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Bear Stearns Meltdown Could Force Buy-Side to Rethink Bulge Bracket Relationships

The failure of a top broker raises questions about the buy-side consolidating broker relationships as well as counterparty risk.

The rapid demise of Bear Stearns could be a wake up call for buy-side traders that are consolidating their trading and research relationships with bulge-bracket firms.

"What we found is that is that some buy-side managers have been consolidating their trading commissions through the Wall Street firms, which is like putting all of their eggs in one basket," says Kristi Wetherington, president and CEO of Capital Institutional Services (CAPIS), an agency broker based in Dallas.

Over the past year, buy-side firms have been consolidating their business in the bulge-bracket firms through the use of client commission arrangements or CCAs. These soft-dollar program allow the buy-side to seek best execution with brokers via electronic trading, while setting aside commissions to pay for third party and independent research. In addition to relying on the bulge-bracket for executions, buy-side firms are relying on the top brokers for their electronic trading tools, execution management systems, algorithms and even their dark pools.

With rumors flying last week that Lehman Brothers, another large player in the mortgage backed securities market, didn't have liquidity to weather the credit storm, there were concerns that another bulge bracket firm could fail. Also, there were reports about Merrill Lynch taking further write-downs as well as Credit Suisse and UBS, while Citi said it would lay off 10 percent of its workforce. "You never know what you're going to read the next day," says Wetherington.

"There's been the assumption in the past that if you trade with a large Wall Street firm that there's s no risk, that you're achieving best execution and getting your research covered and all of that," says the CAPIS CEO. "But what the Bear Stearns meltdown has done is it's called into question the practice of consolidating brokers with only the largest Wall Street firms. It's a wake up call for the buy-side," says Wetherington.

Roughly 50 percent of buy side firms have implemented CCAs, says Larry Tabb, founder and CEO of The TABB Group, which conducted research on CCAs. "Another 63 percent of that group have started cutting back on their brokers and some have chopped out their business (with other brokers)," says Tabb.

Even though folks are consolidating their brokers, the average fund is still using 25-to-50 brokers. "It's not like they are consolidating down to three," says Tabb. That said, counterparty risk is a significant issue, especially with CCAs and CSAs (client sharing arrangements in the U.K.), cautions Tabb.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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