Soft commission

Soft commission is commission given in a non-cash form.

Soft commission frequently raises problems because it is not transparent. This is often a problem in an investment context because investors' money may often be used to pay soft commission in ways that are not apparent to them.

The problem with soft commission is not the commission per se. The soft commission is very often given in a form that clearly helps provides investors a better service (e.g. research, financial data etc.). The problem is the lack of transparency. The bundling of services implied by soft commissions can also distort prices and therefore impose extra costs on investors.

The most common example of this is the provision of research to fund managers in return for brokerage business. It is usual for access to sell-side research to be given mostly to institutional investors who give the brokerage business, with different levels of access being granted depending on the volume of business.

This leads to a serious problem because the value of the soft commission is shown as a cost of broking (which customers see as a reduction in performance) rather than being shown as a management cost (part of the fund mangers fees).

This means fees can look lower than the real cost to investors of the manager's services.

The fact that broking and sell-side research are almost always bundled together makes the system even less transparent as it is virtually impossible to place a financial value on access to research.

At the time of writing, British regulators are considering how to restrict the use of soft commission by fund managers.

Copyright Graeme Pietersz © 2005-2020