Unbundling gathers pace

In an effort to make equity markets more transparent, regulators in the UK require investment managers to clearly separate and delineate the different elements in trading commissions. Broadly, the objective is to make it clear to investors what equity commissions are used for. Though this is primarily a UK regulatory development, the effect is being felt globally as brokers and fund managers have increasingly come to see the “unbundled” model as one that can be used to improve the transparency of their client relationships. Traditionally, institutional investors have paid single “bundled” commission rates for equity trades, a charge that included payment both for the execution of the stock order and for investment research. This made it difficult for an investor to distinguish what was paid for each.

From 1 January 2006, UK fund managers have been obliged by the Financial Services Authority (FSA) to use equity commissions to pay only for execution and research services, and to disclose to their clients the amounts paid for each of those services separately. This necessity to establish separate prices for each service, together with the abolition of soft commissions, and the FSA endorsement of Commission Sharing Agreements (CSAs), have all been catalysts for the unbundling process.

CSAs, a particularly promising industry innovation, give institutional clients the ability to separately choose and reward the firms that provide them with the most efficient execution of trades and the best research. UBS believes its current “hybrid” CSA is a transparent and flexible way for clients seeking an unbundled solution. Under this hybrid model, the total commission on a client’s business is split into an execution part and a research part, with all research providers, whether UBS or one or more third parties, paid from the research part.

The issue of unbundling, seen in its entirety, is a complex and challenging topic for the financial industry. UBS believes it is a fundamentally positive development that will set clearer lines for equity trading and research. As the world’s equity market leader in both research and execution, UBS believes it can be a partner that clients rely on for a clear understanding of the issues involved – in the UK and around the world.

Unbundling should bring increased clarity to the relationship between institutional clients and financial firms, prompting consolidation among the brokers with less scale or expertise. The ongoing cost of developing the sophisticated technology required to secure best execution further supports this trend. Improved transparency will also allow clients to separately identify and reward the best providers of equity trading or research.

UBS has already met with the majority of our largest equity clients to discuss unbundling. To date, nearly half of the investment bank’s UK clients that have decided how they will proceed in the future indicate that they will choose UBS’s hybrid CSA structure. Another quarter or so are only requiring disclosure of commissions, with the remainder choosing other types of structures. UBS believes it has made the necessary investments to give clients an optimal blend of competitive pricing with a superior quality of delivery in both its equity trading and research business, ensuring the firm remains foremost in the minds of any institutional investor looking for a reliable financial partner.