Don’t shoot the broker …

IFR 2052 27 September to 3 October 2014
6 min read

I’m feeling a bit dejected. And I’m not alone. Most of us in the fixed income and credit broking community are ranging from depressed to near suicidal – and, truth be told, not entirely without reason.

It is hardly a secret that brokers are generally struggling at the moment. Volumes are down and regulation is up. Best execution and electronic trading platforms are bad enough for business, without near-invisible volatility and record low rates making life even harder.

Most of us have expressed our doubts about the environment that is being created, but it was having the line pulled by one of my larger clients that really made me look at the world out there. The CEO is a private finance specialist, the CIO comes out of equities, the head of fixed income has a background in treasury and running liquidity funds and only the fourth down the chain of command is a credit fixed income specialist. He, evidently, was the only one who really understood why we might have been essential to the work he does.

MAKING MONEY IN bonds is as much about locking in relative value as it is about the fundamental credit call. Relative value does not exist in equities (other than maybe in the likes of Shell with its dual listing): BP is BP is BP. In the “old days” firms would look for relative value trades, put them on the book and then try to pass them on to the investing clients. Those days are sadly gone.

Salespeople spend most of their time flogging new issues and traders, if they find a relative value trade with a bit of juice in it, will certainly not be giving that to a customer.

Altruism is not a word that appears in the Lexicon of Investment Banking Terminology. Not that brokers have altruism in their DNA either – they are largely superannuated investment bankers themselves.

But what they do bring in most cases is a vast range of experience and a thumping Rolodex.

There is a reason why people get bounced off the trading floor when they hit 50. It is because they have too much experience, because they know too much. They have done their time as distribution cannon fodder and have matured enough to know when to say “No!”

Banks don’t want or need that. They have been around for long enough to know that acting in the clients’ interests belongs in the same category as the cheque being in the mail. Banks may not need them – but investors do.

Altruism is not a word that appears in the Lexicon of Investment Banking Terminology

INDEPENDENT BROKERS HAVE no axes to grind and, as they don’t enjoy the privilege of allocating new issues, don’t hold investors firmly by the neck. Clients owe them nothing other than the margin they charge for sharing their knowledge, their experience and their services. Best execution not only takes no account of this; it firmly outlaws it. Talk of sinking the ship for a ha’penth of tar.

Indeed, “best ex” is fine and dandy but as my senior partner once commented, no trading platform has ever generated an idea. It is the ideas that produce excess return, not the odd cent or penny that is skimmed off the trading price. If the thought-process is correct, then the price should not make or break a relationship.

Small brokerages like our own spend their time scouring the world for relative value ideas or otherwise undervalued paper. The reason it is cheap is because it can’t find a buyer and it can’t find a buyer because the investor to whom it may appeal hasn’t seen it. We take the time to explain why we like it and why we think it makes sense to take it down. Some we win, some we lose. My fourth in the line of command portfolio manager appreciates this but his towering hierarchy misses the point, so he in turn misses the value that we added to his returns.

UNTIL THE CITY of London was visited by the Big Bang in 1986, market-making and broking were strictly separated and, some of those who lost their shirts in 2007/2008 might conclude, with good reason. The conflicts of interest which exist within an investment bank very rarely seem to drop butter-side up for the investing customer. And best ex pushes the banks even further away from investors – remember that all regulation is supposed to protect investors’ interests and not issuers’ – and the free-flow of information, the reason people supposedly go to a “market”, is also being suppressed into non-existence.

Brokers have existed in markets for a lot longer than have market-makers but they – we – are progressively being legislated out of existence.

Current attempts to fundamentally rewrite a rule-book that has, a few notable occasions excepted, worked reasonably well for the past few centuries should make us wonder. Not even FIFA would be mad enough to pass a law that banned defenders from scoring goals or lower league clubs from knocking higher league ones out of cup competitions.

Brokers might not be as good at doing many things that banks are good at. But we do retain within our community an enormous pool of knowledge, experience and knowhow – and legislation and regulation should encourage it being unlocked. It might cost money but it is here for the end-users’ benefit, not to their detriment.

Anthony Peters