Is capital commitment still something the brokers are offering these days?
For those who are new to this concept, once upon a time brokers would offer their own capital and balance sheet to buyside customers. These customers would execute a block trade with the broker, who in making that block, would be on the hook for the created liquidity. The broker's balance sheet would reflect the "open" trade until the broker could complete the trade itself by finding the liquidity it manufactured for the buy-side account. It did this hopefully at a profit.
But as broker capital requirements have changed over time thanks to new regulations such as MiFID II and others, this type of trading has become less profitable and more infrequent. According to Larry Peruzzi, Managing Director International Trading at Mischler Financial Group, this type of trading has become the ghost of trading past.
In its glory days between (2000 to 2005, Peruzzi added that capital commitment ran at closer to 40% at its peak.
First, the current environment is giving capital commitment stiff headwinds. This is a combination of MiFID II regulations in Europe that dictate how and where stocks trade. Also, the prevalence of buy-side to buy-side crossing networks that lower clients risk. Thirdly, agency commission rates below 1 cent per share making a commission premium less palatable. The current sideways market that make capital pricing difficult and lastly, agency algorithms that closely replicate clients' objectives.
Spencer Mindlin, Capital Markets Analyst at Aite Group, shed some light on the issue for Traders Magazine.
Mischler's Peruzzi added that al is not lost when it comes to capital commitment or principal trading. While looking bleak prima facie, he said some larger bulge firms are still able to profit on capital trading but it has morphed more into guarantee VWAP and Market on Close pricing rather than blind portfolio bids. Traders Magazine reached out to several bulge brackets brokers to get their view for this update but none responded to emails or calls.
But what about the second tier or smaller brokers?