November 22, 2012 10:54 pm

Stockbrokers look at pooling back offices

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Several stockbrokers in London are in talks about merging back office operations, in a bid to cut costs and avoid becoming take­over targets in a rapidly consolidating sector.

According to people familiar with the situation, the informal discussions are in early stages and have been prompted by increasingly difficult market conditions that have led to a spate of job cuts and acquisitions among brokers. If a deal to join back office functions is agreed, it would demonstrate an unprecedented level of co-operation in the fiercely competitive sector.

“There’s incredible competition, volume is thin, liquidity is thin. I would say it’s all sort of part of a trend of consolidation, fragmentation and capacity in our industry,” said a senior broker.

“We have a certain amount to benefit from pooling [resources] into larger entities. When business is scarcer, you will inevitably be more attentive to costs and save wherever you can.”

The merger idea was being considered by about a dozen brokers, ranging from those specialising in small-cap companies to large banks, people close to the matter said.

Although a practical plan to merge the back offices has not been drawn up, a person involved in talks said one proposal was to pool resources for settlement and clearing, which would potentially deliver greater cost savings for
the firms involved than if they individually outsourced those functions.

Brokers involved in the discussions said there were many outstanding questions and risks to consider, including how client confidentiality would be protected and how regulations would be met.

“If we give them our back office and something goes wrong then, from a regulatory and stockbroker perspective, who do you kick?” asked one industry executive who was approached about the idea.

But the executive added that market conditions meant brokers were having to consider such moves. “The question is whether the benefits outweigh the hassle.”

Another broker warned: “We don’t want our competitors to know how much business we’re doing.”

However, the broker said the recent introduction of EU short selling regulations had highlighted the potential benefits of sharing costs.

These rules, which came into force on November 1, are intended to address concerns that short selling – betting that shares will fall in price by selling borrowed holdings, and then buying them back cheaply – exacerbates market downturns. They also require investors to disclose their short positions and settle trades sooner.

The broker said the process of locating and borrowing stocks was costly for brokers, but savings could be achieved if they pooled their demand for stock, because doing so would reduce the amount they were charged for borrowing it.

Brokers have been trying to find ways to ease pressure on their margins for some time, as income commission from secondary trading has been squeezed and there has been less advisory work on flotations.

The UK broker sector has contracted after a handful of acquisitions in the
past year.

Investec, the South African bank and asset manager, bought Evolution Group, while the US broker Jefferies acquired Hoare Govett.

At the end of last year Canaccord, the Canadian bank, bought Collins Stewart Hawkpoint, the mid-cap broker – a purchase that led to about 100 staff being made redundant.

Many smaller independent brokers have shed staff, including in back offices, to save money. After a hiring spree, Oriel Securities in March cut a 10th of its workforce.

Sharing back office resources offers a way to cut costs, but brokers disagree over the size of potential savings.

One broker said that even a 1-2 per cent reduction in total cost base would make the move worthwhile. However, another senior broker argued that the savings would be negligible for a broker that did not have a large retail customer base.

Back office operations were a “key area where you realise there’s common ground to cut costs” – hence the growth in outsourcing of that function in the past decade, the senior broker added.

“The sad thing about cutting back office costs is the people there are generally much lower remunerated. You’re not going to make a material difference.”

Even if a merger of back office functions were agreed, the senior broker said, it might only prolong the life of a broker that was struggling to stay afloat. “If you’re going down the river without a paddle, it might buy you three or four more breaths.”

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