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Analysts Forecast More Change for Financial Industry

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Modern Money

New business environments and regulations have reshaped the financial sector. Three experienced forecasters shared their outlooks at the “Redefining The Financial Sector: The Industry Analyst’s View” panel held Monday at the SIFMA Annual Meeting in New York.

From the regulatory fate of high-frequency trading to the commoditization of asset management, these analysts discussed how the financial industry will adapt to the changing marketplace.

Exchanges haven’t won the battle against the big banks yet. Many observers expected exchanges to be the victors and large banks to lose business with the passage of the Dodd-Frank Act as more financial products will be forced to be increasingly transparent or traded on an exchange. “The fact is that this [trend] has been very slow to materialize,” said Daniel Fannon, Jefferies Group’s managing director for brokers, asset managers and exchanges.

Regulators have their sights set on high-frequency trading, but Fannon expects the scrutiny to be “data-driven, not politically driven.” He doesn’t foresee a large overhaul of high-frequency trading rather a fine-tuning that may make the market a little less complex than it currently is.

The two major issues that face brokerages are the possibility of a uniform fiduciary standard and more regulation regarding payments for order flow, said Joel Jeffrey, Keefe, Bruyette & Woods’ managing director of equity research for brokerages. A strict fiduciary standard will have a negative impact on brokers and registered investment advisors because of the cost of building systems to comply with the standard. So Jeffrey expects regulators will increase disclosure requirements for brokers, but not enforce a severe fiduciary standard. “The SEC is quite data-driven and they understand the costs of implementing an overly restrictive policy,” he said.

Though payments for order flow have been in the spotlight recently because of Michael Lewis’ book “Flash Boys: A Wall Street Revolt,” such payments are not a new issue, Jeffrey said. The regulatory discussion about the payments for order flow and conflicts of interest has been going on since the late 1990s. “What will the elimination of this mean for brokers? It’s actually pretty substantial,” Jeffrey said. He noted that about 23% of TD Ameritrade’s commission revenue comes from payments for order flow and that figure is 17% at Etrade. But he expects that regulators will not make significant changes and will instead require more disclosure of payments for order flow to retail investors.

The independent broker and registered investment advisor distribution channels will continue to grow for asset managers as they serve retiring Baby Boomers, said William Katz, Citi’s director of asset managers, broker dealers and exchanges. However, “margins for the asset managers have been going down,” he noted. More competition from new entrants, more interest in passively managed products that carry lower fees, and a continuing commoditization of asset allocation among investment advisors have lead to dropping fees and margins being squeezed. Regulation hasn’t helped the asset management industry either. “Most asset managers will say that their compliance and legal departments are the fastest-growing areas of their businesses,” Katz said.