Reinventing the Relationship:

Institutional Brokerage Profitability

Adam Sussman / Cheyenne Morgan |

V08:024

September 2010

www.tabbgroup.com
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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

Vision
The complex needs of the buy side and the brokers renewed sense of fiscal restraint require the return on client relationship to be calculated with pinpoint accuracy. The days of pricing services to win short-term market share are gone. In forming new relationships and branching out to different products, success is dependent on the sell side efficiently balancing both sides of the ledger: increasing revenues, negotiating rates, managing payouts and efficiently allocating resources to their clients. The brokers at the cutting edge of analyzing client behavior are reinventing the way they look at client relationships. The buy side is not only being viewed in terms of how much commission revenue they generate or resources they consume, but also on how a diverse client base actually helps the brokers support a number of differentiated value propositions. The more diverse a client base the broker can support, the more the trading and assets of those clients work in concert to create a robust and profitable brokerage environment. There is significant upside available for brokers who are able to implement a more robust business model. Financial Exhibit 1 reform that will have a dramatic impact CBOE VIX Index (2007-2010) on derivatives markets, hedge funds, and the capital requirements on banks, is in the midst of being implemented. The SEC and CFTC are not only busy filling in the blanks of the Frank-Dodd bill but are also under tremendous pressure to update market structure. At the same time, the global economy is facing a period of unprecedented uncertainty. Few prognosticators are forecasting calm waters for anytime soon (see Exhibit 1). None of this makes it smooth sailing for the asset management industry. Hedge Source: TABB Group, US Exchanges funds and long-only funds alike are asking for more research and services rather than trying to lower commissions. Brokers will need to be prepared to address these needs. Brokers need to be smarter in how they measure profitability, price their offering and calculate payouts. The first order of business is to instill a client-centric approach in their business. As much as revenue might be associated with asset classes and geographies, it is the client that is the ultimate arbiter of a brokers fate. The amount of revenues generated by a client should be easily accessible to all appropriate parties throughout the firm that interact with a client. Breaking down internal information barriers will create a greater uniformity within each client experience. A higher level of consistent service and support across all areas within a brokerage will increase the brokers ability to cross-sell products. The client should be the only silo.
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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

However, brokers cannot simply provide each and every service their clients may demand. Brokers must leverage their core strengths into new markets or asset classes, or create a platform of services beyond their primary value proposition. In order to do this intelligently, brokers need more granular and flexible client analytics to better target and price new services. Brokers also need to be able to group and analyze clients according to multiple segmentations, beyond the standard categories of asset class, geography and gross revenue. Brokers should be able to segment clients by strategy, liquidity characteristics, and their utilization of research, technology and support. Business managers need to be able to create new segments and views as well. Finally, in a client-centric view of the business, the way in which sales commissions and bonuses are calculated must be recalibrated. Brokers must have the ability to track how clients derive value from the relationship and how they pay for that value. That type of analysis can help move the payout model to one that more closely aligns the interests of the client and the profitability of the business. The upheavals in the institutional brokerage industry are anything but transient, and the window of opportunity will only be open for so long. Over the coming years, it will become clear which firms were able to adapt their business models to a new brokerage paradigm and which headed down the path of least resistance, finding themselves irrelevant.

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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

Table of Contents
VISION ......................................................................................................... 2 TABLE OF CONTENTS ...................................................................................... 4 INTRODUCTION ............................................................................................. 5 THE MULTI-DIMENSIONAL CLIENT .................................................................. 6 THE BROKERAGE BUSINESS MODEL REVISITED .................................................. 7 LEARNING FROM STAT ARB .......................................................................... 7 CAPTURING COSTS ...................................................................................... 10 RESEARCH ............................................................................................ 10 EXECUTION ........................................................................................... 12 THE PROFITABILITY MATRIX .......................................................................... 14 CLIENT ANALYTICS PLATFORM..................................................................... 15 CONCLUSION ............................................................................................... 17 ABOUT ........................................................................................................ 18 TABB GROUP ........................................................................................ 18 THE AUTHORS ....................................................................................... 18

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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

Introduction
The change within the asset management and hedge fund industry has been on fast forward since September 2008 and the rate of change is only going to increase, if the volume and volatility of 2010 is any indicator of long-term market behavior. Buy-side firms must assure that their product offerings are aligned with the changing needs of the investment community and that the performance of those funds meets or beats their benchmark. This pressure exerted on the buy side is quickly transferred to the sell side. The value proposition of a broker is under constant review by its clients, who are looking for unique ideas, a robust underwriting calendar, superior execution tools, and deep pools of quality liquidity across multiple geographies and asset classes. However, the pressure is being applied at a time when the commissions-driven equity brokerage model is suffering. While the equity markets have rallied, shares on the US equity consolidated tape saw a 30% decline with an average daily volume of 12.3 billion shares in March of 2009 to just 7.2 billion in August 2010. Options and futures markets experienced similar levels of decline (see Exhibits 2 and 3).
Exhibits 2 & 3 Consolidated Average Daily US Equity Volume Annual US Options and Futures Volume

Source: TABB Group, US Exchanges

This decline in volume has driven down profits for sell-side execution desks, further straining their ability to serve clients in a time of need. To top it off, the last few months have seen regulatory risk re-emerge. The fear of association must now be added to the fear of counterparty risk. Despite the challenges presented by declining trade volumes, opportunities arise during such a dislocation. In the midst of market mayhem, mid-tier brokers have been given an opportunity to capture market share as their bulge-bracket counterparts deal with a legacy cost structure, regulatory scrutiny and greater bureaucratic lethargy. Mid-tier and niche brokers are creating differentiation in different ways, whether it is from a deep pool of liquidity, valued research, or best-in-class service, all coupled with a competitive pricing model.

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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

The need for differentiation is not only about revenue growth but also about survival. During the relatively calm waters of the second half of 2009 and the first quarter of 2010, the significantly Exhibit 4 lower daily trading volumes resulted in an Why Is Your Commission Wallet Smaller YOY? How Much Smaller is It? even sharper contraction in buy-side commission wallets. With commission budgets shrinking by 20%-30% for much of the buy side, brokers are faced with the dilemma of maintaining clients who now have fewer dollars to pay out (see Exhibit 4). It has become critical for the sell side to leverage their services, whether it be research or low execution costs, to remain relevant to their clients.

The Multi-Dimensional Client

Source: TABB Group Managing the allocation of research, liquidity and service is made more complicated by the fact that the most important and sophisticated clients are now multi-dimensional. Fund companies now manage funds that span the globe, utilize an array of instruments, and have a variety of time horizons, from months to milliseconds. On top of that, the dramatic swing in assets under management over the last few years has wreaked havoc on where funds locate their businesses and how they want to access foreign markets.

Whether a fund manager has on-the-ground analysts uncovering opportunities or has all its operations in one location, the brokerage services required by a global fund are intricate and complex. In addition to research, execution services and stock loan, each with its own market-specific requirements, brokers are expected to help clients understand regulatory loopholes, anticipate how the market will behave the day after local holidays, and explain country-to-country exchange rules. What makes this even more complicated for a broker is that it is no longer true that the London arm of a management company will pay for services related to UK trading. The business is as likely to come out of New York or Hong Kong. The other major trend in buy-side behavior is an increase in the use of derivatives. The recent spate of economic and political uncertainty around the globe underscores the importance of being prepared for market volatility. The pressure on the sell side to help clients navigate these choppy waters is only going to increase. As the need to manage risk increases, the need for multiasset-class execution across options, futures and FX also increases. Being able to offer this wide array of services affords brokers the opportunity to reaffirm their ranking on a clients contracting list of counterparties.

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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

The Brokerage Business Model Revisited

In response, sell-side brokers are trying to optimize the institutional trading business. Futures commission merchants (FCMs) are launching equity execution desks. Equity execution brokers are forming alliances with niche research providers. Brokers catering to high-volume hedge funds are creating flexible pricing models tailored to the need for low-cost executions and access to stock borrows. Everyone is scouring the institutional investment management landscape looking for opportunities. However, all of these new initiatives require a more centralized view of client revenues. Information on revenues has not traditionally been shared across business lines, trading desks or geographies. This myopic approach can lead to a major client of the equities division being treated as insignificant by the municipal bond desk. An isolated view of a client might have been acceptable in an era when clients and fund strategies could be neatly divided, but now this silo approach only hinders the sell side from capitalizing on existing relationships and cross-selling opportunities. An overall view of client behavior can help the broker better target and price new services in order to obtain incremental revenue gains from existing clients, such as offering better FX spreads on the back of a global equities trade, or something more complex, such as the way prime brokers price their statistical arbitrage offering.

Learning from Stat Arb

The way in which prime brokers cater to statistical arbitrage hedge funds (and other high-volume model-driven strategies) is indicative of the sophistication being brought to the brokerage business model. High frequency traders are notoriously sensitive to costs and speed. The strategies are focused on capturing minute and fleeting arbitrage opportunities across various market centers. In order to successfully implement their strategies, model-driven funds utilize direct pipes to the exchanges to minimize latency and negotiate near-zero commission rates for their brokers. But the commission rates model-driven funds pay for an execution about $.0007/share are not enough to sustain a relationship with the sell side. The latest tweak to the brokerage business model is an arrangement where the broker keeps that net rebate associated with the funds trading and counts it toward the funds commission pool. This works because these strategies often act as liquidity providers to the exchanges; they are posting orders to the order book more often than they are removing orders. Because the hedge fund is trading through direct pipes, they are privy to the same execution details as the broker. Both the hedge fund and the prime broker calculate the net rebate from the trading activity to make sure they agree on the amount counted toward the total commission pool.

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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

TABB Group estimates that for stat arb funds with cost-plus commission deals, the net rebates account for 80% of the commission revenue. In exchange, the prime broker offers discounted stock loan CfD with Execution Give-Up Exhibit 5 to the stat arb client. But without a Cost-Plus Execution Model robust, real-time system that captures the Exchanges, MTFs, Dark Pools net rebate, the broker has no idea if the A portion of the net stat arb firm is generating revenue or rebate is applied as commissions The hedge fund creating losses. There is simply no executes through a sponsored access pipe margin, or for that matter, margin of Executing error, in this business model for manual Prime Broker / Hedge Sponsored Broker Fund processes built on spreadsheets (see Access Exhibit 5).
The net rebate is captured and But, while a robust trading infrastructure retained by the broker and billing system are critical, a Synthetic Finance | London | 29 April 2010 stat arb-focused prime broker must also have a substantial amount of stock loan Source: TABB Group inventory. One of the ways to build up that inventory is to attract funds that custody long positions overnight at the prime broker. One of the important elements in attracting and maintaining traditional buy-side accounts is to be open and transparent about how the broker views the account. In the first sample report below (see Exhibit 6), the exact cost of the liquidity is not broken out. In the second example, where more-formal profitability analysis is employed, costs are clearly segregated. In this case, XYZ Investment Management is trading 500 million shares a year and paying $.0174/share, and the gross commissions are $8.7 million per annum. However, the cost of the liquidity on average is 2% of gross commission. Then clearing and settlement fees are tacked on as well to calculate net commissions.

Exhibit 6 Internal Client Commissions Reports

Before Profitability Analysis: After Profitability Analysis:
XYZ Investment Management
Account Summary:

XYZ Investment Management

Account Summary:
Total Shares Traded Exchange/ECN Dark Pools Blended Rate Gross Commissions Costs Net Commissions 500,000,000 371,296,623 128,703,377 $0.0174 $8,700,000 ($206,453) $8,493,547

Current Rank Total Shares Traded Exchange/ECN Dark Pools Blended Rate Gross Commissions Execution Costs Exchange/ECN Dark Pools Clearing Costs Net Commissions

126 500,000,000 371,296,623 128,703,377 $0.0174 $8,700,000 ($200,453) $0 $6,000 $8,493,547

Execution Cost Details: Exchange/ECN

Venue NASDAQ ARCA NYSE Direct Edge BATS Other Shares Posted 32,043,158.83 23,943,449.59 21,797,209.40 19,054,580.56 16,627,177.28 16,488,242.48 Shares Taken 59,508,723.53 44,466,406.39 40,480,531.74 35,387,078.18 30,879,043.52 30,621,021.74 $ $ $ $ $ $ Rebates 92,925.16 71,830.35 45,774.14 49,541.91 41,567.94 16,197.27 $ $ $ $ $ $ Costs (148,771.81) (128,952.58) (52,624.69) (88,467.70) (74,109.70) (25,363.20) $ $ $ $ $ $ Net $ (55,846.65) (57,122.23) (6,850.55) (38,925.79) (32,541.76) (9,165.94)

Source: TABB Group

Internally, the broker needs to look at these clients from all angles. While these funds may not generate a tremendous amount of commission revenue, the loaning of their long positions to stat arb clients needs to be incorporated into how the broker values each client; otherwise, a competitor with a better
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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

profitability matrix will step in with a more appealing value proposition. The broker could even share some of this information with the client by adding it as a line item in the client commission analysis. Developing this central view of profitability will also allow brokers to classify and rank their clients into tiers using the measurements they feel are most appropriate and use this information to allocate their resources accordingly. The key point is that brokers need to identify, aggregate and attribute client revenue and costs across the enterprise. Then, the services received and the payment mechanism can occur on different continents or across multiple asset classes. Research services in US equities can be paid through trading desks around the globe and across multiple asset classes. Revenues can be accounted for in less obvious ways as well, such as margin interest, stock loan, and FX spreads. The new brokerage model must take into account the ways that different buyside strategies can be leveraged under one model. Not only do clients generate revenues in different ways, but there are also cases where clients are indirectly responsible for the revenues generated by other clients. Just as the most successful exchanges create models that attract both liquidity takers and liquidity makers, the most successful brokers create models that attract and retain diverse clients.

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Reinventing the Relationship: Institutional Brokerage Profitability

September 2010

Capturing Costs
In order to implement a robust, enterprise-wide client ranking system, the broker must not only capture all sources of client revenue, but must also capture all the costs associated with servicing the client as well. The ability of a firm to get at client-level costs often lags behind revenues for several reasons. First, people are much more motivated to reveal how much revenue their clients are generating, since that is often the basis of their compensation. Second, even the cost centers dont want to brag about their costs for fear of being castigated as inefficient. Third, costs can be much more difficult to capture. The difficulty in capturing client-level costs can be broken up into three categories: acquisition, aggregation and attribution. Acquisition: The timeliness of data acquisition can vary. Technical support or access to company management might only be available on a weekly basis. Execution costs need to be captured on a daily basis, if not in real time. The key elements are that the data must be entered/retrieved from the cost source and that it is captured on a regular basis rather than in an ad hoc fashion. Aggregation: The ability to view client revenue across the enterprise should not be an ad hoc IT request that takes days to fulfill and is prone to manual error. All appropriate client revenue, costs and profitability should be viewable in aggregate and segmented into discrete views. In addition, users should be able to roll up the data by groupings such as asset class and geography. Attribution: Brokers have long depended on averaging costs across their client base by either assigning a fixed percentage or weighting it by the size of the fund, trading volume, etc. Accuracy was either deemed quixotic or unnecessary as long as revenues and profits went up. Nowadays, this is no longer sufficient. Client-level costs are critical to creating a competitive edge. If a firm has not taken any steps toward capturing costs, the goal may seem unachievable. However, the basic infrastructure is usually at arms length. Most brokers are already tracking human resource costs. Execution cost management systems, such as those offered by Firm58 and William Ryan Group, can help brokers get their hands around execution cost management. The key is to identify the types of data points that will allow the broker to better identify client profitability and new opportunities.

Research
Research costs can be difficult to acquire and ultimately assign to a client because a lot of the cost comes in direct client contact. It takes a lot of conscientious analysts willing to enter their time to even come close to measuring client utilization. Assuming all of the necessary time tracking is captured across all products and time zones, the data then needs to be aggregated into a centralized database. Next, the cost needs to be attributed to clients. This can become complicated, because some clients have multiple funds that negotiate and allocate
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Reinventing the Relationship: Institutional Brokerage Profitability

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commissions separately, while other clients have multiple funds but centralize the commission process. The broker needs to be flexible enough to work within either arrangement but always be able to provide fund-level or investment company-level commission numbers. In addition, keeping track of what proportion of gross commission dollars actually stays with the brokerage firm is becoming more complex. Nearly two-thirds of the buy side now uses Commission Sharing Agreements (CSAs), and TABB Group expects the number to reach 75% by year-end 2011. CSAs give the buy side incredible flexibility and transparency over their research commission spending. CSAs have also allowed brokers to change their business models. Agency brokers have been partnering with complementary niche research providers. ConvergEx Group, LLC and Code Red, a provider of research management solutions, formed just such an alliance where ConvergEx could provide research reports through Code Reds research management system. Liquidnet also made a strategic investment in OTR Global, an independent research firm focused on providing deep Exhibit 7 investigative channel research for What percentage of your gross commissions institutional investors. ITG joined the stays with your CSA broker? party when they expanded their content offering by becoming the exclusive distribution channel to independent research firm Disclosure Insight. However, CSAs create additional operational and accounting challenges for brokers. There is now a need to keep track of the percentage of gross commission dollars coming in the door, the cost of executing those orders, and now, how much is being paid out to thirdSource: TABB Group, Equity Brokerage 2010 party research providers. Less than half of all buy-side commission dollars going through CSA brokers remain in-house, so it is becoming imperative that the commission allocation process be managed as efficiently and accurately as possible (see Exhibit 7). The ability to combine research utilization, execution costs and CSA practices results in a robust commission management platform. This platform allows for easy access to information on research credits and commission balances and trade details, along with the ability to manage research/CSA payments. Such a system also helps account for the amount of revenue passed on to any research partners.

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Reinventing the Relationship: Institutional Brokerage Profitability

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Execution
Execution costs are difficult to assign back to clients because most exchanges and alternative trading systems do not include the actual fee (or rebate) in the execution message; rather, the message just indicates whether the order added or removed liquidity or was routed outbound. The broker then needs to create a separate store of the maker/taker fees and apply it to each fill. Yet the fees on some exchanges are not so straightforward. There are often tiered volume discounts, varied pricing for dark and lit Exhibit 8 orders, and special charges dependent on Number of Pricing Changes by US Equity the price of the stock as well. An effort Exchanges, 2007-2010 among exchanges to attract order flow has also caused posting and rebate fees to change quite frequently. With more than forty execution venues competing for market share, posting fees and rebate amounts shift quite frequently. In order to attract liquidity, some venues have offered discounts on fees and an inverted pricing scheme. From 2007 to 2010, there were more than sixty changes in fees on US equity exchanges (see Exhibit 8). While an agency brokerage might only be Source: TABB Group concerned with venue-related execution costs, full-service brokers need to take into account the trading profits and losses during a capital commitment trade. If a client is consistently demanding capital for trades that cause the broker to incur losses and isnt making up for those losses in commission revenue, the broker needs to re-evaluate the allocation of the firms capital. Along with research and execution costs, brokers must incorporate the cost of sales in client profitability, whether its a traditional sales trader or an electronic trading sales force. While some payout models might be based on gross commission revenue, if a broker wants a more complex model it will need a more robust compensation management package. Finally, there are less tangible costs on the trading desk. For instance, a client requests customization to an algorithm. Then that same client also needs guidance on how to most efficiently use that algorithm. Or there is custom integration needed to get the brokers Execution Management System connected to the buy-side Order Management System or back office. The broker needs to be able to take charges it incurs from multiple internal resources and assign them to the appropriate clients. Now apply the complexity of mapping each of these costs across multiple asset classes and geographies back to clients who also have multiple trading desks with unique identifiers. The amount of labor required to complete such a task can quickly compound. As the buy side looks to trade more products around the world, the race to become a one-stop, sell-side shop can quickly become a dead
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Reinventing the Relationship: Institutional Brokerage Profitability

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end unless the return on relationship is properly optimized. If a broker is only looking at costs in the aggregate and then spreading them out among clients on a volume-weighted basis, the broker may be unknowingly treating certain clients unfairly. In order to optimize its business model, brokers need a central system that helps them quickly determine which clients and products are profitable -- or not -- and also determine the behaviors that lead to profits or losses. While the list of inputs is different across the client base (and it changes as the broker expands), the ultimate output is the same: client ranking.

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The Profitability Matrix

The ability to attribute costs to specific clients is only useful if the broker acts on the information. The brokers that are most effectively competing today are intelligently allocating resources and even changing their business models based on detailed information about what resources clients are demanding, how they pay for those resources and the total cost to the broker. After client costs are being effectively captured, the next step is to rank clients. Brokers need to have systems in place that can manipulate cost and profitability data so clients can be correctly segmented and ranked. As discussed above, segmentation can be based on services utilized (e.g., idea-driven versus modeldriven), fund size, asset class and geography. Client ranking can also be different according to different metrics, such as total revenue, gross commissions, net commissions and, ultimately, profitability. Brokers that do a better job of drilling down to client-level data and create unique views of profitability metrics will be able to tailor their businesses more effectively. In order to appropriately manage large, global, idea-driven fund companies, brokers need to be able to identify, aggregate and attribute usage of research, trading, sales traders, sector specialists and the entire suite of electronic trading services around the globe. The information needs to be shared throughout the organization so that when the client establishes a relationship with a new trading desk, its still treated as a loyal client. These clients not only have distinct requirements within their own investment and execution processes, but they also have revenue generation that matches their usage or cost levels. While the top asset management firms account for a substantial portion of industry commissions, it would be shortsighted to view all clients through the same lens. While firms that generate less revenue will fall under lower tiers and should also have access to a lower level of services, the most profitable mediumsized buy-side firm can have a higher return on relationship than a large fund. The medium-sized fund might leave more assets custodied at the prime broker, pay a high commission rate and utilize fewer resources. There are other buy-side clients that are unique in that they require a wide array of products and services. They may not have the revenues to access all services in their entirety but may need each on a smaller scale. In this case, a broker could try to craft products to fit different needs by taking a close look at the costs they would incur on providing each service. It is important to be flexible enough to work with clients to provide some access in varying flavors.

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Client Analytics Platform

In todays data-driven era, brokers who still rely on flawed intuition risk falling prey to well-informed competitors. The most successful brokers are automating the cost-capture process, aggregating client data across the enterprise and intelligently allocating research and pricing liquidity. Exhibit 9
Manual Process for Client Analytics

While a number of the bulge bracket brokers have built client analytics Multiple Database Infrastructure platforms internally, it is a resourceintensive task that only a few brokers can Exchange Rates effectively in-source. Mid-tier brokers are unlikely to have the necessary internal Analyst Time Data Export Spreadsheet resources to assign to such a project. But Commission Fees providers in this space -- including Firm58, SunGard and ADP -- are bringing Algorithmic Usage Manually sort, map, and evaluate a more formal process within all brokers reach. These technologies give firms the flexibility theyre looking for; data can be reported in any number of ways once it is Source: TABB Group collected and normalized. Vendor solutions often offer user-friendly interfaces and analytics that would not be cost-effective for an internal IT team to build. The result is timely, intuitive data that is immediately actionable. Historically, one of the major obstacles to creating a client analytics platform is that the data is stored across hundreds of databases in a variety of formats. Commissions are held in one system, while fees charged by the exchanges could be in another system. Analyst time is captured in timesheet software, and access to company management is tracked elsewhere. This siloed approach hinders the ability to produce reports on a timely basis because these various systems are not linked. Instead, the desired data must Exhibit 10 be pulled from each underlying database Universal Client Analytics Platform separately into what often becomes one Global Account Review massive spreadsheet (see Exhibit 9). The first solution is to automate the aggregation of information from as many sources as possible. Then the data needs to be properly mapped. Each commission dollar, rebate, interest payment, research chit and custom algorithm expenditure should be stored so it is mapped to a client. But the client is just one view. In order to support flexible views of the business, the data should support multiple and simultaneous segmentations.
Americas EMEA APAC

Prime Broker

Electronic Sales

Research

Derivatives

Revenues

Costs

High Touch Equities Low Touch Equities Options Executions Stock Borrow Swaps Desk
Client Analytics Platform

Sector Analyst Exchange Fees Repo Costs Cost of Capital

Source: TABB Group

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The ability to manipulate this data in a variety of ways is critical because straightforward analysis does not always suffice. Although a client may seem unprofitable at first glance, it is possible that they may add value to the overall business in other ways. For example, the client may be absorbing fixed costs that would have been otherwise reallocated to every other client. Looking at this type of client simply on a trade-by-trade basis, it would be difficult to show a profit. But with further analysis, nuances such as reducing fixed costs to other clients can be factored in when looking at the overall client relationship (see Exhibit 10). Any firm that does not have a robust, globally integrated set of controls over execution costs, commission management, and compensation is at risk of losing clients and seeing deterioration in the return on its buy-side relationships. Any firm that still conducts such client analysis manually, or only engages in this type of analysis on ad-hoc basis, cannot compete against those who are turning client analytics into a science.

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Conclusion
In the era of the universal client, the brokerage infrastructure needs to be expansive but still retain a flexible business model. The opportunity to offer a full-service value proposition is back. Brokers need to deliver value on both the execution services side and the investment decision-making side. In bolstering attempts to increase revenue, keeping costs down and maintaining a lean operation is critical. But managing commission structures and margins on newlydemanded buy-side services is much more of a challenge than it has been in the past. Brokers must implement a client analytics infrastructure that is flexible and on-demand. There are nimble technology solutions available today that automate the following tasks: Data Aggregation: Few brokers create a full audit trail of an order, from the receipt of the order from the buy side to the detailed explicit costs. Trade data should be collected as part of the trading process and should be easily accessible. Basic analysis, for example, examining revenue inflows and comparing client costs, may not reveal the true reasons a business is underperforming. A number of elements such as access fees, research utilization, ticket/share volumes, and market data costs should be factored into the cost analysis to prevent overspending. Customizable Analysis: There are several ways in which a broker can get a clear picture of client profitability. A broker can create client metrics on a pertrade basis; this snapshot can either be broken out by trader or taken as a holistic view of the entire desk. Examined in conjunction with client activity, the results of these findings can help a broker determine how to properly service the client. If revenue is too low, the client should be excluded from certain valueadded services to which higher-paying clients are entitled. If a client is paying too much, a broker may be at risk of losing the business because another broker may be able to offer the same services at a lower rate. Scalable Infrastructure: Scalability of operations is limited when there are multiple groups and desks who own spreadsheets and databases that do not communicate with each other. During times of heightened volatility or volumes, the ripple effect on manual processes can have an unbridled effect on daily operations. Day-to-day tasks can quickly become backed up and create a delay in client reporting and calculating performance. Information Sharing: The initiatives mentioned above may all be in vain if positioned as a standalone product that is proprietary to any one group within the firm. In order for any analysis to reach its full potential, information must be readily accessible within all areas of the firm from the front office to the back and across all products and levels of management. Traders and managers should not only be privy to information that is relevant to their team; rather, all information should be viewed as it relates to the greater good of the firm in its entirety.
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About
TABB Group
TABB Group is a financial research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the methodology of first-person knowledge, TABB Group analyzes and quantifies the investing value chain from the fiduciary, investment manager, broker, exchange and custodian. Our goal is to help senior business leaders gain a truer understanding of financial issues and trends so they can grow their business. TABB Group members are regularly cited in the press and speak at industry conferences. For more information about TABB Group, go to www.tabbgroup.com.

The Authors Adam Sussman

Adam Sussman is director of research at TABB Group. Sussman joined the firm in 2004 as a senior analyst. Before that, he served as a senior product manager responsible for order-management systems, routing and next-generation trading tools focused on the equities and options markets at Ameritrade, Inc., a brokerage industry subsidiary of Ameritrade Holding Corporation. Sussman earned a BA in philosophy and comparative literature at the University of Rhode Island. At TABB Group, Sussman has authored a number of reports, including Prime Brokerage 2010; US Equity High Frequency Trading: Strategies, Sizing and Market Structure; Equity Risk Models: The Evolution of Predictions; Equity Swaps and OTC Options: A Buy-Side Perspective; International Perspective on Transaction Cost Analytics; Performance Anxiety: A Buy-Side Study on Benchmarks and the Investment Process; European Institutional Equity Trading 2007; Modular Algorithms: The Growing Choice of Buy-Side Execution Strategies; Institutional Equity Trading 2006; Hedge Funds 2006; Outlook on Algorithms; Trading Under a Microscope: The Buy-Side Perspective on Transaction Cost Research; Institutional Equity Trading 2005; and Managing Risk in Real-Time Markets.

Cheyenne Morgan

Cheyenne Morgan joined TABB Group in February 2007. Cheyenne manages TABB Groups LiquidityMatrixTM Report, which tracks monthly market share and pricing of exchanges, ECNs, dark pools, and crossing networks. As an analyst, she is a contributor to both TABB Group research as well as client-driven consulting projects. Before joining TABB, Cheyenne served as an analyst at Markit Group, Ltd., where she worked on bringing transparency and efficiency into the syndicated loan business and conducted market research on the loan industry. Prior to Markit, Cheyenne began her career at Sumitomo Trust and Banking, Ltd., where she worked in the Corporate Investment Management Group. Cheyenne attended the Leonard N. Stern Undergraduate Business School at NYU, where she graduated with a BS in Finance.

2010 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. |

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www.tabbgroup.com Westborough, MA + 1.508.836.2031 New York + 1.646.722.7800 London + 44 (0) 203 207 9397
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2010 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. |

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Drive topline revenue by engaging new clients that may demand more sophisticated commission structures such as cost-plus billing, tiered rates, rates by product, etc. Measure, manage, and optimize brokerage, clearing and execution costs as well as other trading-related expenses by client, trader, venue, and product. Build customer loyalty and protect revenues by aggressively growing soft dollar/CSA/CCA programs. Pay sales and trading commissions on net rather than gross P&L, and manage complex sales splits. Expand your offering by adding content or analysts, which may require payouts based on covered-name trades. Extend customer reach to more asset classes and international markets. Meet regulatory and compliance reporting requirements. Remove silos, add online reporting across asset classes and lines of business.

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Any firm that does not have a robust, globally integrated set of controls over execution costs, commission management, and compensation is at risk of losing clients and seeing deterioration in the return on its buy-side relationships. Any firm that still conducts such client analysis manually, or ... on ad hoc basis, cannot compete against those who are turning client analytics into a science.
Adam Sussman/Cheyenne Morgan The TABB Group, LLC.

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