There is no question that Wall Street is a far more transparent place today than at any point in history. Generally speaking, broker-dealers are well aware of the pricing models employed by the exchanges, investment managers know-how and for what their brokerage counterparties charge, and end investors can see exactly what fees they are incurring. For trading in particular, there is now a tremendous amount of data – some of it mandated by regulators, and some driven by market forces – around order routing that only a few years ago would have been nearly impossible to obtain. But even as the industry continues to laudably move forward on this score, one area has remained stubbornly opaque for far too long: the transactional connectivity fees charged by some OMS and EMS vendors.
These fees are not only non-transparent, they are also considerable. And worse yet, legacy providers often go to great lengths to make it difficult or downright impossible for the buy side to know how much their brokers are being charged. For LiquidityBook’s part, we’ve always strived to be upfront about our connectivity fees. We charge a flat fee for the proprietary FIX network we operate, we don’t charge any additional transactional fees, there are no tiers or minimums to reach, and there certainly aren’t any NDAs.
Take the case of Voya, who recently faced a situation that illustrates this problem. According to an article last summer in the Financial Times’ FundFire, Voya was asked by Luminex, the buy-side owned block trading utility, to discuss its commission rates after the investment manager’s OMS provider increased the fees it charges Luminex to close to 40% of the total commission. However, when Voya attempted to learn how much the vendor was charging, Luminex wasn’t able to divulge. Voya’s vendor, like several others, imposes strict non-disclosure agreements on their brokers that explicitly forbid them from disclosing the fee to the end buy side client, effectively baking price opacity into their business model.
“The amount of money we are charged by some OMS vendors is tremendous, and with the NDAs it makes it impossible for us to have a frank conversation with our clients about our costs and how those impact commission rates,” said Jonathan Clark, CEO of Luminex. “If eaten by the broker or trading platform, these costs can be a major barrier to entry for innovative new firms, and if they are passed back to the buy side via increased commissions, they can significantly erode alpha.”
To Clark’s point, Aite Group estimated that brokers paid $1.23 billion globally in 2017 for client connectivity fees, and last month the analyst firm convened a panel at its “Equities, Me, and the Fees” conference on the topic. In addition to the sheer cost, one panelist, who manages OMS vendor relationships for a bulge bracket, lamented the lack of transparency around connectivity fees, noting that virtually none of vendors the firm does business with are willing to provide a rate card.
That’s probably because several vendors are increasingly employing pricing models where they provide the software to the buy side at a rock-bottom rate (or in some cases, free), only to make a fortune charging their brokers massive transactional fees on top of the connectivity fees they already pay.
Clearly this is a model that’s worked for razor manufacturers and printer makers for many years, but in those industries the replacement blades and toner cartridges aren’t paid for by a third-party who can’t disclose the fees. Additionally, when the sell side is forced to adjust the execution or research services offered based on costs dictated by that client’s OMS provider, the buy side’s ability to ensure it’s obtaining Best Execution for its clients may be put at risk.
And then there’s the MiFID II issue. Under the regulation, payments to third-party technology providers whose services are inextricably linked to the execution of an order aren’t considered inducements, but it seems more and more in the industry are starting to wonder why that is in the case of OMS providers who don’t operate their own FIX network and are simply adding a tack-on fee.
In addition, the unbundling requirements mean that brokers must disclose any benefits a client is receiving in addition to investment services, which ought to put the NDAs on shaky legal ground. Bottom line, these legacy business models are completely at odds with MiFID II’s push towards transparency, and there is no reason to exclude them from its jurisdiction, especially since they appear to be playing a growing role in the decisioning around how orders are executed.
For LiquidityBook’s part, we’ve always strived to be upfront about our connectivity fees. We charge a flat fee for the proprietary FIX network we operate: $500 per broker, per connection. We don’t charge any additional transactional fees, there are no tiers or minimums to reach, and there certainly aren’t any NDAs. We certify, manage and provide full support of our own FIX network as part of our offering, and because our POEMS (portfolio, order and execution management system) is fully SaaS-based, hosting fees and other costs associated with on-premise deployments are also eliminated
Without this level of transparency, it is impossible for a buy-side firm to truly understand its total trading costs. Managers clearly have an appetite for deeper, more meaningful understanding of their TCA, as evidenced by the success of platforms offered by next-generation providers like Dash Financial Technologies. Their Dash360 transparency tool provides granular detail on all aspects of how each order is routed at both the parent and child level, as well as virtually all associated costs, and it has been a big part of why the firm has grown to become a dominant provider in both the options and equities spaces.
The only cost it doesn’t account for? OMS and EMS connectivity fees. Take a wild guess as to why that is.
Ultimately, the first 18 months under MiFID II have been an overall positive for the industry globally, but with the growing consensus that similar rules will eventually be adopted elsewhere, it is useful to identify where EU regulators may focus on firms not being in compliance with the spirit of the mandate. The handling of OMS connectivity fees is one such area. Firms with business models centered on opaque, tack-on fees cause nothing but headaches for both sides of the street, and if the legacy players have no incentive to change, perhaps it’s time for regulators and the industry as a whole to give them one.
