Broken brokers

Times are changing for stockbrokers, and for the most part, not for the better. The future is clouded not only by signs that equity markets may have run out of steam, but also because of the uncertainties generated by sovereign debt worries. Then there are the regulatory issues, which have left many brokers barely able to suppress a hiss when mentioning the Financial Services Authority (FSA).

The first of the ill winds currently chilling the sector was whipped up by the credit crunch, and the impact it had on the corporate finance industry. In the face of the financial crisis, companies drew in their horns, closed expensive or unprofitable sides of the business and generally pulled down the shutters in order to survive. Yes, there was an initial bout of cash-raising, but that has long since ended. Those companies that did survive are now leaner and fitter, and are more focused on generating free cash to pay down debt rather than doing big corporate deals. This means less corporate-finance work. Meanwhile, market-making has also suffered as a result of a fall in share trading volume.

Then there are brokers' bond divisions, which in better times were one of the top revenue generators. Not any more. Unsurprisingly, investors have adopted a suspicious attitude towards bonds given the fact that even sovereign debt is now under pressure from the rating agencies. And while there is little prospect of a move in the short term, there will be a time when interest rates start to rise, and that won't be good for bond prices, either.

Over ruled

The next element in the sector's woeful fortunes is regulatory. The FSA has come in for some stinging criticism for having failed to have avert banking excess. It is being accused of making up for this by adopting a more hands-on approach, which some brokers regard as being more like two hands round the neck. True, greater transparency has benefits, but there are others rules that the industry regards as stifling, notably the big increase in contributions to the Financial Services Compensation Scheme. Charles Stanley provides a typical example; it was subject to a levy of £2.6m in relation to the failure of Keydata, a company that it had no dealings with. These sums are significant, given that the group's pre-tax profit for the whole year was just £13.6m.

There are other worries too about what is coming down the track from European regulators. Admittedly, current proposals may be kicked into touch, but there is a French idea to abolish advisory dealing (something that the French don't have). Other regulations have taken their toll, too, notably the cost of complying with the Retail Distribution Review. This has raised the bar on qualifications for private-client brokers, many of whom have failed to achieve the necessary grade, while broking firms have had to pay as much as £5,000 per broker just to sit the exams.

Game changer

Given these issues, a much greater proportion of revenue is being generated by the private-client side of the business. Rich people have been keen to maximise their returns at a time of low interest rates, which gives this side of the broker's business a healthy boost. Evolution Securities , for example, last year saw commission from fixed-income trading fall 59 per cent, while the equity market-making side actually made a loss. By contrast, its Williams de Broë private-client business boosted revenue by 21 per cent, to a record high. Strong equity gains in that period also energised performance fees and boosted assets under management.

Unfortunately, that is as far as the good news goes. Firstly, sentiment looks like it is once again moving against equities, with few people expecting the FTSE 100 index to motor to 7000. Secondly, there is a declining generational flow, which means that investment portfolios being handed down to the next generation are increasingly being turned into cash to pay for things like school fees and other financial burdens. And while execution-only business, where the broker acts simply to effect a transaction, is not to be sniffed at, investors are proving less likely to move to advisory and ultimately discretionary agreements, whereby the broker assumes a more hands-on role and charges a higher fee.

Does this pointing to the end of stockbrokers as we know them? Probably not, but there have been some signs of a change in their revenue mix. Brewin Dolphin , for example, has sold off its corporate advisory and broking division as part of a major review that will see the group move towards becoming as a pure asset manager. And last year, Shore Capital bought a majority stake in Spectrum, an investment vehicle formed to acquire a 58 per cent stake in DBD, a German 4G data services telecoms business.

Favourites

Charles Stanley takes pride in its clients. It may sound corny, but this forms the bedrock of achieving a good reputation. And with that comes more business, something that last year's performance illustrates well, with pre-tax profits up over 30 per cent and funds under management up 13.3 per cent at £14.5bn. Crucially, this was not just a product of the rise in equity markets; there was also a net inflow of funds in both the advisory and discretionary business.

Outsiders

WH Ireland has done well to stem its level of losses. New management has been installed and the sale of its stake in the Australian broking business DJ Carmichael has enabled the group to pay off its bank debt. However, it faces the same headwinds as its larger rivals, and management is understandably cautious about the near-term outlook. Also, there is no dividend to offer shareholders any comfort.

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