A study on the broker-dealer industry points to what firms must do to cope with pressures such as a shift towards fee-based advice.

Broker-dealers’ margins are under pressure, meaning that firms able to exploit niche positions or economies of scale through size will prosper, a report said, suggesting the middle ground is being squeezed.

The comments came from Cerulli Associates, the research and consulting firm.

Returns on assets are being hit, as advisors have chosen to put more money into low-cost “passive” strategies and products, as well as institutional share classes. This means revenue-sharing to broker dealers has come down, Ken Shirk, director of Cerulli’s intermediary practice, said in the report.

"Margins are getting squeezed across every channel, B/Ds are challenged by explicit costs related to technology, operations, and compliance, as well as implicit costs causing a reduction in return on assets,” Shirk said.

Broker-dealers are also seeing business pressured by clients’ move towards registered investment advisors, part of a general shift towards fee-based advice at the expense of commission-driven brokerage. This is a process that has accelerated amid the arrival of the Department of Labor’s fiduciary rule, even though that rule has encountered recent legal road-bumps. (Recent attempts by the Securities and Exchange Commission to suggest pushing the process forward have been criticised for being over-complex, as seen here.)

For some time, there has been a trend of staff at broker-dealers defecting to RIAs or forming their own businesses, seeking more independence and control.

“As mega teams have shown a preference for autonomy and economics of the registered investment advisor (RIA) channel, they either affiliate with a broker-dealer RIA platform or move altogether to affiliate directly with an RIA custodian. The loss of these assets, or the shift of assets into less profitable platforms, puts downward pressure on return on assets,” the firm said.

Broker-dealers are fighting back by using their access to advisors to renegotiate revenue-sharing agreements with asset managers and promote strategic marketing partnerships and data packages.

Even so, the margin pressure is causing asset managers to re-valuate strategic partnerships. Nearly 90 per cent of national sales managers are more closely evaluating partner firm relationships on the basis of return on investment, compared to five years ago, the report said.

"Small broker-dealers are ill-equipped to shoulder losses to their already thin profit margins, and consolidation will accelerate," Shirk said. "The impact of these challenges has been masked by market growth. Still, some boutique broker-dealers are joining larger independent broker-dealers and becoming large offices of supervisory jurisdiction. The move allows them to lean on the IBD's scale and infrastructure, but still maintain a reasonable degree of autonomy,” it continued.

Wirehouses have also adjusted strategies in response to margin. "While the wirehouses are well positioned with a highly productive advisor force that boosts profitability, the high cost of recruiting packages has weighed on margins. In the past two years, the wirehouses pulled back recruiting budgets to protect margins, trimming bonuses that skyrocketed in recent years."

The report is titled US Broker/Dealer Marketplace 2017: Segments of Strength.

Another headache for the industry is how Morgan Stanley, one of the largest broker-dealer businesses in the US, last year decided to walk away from a pan-industry “protocol”, established in 2004 by hundreds of firms, under which they agreed not to sue each other when teams of staff defected. UBS and Citigroup have also left the arrangement. Morgan Stanley had complained that the protocol was being abused.