Why the broking industry doesn’t get it and the regulator gets it even less

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I’ve had the opportunity to speak to numerous brokers in recent weeks and the sad fact remains much of the strategy is stuck in yesteryear. The idea that hiring more analysts and promoting a full deck colour brochure of their supposed ‘depth’ to clients is somehow more important than the content they can actually provide in a dumbed down compliance constrained world. The game has changed. The regulator has even less understanding than the brokers when it comes to understanding client needs. The buy-side investment community is also becoming highly resource constrained. To have to waste countless hours on admin to set a price on increasingly valueless research does them no favours.

Don’t be fooled by Smart Karma or Research Pool or any other 3rd party research aggregator. It is the same dumbed-down research bundled into a convenient pricing structure. I’ve looked into the economics and unless a research provider has a huge following the returns on contributing to these third party platforms is next to worthless. The more mouths to feed, the less return. On top of that the platform has no real control over what goes into it. It is a convenience store but in that vein, the nutritional value remains relatively low.

The simplest form of strategy is to set up ‘Special Forces’ type research teams. These teams don’t write rated research but charge on a ‘per mission’ basis. Take GLG. They have no broking license but carry out bespoke requests. Why aren’t brokers following this model? It is insane to hire more in sales, research and trading when the regulator is squeezing the traditional proposition to zero.

Two questions:

Did regulators actually ask smaller scale institutional  investors what they needed before they imposed rules which will dramatically increase their cost of doing business, the very opposite of the goal the regulator thinks its rules will create?

Are the traders of risk willing to take any risk to fill a gaping hole the very people they proclaim they serve are crying for?

What I see is more of the same. The bunker mentality. Conforming to outdated models to keep their inflated salaries alive for as long as possible pandering to internal politics to survive. Badgering clients to fill in irrelevant polls which serve no purpose but the promise of magical commission dollars in the future to their out of touch bosses at HQ. Some brokers even publish “the best of research” weeklies as a sort of self-appraised quality control mechanism to push on clients. Let’s think about that. If all research was properly screened before being published there would be no need to tell clients that this is the tiny fraction of research that isn’t (supposed) rubbish. It is actually confirming client’s worst fears – sell-side brokers aren’t listening  (as usual).

The gig is up. Regulators are even more clueless. Instead of trying to provide a marketplace where smaller boutiques can survive they drive the cost of compliance to such a degree that in many cases the teams of internal watchdogs swamps the investment decision makers. That’s right! The hottest ticket in finance is in compliance. A headhunter told me the network of compliance officers is so tight across firms there is almost a deliberate ‘insider’ matrix among them which encourages them all to switch firms to keep driving up their ‘collective’ remuneration. The people in charge of preventing scams are in fact the biggest operator of insider trading!

We’ve countless examples of how inept regulators are. Bernie Maddoff the biggest of them all. Despite multiple investigations and the clearest set of breaches presented to them they failed to uncover a $65bn fraud. Many regulators by background are lawyers meaning they are full of theory but devoid of real world practice. Regulators would be better off hiring convicted traders to hunt down fraud and illegal behaviour. As it stands they are as clueless as ever thinking more biting regulations will help the market. Wrong. Free it up but raise the penalties for actual wrong doing. I’ve never met an investor who doesn’t want to keep a useful broker alive. That’s why the payment skew is like it is. It isn’t just about Michelin 3-star meals and strip clubs. All the regulator has done is make an uncomplicated system almost unworkable. Although if brokers woke up to the fact that providing ‘special forces’ that clients directly requested and paid for they’d fill a gap which the regultor would have no answer to and make the iTunes research fintech companies obsolete overnight.

MiFID 2 will be the crowning glory of regulatory failure. MiFID 3 will be here before we know it as evidence of the catastrophic bungle it’s predecessor already is before it is in effect. Then again it is an EU directive – that ought to have told us something.

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