Direct Access Brut Tries New Approach To Buy-Side Penetration

Disintermediation. That's a nasty word these days, especially if you are a Wall Street broker-dealer that is used to receiving trading commissions from institutions. Thanks to the rise of ECNs and the subsequent emergence of direct-access brokers, there are now more ways than ever for institutions to electronically route orders directly to multiple execution destinations, without any assistance from broker-dealers. Indeed, over the last year or so, direct-access vendors have ventured into uncharted waters, establishing niches in the buy-side community by offering their technology to smaller hedge funds and mid-sized institutions.

But a handful of direct-access players have either direct or indirect ownership ties to broker-dealers-ties that create a significant dilemma. On the one hand, these firms want to penetrate the buy side, but, on the other hand, they would prefer not to snare institutional business at the expense of their broker-dealer owners.

So what to do? Well, one solution is for direct-access brokers to offer institutions the chance to reimburse broker-dealers they do business with. For example, the Brut ECN recently launched a direct-access trading system that empowers institutions using the platform-dubbed the Brut Workstation--to re-route most of their trading commissions to the broker-dealer of their choice.

In the past, institutions routing orders to the Brut ECN-which is owned by a large consortium of Wall Street investment firms and brokerages-paid all of their trading commissions to the ECN. But now, via the Brut Workstation-instead of paying their full commissions directly to the Brut ECN-institutions can route between "70 and 80 percent" of their commissions to designated broker-dealers, says Brut CEO Richard Schenkman.

"Institutions today are forced to make a choice: either execute electronically (via an ECN) and use those commissions to get best execution, or execute manually through a broker and pay for that broker's value-added services," he says. "But through the Brut Workstation, we are able to resolve that conflict .... Now, you get not only the execution services of an ECN, but also distribute (your) commissions to a broker for the value-added services they provide."

Brut's so-called sponsorship business model is intended to strengthen the relationships between broker-dealers and institutions. Schenkman says that around 40 broker-dealers-including the full complement of brokers that own stakes in the Brut ECN-have agreed to offer the Brut Workstation to their institutional clients. And institutions that use the platform, he says, will benefit from trading through an ECN without "fragmenting their commission dollars" and fracturing strong broker-dealer relationships.

But what, you may wonder, is Brut's true modus operandi for its sponsorship model? Is it really to enhance broker-dealer-institution relations, or has it been created simply to appease the ECN's powerful owners? Well, Fritz McCormick--an analyst covering institutional e-brokerage at research and consulting firm Celent Communications-says it's probably a little bit of both.

Direct-access brokers, says McCormick, are definitely making inroads at small to mid-sized buy-side firms-but have yet to build a niche among larger institutions. Therefore, he says, it makes sense for someone like Brut to use broker-dealer compensation to incent large buy-side players to employ its front end.

"The reality is that while there is going to be a lot of movement among institutional investors towards direct-access systems, there is always going to be a sweet spot for the broker-dealers-(especially among) larger institutional investors who are really pushing a lot of volume," says McCormick. "That's going to be the market that is going to be the toughest for direct-access players to crack ... and Brut (thinks) that the only way that they are going to snag a piece of the larger segment of the institutional market is through cooperation with broker-dealers."

But he says it is also likely that the sponsorship model was created, in part, to keep Brut's broker-dealer owners happy. McCormick adds that he is not aware of any other direct-access brokers that offers institutions the ability to re-route trading commissions.