With little innovation having occurred in the Aggregation industry over the last 20 years, we believe it is in serious need of a reboot. Enter, stage right, Aggregation 2.0.
To understand this story, though, we first need to rewind to the opening scene…
How did Aggregation arise?
Commission Sharing Agreements (CSAs) are used around the globe to unbundle execution and research commissions. In the US, less than 40% of trading volume is unbundled using a CSA, with the bulk still being still traded at a bundled (“full-service”) rate. Aggregation is the most common method used to manage CSA credits that are paid alongside a trade. MiFID II has created a new transparency standard that has resulted in an increase in the use of CSAs, especially in the US. As buy-side firms increase their number of CSA partners and are also required to meet the latest regulatory obligations of MiFID II and RPA (Research Payment Account) administrators, there is a growing need for aggregation services.
According to industry surveys, aggregation has risen 50% in recent years as a response to the administrative responsibility on asset managers of managing programs individually.
There are two main aggregation service models available in the market:
- Custodial aggregation – this is where CSA balances are swept to, and held by, a single “Custodial” aggregator;
- Virtual aggregation – this is where CSA balances are held with each CSA broker and a software-based technology solution virtually aggregates these balances for the asset manager.
Service model 1: Custodial aggregation
Custodial aggregation was the first model on the scene. This model ensures CSA dollars are physically moved from multiple CSA brokers into a single account that is held with the aggregating party. This is typically a broker and most often the cash is held on the broker’s own balance sheet.
Custodial aggregators typically impose a per-share “toll-charge” on CSA brokers, rather than charging the asset manager. This charge can cost CSA brokers millions of dollars annually and results in decreased purchasing power for the asset manager. Custodial aggregators typically deliver their services using a customer support or relationship manager-led approach, which can be very costly if, for example, these teams sit in Manhattan.
Below is a list of the pros and cons of the custodial aggregation model, from the perspective of the asset managers and brokers receiving this service:
Service model 2: Virtual aggregation
Virtual aggregation joins our play in scene two. It offers a software-based approach to aggregation that provides asset managers with diversification of counterparty risk as CSA balances continue to sit with each CSA broker separately. Virtual aggregators are typically not brokers and therefore charge a fixed license fee to the CSA broker, irrespective of the number of shares executed. A flat fee charge means there is limited impact to an asset manager’s purchasing power with their CSA brokers.
Virtual aggregators, such as Commcise, have focused on providing solutions that are fully- automated, thus requiring less involvement of customer support teams and brokers, resulting in lower end-to-end costs to manage the process. We fundamentally disagree with the principle that it costs more to reconcile a trade of 100,000 shares of Verizon than to reconcile 10,000 shares of Verizon. All other things being equal, the effort involved is the same for both trades. Using technology, the cost of reconciling trades is in no way impacted by the volume of the trade. We therefore think it’s time to say goodbye to using volume (i.e. number of shares traded) as the basis of a commercial charging model for a service that has become commoditized with the use of technology – this is a key driver for Aggregation 2.0.
In a virtual aggregation model, asset managers and brokers access a single client portal where trades are instantly reconciled; both parties track a single common balance; both parties manage payments transparently; both parties share a single common audit trail. Asset managers can benefit further from seeing full commission wallet reports. These benefits include a view across the research components of both CSA and full-service rates trades that are all unbundled, client / fund-level reporting and granular research accounting, to name just a few (dependant on the solution provider).
Below is a list of the pros and cons of the virtual aggregation model, from the perspective of the asset managers and brokers:
The denouement: what is Aggregation 2.0?
As part of asset managers’ search for best-in-breed solutions, we see the aforementioned models converging, combining aspects of each, to create Aggregation 2.0. Here are some of the key attributes of an Aggregation 2.0 service:
- CSA brokers are charged a low fixed-price fee and are not penalised for improving trading relationships. This represents a more MiFID II-compliant, conflict-free approach;
- CSA brokers are not disintermediated and have direct access to the asset manager;
- The asset managers can choose exactly where they want their balances to be held:
- with CSA brokers;
- with a custodial aggregator;
- with an RPA Administrator;
- with themselves in the case of P&L funds (and often with an RPA) or;
- any combination of the above.
- The asset manager can choose the level of protection that applies to their research credits – whilst this isn’t currently possible in the US (due to conflicts with the 40 Act), it is definitely possible in other jurisdictions around the globe. RPA accounts in Europe are held in the name of the asset manager and therefore offer high protection;
- Automatic, timely trade reconciliations are performed by the technology;
- Outsourced operations team manage any reconciliation exceptions for the Asset Manager;
- Depending on where balances are held, The asset managers can additionally choose:
- who performs research provider due diligence – brokers or an outsourced operations team
- Who makes payments – brokers or an outsourced operations team
- A research accounting framework that allows the Asset Manage to provide fair allocation fund-level reporting for their clients;
- A single end-to-end audit trail is always visible to the asset manager and their brokers;
- Asset managers get oversight over the whole process;
- Asset managers can ensure their data is held securely and know who can access it.
The commission aggregation market is evolving. Competitive and regulatory pressures are driving these changes. Asset managers are demanding more from their aggregation providers because, in turn, regulators and asset owners are demanding more transparency from the asset managers. Aggregation 2.0 has been a long time in the making, but it is now firmly here. Old school aggregation exit, stage left.
In the interests of full transparency, Commcise provides virtual aggregation technology as well as an Aggregation 2.0 offering in partnership with custodial aggregators and other banking partners. To learn more about Aggregation 2.0, contact Commcise today.