The majority of cash equity commissions are

GREENWICH ASSOCIATES GREENWICH REPORT Q2 2015 Business as Usual? Eying Fundamental Change in Payment for Research The majority of cash equity commissions are currently allocated to brokers as compensation for research services (written product, analyst service, sales service, and corporate access). But fundamental change may be afoot as U.S. investors with significant global operations await the European Commission s upcoming pronouncements on whether to modify or eliminate these soft dollar arrangements. While investment managers should clearly be careful stewards of their clients assets, the devil as usual is in the details. Greenwich Associates believes current proposals have the potential for serious negative consequences for both the buy side and sell side. Put simply, European regulators contend that while investment managers are more rigorous when purchasing research services from their own wallet, they become sloppy buyers when spending their clients money. The more radical solution put forward in Europe is full unbundling, which would require investment managers to pay hard dollars for research out of their own P&L, rather than compensating research providers via commissions. Such an outcome would be, in our view, a solution in search of a problem, likely lessening the availability of sell-side research, which in turn would meaningfully disadvantage small/mid-sized asset managers unable to support large in-house research teams of their own. Even if regulations settle short of full unbundling, European proposals are leading many global managers to review current policies with an eye toward global consistency and adoption of best practices. These are positive goals in and of themselves but have the potential for unintended consequences affecting the availability and quality of research. John G. Colon is a Managing Director of the Firm's Market Structure and Technology practice. Study Participants Greenwich Associates conducted in-person and telephone interviews regarding U.S. equity investing with 243 U.S. equity portfolio managers and 321 U.S. equity traders between November 2014 and February 2015. Respondents answered a series of qualitative and quantitative questions about the brokers they use and their businesses in the U.S. cash equity space. Reviving a Long-Running Debate European regulators believe that the value of research services is independent of commission volumes and that therefore the payment mechanism should be independent too. Doing so, in their opinion, would eliminate the possible inducement for investment managers to alter their trading frequency or strategy in order to generate the commissions to pay for research. Unbundling is a potential mechanism to sever this connection, but proposals also call for greater rigor in how research is valued and for increased transparency. For example, explicit contracts for research and having payments flow through dedicated accounts provide transparency to end investors as to how and why their fund managers are allocating commissions. The debate is reminiscent of discussions in the U.S. in the late 1990s and early 2000s around the definition of soft dollars, permissible services under Section 28(e) of the Exchange Act, and whether investors would consider hard-dollar payments to pay for research and advisory services. Ensuing clarifications around eligible services and the use of commission management programs to enable investment managers to better meet best execution obligations while compensating research brokers including nascent independent research providers appeared to put the issue of unbundling largely to rest in the U.S. However, in an increasingly global investing world, major investment managers are reviewing their policies and practices in light of European proposals. There is keen interest on the part of investment managers in adopting global best practices not only to meet regulatory obligations, but also to simplify their operations and interactions with clients. 2015 GREENWICH ASSOCIATES GREENWICH REPORT

Key areas of discussion and debate are around: How to Value Research Proposals call for separate research budgets based on contractual agreements with individual research providers in advance of the relevant period. How to set these budgets and value specific consumption of research services from the sell-side represents a major challenge. How to Fund Research Budgets Institutions are expected to establish separate research accounts through which all researchrelated payments are made. How to fund these accounts is perhaps the most contentious area of debate whether commissions may be used to fund research accounts or investment managers must fund them out of their own P&L via an explicit increment to their management fee or some blend of the two. The Level of Transparency/Approval Investment Managers Must Provide/Obtain From Their Clients Initial proposals called not only for detailed budgets and justification for research expenditures, but also for client sign-off in advance of managers proposed spending on their behalf. More recent indications are that these requirements will be softened to lessen what would otherwise be an enormous administrative burden. U.S. Cash Equity Research: Not a Growth Business If the current system of paying for research via commissions unduly benefits certain market participants, it doesn t appear to be the sell side. Greenwich Associates universe of larger institutional equity investors generate an estimated $9.8 billion in cash equity commissions. According to traders, 60% of these commissions $5.9 billion are directed to pay brokers and third-party research providers as compensation for research. While $6 billion is a considerable sum, it is far below peak levels and is not where most brokers would view cash equity research as a profitable endeavor. As a highly competitive business, many sell-side brokers have already responded to the pressure on commission pools by downsizing and juniorizing research and distribution teams hardly indicators of indiscriminate spending by the buy side. Research as a Process, Not a Product That a nearly $6 billion stream of payments is directed to research providers largely without any contractual underpinnings might be startling to those outside the equity business. Even so, Greenwich Associates questions the basic regulatory premise that the current process makes investors sloppy buyers. Brokers provide research with the expectation, but not the promise, that they will be rewarded. Broker Longer-Term U.S. Equities Commission Trend (in billions) Total: $10.9 $5.2 $10.3 $5.3 $12.2 $6.7 $13.9 $6.1 $13.2 $11.6 $4.8 $10.9 $4.7 $9.3 $3.9 $10.3 $4.1 $9.8 $3.9 $5.7 $5.0 $5.5 $7.8 $7.0 $6.8 $5.4 $5.9 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Sales trading and agency execution, capital commitment Research/Advisory, sales and corporate access Note: Based on the average reported spend of $16.6 million per account, the total estimated commissions for the Greenwich Associates universe is $9.8 billion for the 12 months ended Q1 2015, when projected to trading universe of 585 accounts in the 2015 study. Source: Greenwich Associates 2015 U.S. Equity Investors Research Study GREENWICH REPORT 2

Proportion of Research/Advisory Allocation for Research, Sales and Corporate Access Total Institutions Greenwich Associates Priorities* 25% 21% Direct access to companies management** 19% 24% Analyst service 21% 26% 2 26% Research conferences and industry seminars Sales service 1 Individual company studies and stockspecific ideas/recommendations*** Economic analysis and portfolio strategy advice Data services (i.e., access to models and data) 2% 6% 4% Industry, cross-sector or cross-region studies*** 10% Other (i.e., customized research, expert, networks, etc.) Q1 2015 Q1 2014 0% 10% 20% 30% 2% 0% 10% 20% 30% Note: Based on 148 respondents in 2014 and 169 in 2015. *Greenwich Associates Priorities are defined as institutions in Tiers 1 4 of seven. Tiers are determined by institutional commission volume, with Tier 1 containing the largest and Tier 7 the smallest commission payers. **Direct corporate access includes non-deal roadshows, one-on-one company meetings and conference calls need. *** In 2015, combined company studies and stock-specific ideas and created a new industry/cross-sector/cross-region category. Source: Greenwich Associates 2015 U.S. Equity Investors Study votes, commission management programs and a mix of high-touch and low-touch trading give investors the tools they need to manage their expenditures. Perhaps most important, however, is the nature of research itself as a process rather than a product, making it inherently difficult to price. Of the 60% of commissions directed as compensation for research/advisory services, portfolio managers would view the majority as allocated for access rather than product. Competition and wide, immediate distribution of research via technology have significantly devalued written product, leading research providers to add value through access to company managements, to their research analysts and to sales professionals. Commission allocations to individual brokers are largely based on broker votes widely utilized by investment managers particularly larger managers that generate the bulk of cash commissions with votes routinely scrutinized to align payments to values. In addition, commission management programs are actively used to manage research payments and free trading desks to pursue best execution independent of payment for research. Nearly all larger institutions have commission management programs in place, with the proportion of their commissions flowing through them doubling since the financial crisis from 1 to 35%. Proposals requiring specific, accepted research contracts are sparking debate about how to price research, but it s really a question of value rather than price. The allocations noted reflect research as a process rather than a product. Based on their investment strategies, interest in particular companies or sectors and internal resources, the same written report, analyst call or company visit may have dramatically different value to different investors or even different value to the same investor over time. GREENWICH REPORT 3

Commission Management Use Greenwich Associates Priorities* Proportion of Greenwich Priority accounts with commission management programs** Among current commission management program users, U.S. equity commissions paid via commission management programs 2015 (72) 8 35% 2014 (63) 86% 30% 2013 (70) 8 2012 (83) 82% 2011 (88) 70% 31% 32% 31% 2010 (73) 55% 2 2009 (79) 51% 22% 2008 (73) 49% 1 0% 25% 50% 75% 100% 0% 25% 50% Note: Numbers in parentheses represent total respondents. *Greenwich Associates Priorities are defined as institutions in Tiers 1-4 of seven. Tiers are determined by institutional commission volume, with Tier 1 containing the largest and Tier 7 the smallest commission payers. **Commission Management Programs provide commission management capabilities under terms of Section 28(e). Source: Greenwich Associates 2015 U.S. Equity Investors Research Study This does not imply that research providers and investment managers are not paying close attention to resource consumption. A majority of investors do track metrics such as analyst calls and visits, invitations to conferences and one-on-one company meetings. Brokers routinely provide metrics of this sort to individual clients to inform discussions of services Broker Services Tracked by Institutions One-on-one company meetings Analyst visits Invitations to conferences New issue allocation Performance of broker recommendations* 9% 29% 5 45% 45% 6 82% 91% 91% 0% 25% 50% 75% 100% Total institutions Greenwich Associates Priorities** delivered relative to commissions paid. This resource tracking, however, is typically to help inform investor assessments of the overall value delivered by individual research providers and is not linked to an a la carte menu of prices for specific products or services. While investment managers may complain about brokers unwillingness to provide pricing for specific services, an a la carte structure is not in the best interest of brokers, investment managers, or investment managers clients given the inherent difficulty of predicting exactly where value will be derived. Particularly in the case of those brokers providing broad coverage of sectors and companies, giving clients the option to call on different broker resources as their needs dictate provides valuable flexibility. Not unlike mining for gold, experience says the nuggets are there, but a lot of dirt will have to be sifted through to find them. The best method for investment managers to determine the value of research may simply be replacement cost analysis: Can they produce on their own the information and insights brokers now provide, of a comparable or better quality and at a comparable or lower cost? Note: Based on random sample of 62 institutions. *e.g. StarMine, Alpha network, etc. **Greenwich Associates Priorities are defined as institutions in Tiers 1-4 of seven. Tiers are determined by institutional commission volume, with Tier 1 containing the largest and Tier 7 the smallest commission payers. Source: Greenwich Associates 2015 U.S. Equity Investors Study GREENWICH REPORT 4

What s the Potential Impact? The answer ultimately depends on whether one sees investment managers as sloppy buyers of services. Greenwich Associates believes broker votes and commission management programs bring structure to valuing and paying for research and afford investment managers with a high level of access and flexibility while protecting the interests of their clients. It is notable that the current regulatory push is not lead by investment managers clients whose assets are at stake. European Commission pronouncements in June and subsequent months will bring greater clarity, but some changes appear inevitable: Exploration of alternative pricing models, including more a la carte pricing based on specific resources consumed, alpha capture, etc. Greater rigor in connecting broker votes to allocations Expenditures on research managed toward dollar amounts with less connection to trading volume Further increases in commission volume flowing through commission management programs Increased transparency to investment managers clients on how research costs are borne by their funds How these trends will impact U.S. institutions overall expenditures on research is anyone s guess, particularly if European regulations move toward full unbundling. However, given the generally flat-to-down direction of the overall cash equity commission pool and the related pressures on broker profitability, even a modest decrease could have a meaningful impact on sell-side provision of research with narrowed coverage and sell-side resources flowing to those investment managers most willing and able to pay. Bear in mind that Greenwich Associates studies have long revealed the intention of investment managers to cull the number of providers used for both research and execution. This year 2 of portfolio managers and 30% of traders express the intention to reduce the number of providers they use. Notably, a similar intention was expressed last year, and the year before, and the year before that, but with little evidence of meaningful cuts. Why? Because most research providers and execution firms are used for valid reasons: If investment managers cut their payments and broker lists to demonstrate rigor in their processes, someone will be left holding the short end of the stick the question is who? n John G. Colon is Managing Director of Securities and Trading, Banking and Capital Markets. He advises on the institutional equities markets globally. Methodology Greenwich Associates conducted in-person and telephone interviews regarding the U.S. equity investing with 243 U.S. equity portfolio managers and 321 U.S. equity traders between November 2014 and February 2015. Respondents answered a series of qualitative and quantitative questions about the brokers they use and their businesses in the U.S. cash equity space. The data reported in this document reflect solely the views reported to Greenwich Associates by the research participants. Interviewees may be asked about their use of and demand for financial products and services and about investment practices in relevant financial markets. Greenwich Associates compiles the data received, conducts statistical analysis and reviews for presentation purposes in order to produce the final results. Unless otherwise indicated, any opinions or market observations made are strictly our own. 2015 Greenwich Associates, LLC. Javelin Strategy & Research is a division of Greenwich Associates. All rights reserved. No portion of these materials may be copied, reproduced, distributed or transmitted, electronically or otherwise, to external parties or publicly without the permission of Greenwich Associates, LLC. Greenwich Associates, Competitive Challenges, Greenwich Quality Index, Greenwich ACCESS, Greenwich AIM and Greenwich Reports are registered marks of Greenwich Associates, LLC. Greenwich Associates may also have rights in certain other marks used in these materials. GREENWICH ASSOCIATES www.greenwich.com 6 High Ridge Park Stamford CT 06905 USA Ph +1 203.625.5038/+1 800.704.1027 ContactUs@greenwich.com