Alpha capture

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Alpha capture is the process via which a broker submits trade ideas to its client investment fund managers who then use them to adjust their positions in equities or other asset classes so that they can achieve market outperformance (alpha). Where the ideas are successful the clients make ex-gratia "commission" payments to the broker. There is no commission paid where the idea generates negative alpha.

Alpha capture presents conflicting regulatory issues in different jurisdictions.

US position

  • Hard dollar payments by US clients for trade ideas, where not accompanied by trade execution, may amount to investment advice, for which the provider must be registered under the Investment Advisers Act.
  • However, payments which reference execution in some way (typically as commission on an equities execution, but not necessarily) are exempted from this rule.
  • Where a person providing trade ideas is not a registered investment adviser any alpha-capture payment would have to reference a trade execution.

UK position

  • No prohibition on non-fiduciary brokers being compensated for trade ideas.
  • To the contrary, to comply with FCA inducement rules brokers should be compensated, preferably as clearly as possible, for services they provide:
    • A separate hard-dollar payment specifically for trade ideas, unrelated to execution, would be ideal;
    • If clearly disclosed to a client, payment can be extracted out of commission on trade execution.
    • Impliedly, where linked to commission there should be some correlation between execution and success in the trade ideas, otherwise the provider may not in fact be compensated for its trade ideas (hence it is better to compensate in hard dollars).
    • FCA rules only apply to FCA regulated entities
    • These are extrapolations from recent discussions on best execution and inducements: the FCA has said little about alpha capture specifically, except to highlight concerns (in 2006) about potential market abuse.

In summary: The only means of satisfying both regimes is to link the payment to some sort of execution.