identification and detailed disclosure of third-party provided services. This lack of identification and disclosure of full-service brokerage firms’ proprietary services purchased by fiduciary investment advisors’ with their institutional clients’ brokerage commissions makes it difficult, if not impossible, for clients, co-fiduciaries and regulators to monitor and test for fiduciaries’ appropriate uses of institutional clients’ brokerage commissions [under Section 28(e) of the Securities Exchange Act of 1934, and test for conformity with fiduciary duty]. In July of 2006, at the time of the release of the SEC’s “Commission Guidance Regarding Client Commission Practices Under Section 28(e) of The Securities Exchange Act of 1934”, Chairman Cox agreed to “soon issue interpretive guidance on commission disclosure and transparency” during the same announcement several SEC Commissioners and staff members commented on the importance of this “second wing of guidance on the disclosure and transparency of the uses of institutional clients’ brokerage commissions”.(1) The SEC has been reminded of this “promise” of additional guidance several times, but so far, no such additional guidance seems forthcoming. -------- (1) See, Commission Guidance Regarding Client Commission Practices Under Section 28(e) of The Securities Exchange Act of 1934 (July 18, 2006) at > http://www.sec.gov/rules/interp/interparchive/interparch2006.shtml and see, SEC “Sunshine Meeting” July 12, 2006 at > http://www.connectlive.com/events/secopenmeetings/2006index.html


	Bill George July 18, 2008 08:19 PM PDT Anybody who has an interest in Client Commission Arrangements (CCA’s), Commission Sharing Arrangements (CSA’s), brokerage commission disclosure, and brokerage soft dollars, should visit and carefully read the referenced article, “Client Commission Agreements Go Global and Multi-Asset-Class” by Ivy Schmerken published on the Wall Street Technology – (Advanced Trading) website on July 16 2008. A careful reading of the section of the article titled “CCA’s Go Global” is particularly interesting if one focuses on the fact that CSA’s and CCA’s are very different structures and the terminology should not be confused or used interchangeably, as it has been here, in a global context. Client Commission Arrangements are a structure and process which allows brokers claiming to provide “best execution” to execute trades and at the request of the broker’s (fiduciary advisor) clients’ to pay for third-party research with any excess commissions paid-up above the fully-negotiated costs of execution (i.e. soft dollars). The third party research providers’ requests for payment, the advisors’ authorization to release “pool commissions” to third party research providers and the checks issued out of the "commission pool" to pay third party invoices all provide a paper trail documenting and disclosing payments to third party research providers. When issuing its July 12, 2005 "Commission Guidance Regarding the Appropriate Use of Client Commissions", and announcing the creation of CCA’s the SEC didn't issue guidelines for the unbundling and disclosure of brokerage commissions used to pay for proprietary services which are provided by brokers for the excess commissions “paid-up above the fully negotiated costs of brokerage execution” (soft dollars). Therefore, as in the past, bundled undisclosed proprietary services provided to fiduciary investment advisors by brokerage firms are not disclosed, and they are not by regulation identified and tested for compliance with Section 28(e) of the Securities Exchange Act of 1934. Additionally, in CCA’s it’s interesting to note that advisors’ requesting payments for third party services are liable for regulatory compliance and payment (to third party providers) under the CCA, whereas, in the past, brokers were liable for complying with Section 28(e) and they were directly obligated for payments to third party providers (under the provided by clause). At roughly the same time (2003 -2005) that the SEC was studying soft dollar brokerage and the appropriate use of institutional advisors’ clients’ commissions in the U.S., foreign regulators were studying soft dollar regulations in their jurisdictions. In Great Britain the Financial Services Authority (FSA) issued new regulations which included guidelines for the disclosure and transparency of all services provided in exchange for institutional advisors’ clients’ brokerage commissions paid-up above the fully negotiated costs of execution. Following the FSA’s release MiFED in the European Union issued very similar soft dollar disclosure requirements, as did the Canadian Securities Regulators. It seems that most foreign regulators have been satisfied with their regulations and guidelines for disclosure of soft dollar commissions. And, I haven’t heard of any jurisdictions considering going backward to accept the structure and processes of defined in CCA’s which enable non-disclosure of bundled proprietary services in advisory clients’ soft dollar brokerage arrangements. In consideration of the foregoing it seems using the terms Client Commission Arrangements and Commission Sharing Arrangements interchangeably is wrong and confusing. I imagine when commission management software systems are implemented in foreign jurisdictions they have to be adapted to comply with local jurisdictions’ regulations covering the disclosure of soft dollar commissions in Commission Sharing Arrangements (not CCA’s) and proprietary services are unbundled and disclosed to comply with foreign regulations. (One other point about the original Traders Technology article, one commenter, Robert Iati, mentions that The FSA has “replaced soft dollar arrangements as a result of the implementation of Rule CP176”. FSA Rule CP176 has not replaced soft dollar arrangements, the Rule has clarified the definition of soft dollars and it provides guidelines for how institutional investment advisors must disclose the uses of soft dollars).

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