“The value of the Swedish model is that it is the only way to ensure best execution,”
“Unbundling fixed income is the next big challenge, I think the Swedish model can be applied to other asset classes than equities. It’s a bit more difficult. But it can be done.”
When thinking about the unbundling of payments for research from payments for execution, it can help to keep in mind best execution. Ever since MiFID in 2007, there has been an obligation in Europe for the buy side to obtain best execution. MiFID II strengthens that commitment, requiring asset managers to take “all reasonable steps” to ensure it. But one of the potential pitfalls in achieving that vision is the difficulty of doing so under commission sharing agreements. This led a group of asset managers to come together in 2014 to produce an alternative, which has come to be known as the Swedish model: complete unbundling of commission payments.
“The value of the Swedish model is that it is the only way to ensure best execution,” said Andreas Wollheim, head of trading and treasury at SEB Asset Management. “At that time , the CSA was the only model available. But I never liked CSAs, due to their complexity. For example, our business has many different funds and strategies. We need at least 25 brokers to achieve best execution. But under the CSA model, if you have more than 15 brokers, it becomes very complex. We don’t have the time or the resources for that.”
The key question many buy-side firms face, especially the smaller ones, is whether or not a process can be found to handle multiple broker relationships, given the increased obligations under MiFID II. Specifically, it was the prospect of daily reconciliation with multiple brokers that proved too much for SEB Asset Management. The problem essentially boiled down to a choice: either expend substantial resources attempting to handle the increased regulatory workload, or cut the number of brokers down to 15. Analysis of the firm’s business, however, suggested that it would not be possible to ‘make do’ with just 15 brokers.
At the same time, the Swedish regulator Finans Inspektionen made it clear to the firms under its authority that they did not like the link between research and the transaction. But as Wollheim noted, “under the CSA, that link still exists.”
Complete unbundling breaks that link. One of the key figures in the development of the Swedish model was Hans Lindh, head of trading at Swedbank Robur (see interview in issue 3). According to Wollheim, Lindh’s idea sounded strange at first – but the advantages soon became clear, and before long, SEB Asset Management began using it. Perhaps one of the biggest potential benefits of the new model, aside from the reduction of reconciliation burden versus CSAs, was the potential to allocate payments more efficiently to where they are really needed.
“In the CSA model, you have to trade with your brokers or you don’t get research,” said Wollheim. “That can be a problem. For example, we have a fund that trades twice a year. They have a high need for research, but if you never trade, under the CSA, you get no research. Whereas with the Swedish model, we can allocate research based on the need.”
This benefit may be particularly important, given the challenges both smaller participants and smaller stocks face in the light of unbundling and the falling commissions paid overall to brokers (see America at the Crossroads on page 10 for a comparison with the USA). However, now that the model is becoming more established, other questions are emerging about its potential to shape markets – including those beyond the world of equities.
“Unbundling fixed income is the next big challenge,” said Wollheim. “I think the Swedish model can be applied to other asset classes than equities. It’s a bit more difficult. But it can be done.”
While SEB Asset Management has not implemented the Swedish model outside of equities, the firm is currently in discussions internally about how this might be achieved. However, these developments are at an early stage.
Nevertheless, what is clear is the gain in efficiency and time involved in the Swedish model, versus the CSA alternative. More than just a time and cost-saving exercise, the unbundling can also be used as a selling point to clients of the asset manager. The prospect of liberating the buyside from the tyranny of manual processes and expensive, complex compliance chores can be invaluable from a number of perspectives all at once.
“When our budget is set, the portfolio manager, the head of equities and compliance meet and agree the numbers,” said Wollheim. “We send one payment per fund, via RPA. We vote internally, and a week later we pay the money. Compare that to all the daily reconciliation and sorting files under a CSA. This is the better path – it’s operationally sound and it ensures best execution. We can show to clients that best execution is our only priority.”
The future of commission payments
Andreas Wollheim, head of trading and treasury at SEB Asset Management
Head of Global Buy-side Research