Morgan Stanley Said to Seek Fees From ETF Issuers to Carry Funds

(Bloomberg) -- Morgan Stanley has a message for the exchange-traded fund world: Pay up. Or else.

The firm has told some fund issuers to pay a fee or risk having future offerings blocked from its sales network, people familiar with the matter said. The plan, which charges ETF firms for transaction data, drew initial resistance from some large fund providers, including BlackRock Inc., and the firm lowered fees in response, said the people, who declined to be named because the information is private.

The move by Morgan Stanley’s wealth management unit, which manages more than $2 trillion in client assets, reflects an effort on Wall Street to bolster brokerage revenue as investors flee expensive actively managed funds for cheaper passive products like index funds. It also poses a challenge to the burgeoning ETF industry, which has thrived by offering low-cost funds.

“If there is any degree of success I wouldn’t be surprised if others swoop in to follow suit,” Ben Johnson, director of global ETF research at Morningstar Inc., said in an interview.

Bruce Dunbar, a spokesman at Morgan Stanley, declined to comment.

Big Player

Morgan Stanley’s wealth management business is focusing on payments from issuers as investors pour money into the sector and new ETFs come to the market almost daily. The funds attracted $286 billion in the past year and have taken in about $700 billion during the past three years, according to data compiled by Bloomberg.

At the same time, ETF issuers know that success means having the broadest distribution -- and Morgan Stanley is a juggernaut. It had more than 15,700 financial advisers at the end of last year and managed $877 billion in fee-based accounts.

Yet the low-cost of ETFs makes it a tough business for both brokerages and issuers to squeeze revenue from. Over half of the money that flowed into ETFs in the past year went to products with an average fee of 0.09 percent or less, according to an analysis from Bloomberg Intelligence.

Against this backdrop, Morgan Stanley’s wealth management business, while thriving, reported a 10 percent decline in fourth-quarter transactional revenue, to $774 million, in part because of lower commissions. The unit reported record net revenue of $4 billion for the period driven in part by gains in asset management fees.

Fee Proposals

Over the past several months, Morgan Stanley has produced several fee plans, according to documents obtained by Bloomberg and people involved in the discussions. The plans have ranged from charging based on assets to a per-fund expense of as much as $10,000 a year. The firm is finalizing its latest arrangement, a person with knowledge of the matter said.

On the disclosure section of Morgan Stanley wealth management’s website the company says the charges pay for data on transaction activity by the firm in an issuer’s ETF. It also adds that Morgan Stanley “may choose not to offer” new funds from those who decide not to pay.

In a document called an ETF Data Analytics Agreement that was obtained by Bloomberg, the company lists charges of $50,000 a year to $550,000 a year depending on the number of funds an issuer places on the Morgan Stanley platform. The agreement says the fees became effective Jan. 1.

In another version of the agreement sent to providers early last year, Morgan Stanley set a fee based on assets. It also said the cost covered a range of services including access to the firm’s financial advisers, branch management and home office personnel. That proposal was later changed to a fixed charge of as much as $10,000 per fund per year for a minimum of $150,000 with no cap on cost.

BlackRock’s Move

After considerable negotiation, BlackRock, the largest ETF provider, and others signed onto a revised plan. The fees range from $550,000 for firms that have more than 100 funds on the platform to $50,000 for those with as many as five. Peter McKillop, a spokesman for BlackRock, declined to comment.

Much of the success of the arrangement could depend on the cooperation of some of the biggest providers. Vanguard Group, the second-largest ETF provider, doesn’t pay firms for distribution of its funds, according to David Hoffman, a company spokesman. He didn’t comment on whether the firm signed the latest agreement. Brendan Paul, a spokesman at State Street Corp., declined to comment on the agreement.

Several firms already charge ETF providers. UBS Group AG has a data fee although its disclosure says that if issuers don’t pay it won’t be held against them when the firm decides which ETFS to offer clients. Charles Schwab Corp. charges for listing on its platform which offers commission-free ETFs.

‘A Meritocracy’

Morgan Stanley also addresses investor conflicts. In its disclosure the firm says conflicts are mitigated because its financial advisers and branch managers don’t receive extra compensation from the arrangement. It also says fees are fixed and aren’t based on new sales or assets invested in each ETF, providing no added incentive for Morgan Stanley to promote ETFs that agree to pay.

Morgan Stanley’s plan could inhibit smaller ETF players from gaining customers and diminish the transparency the industry is known for. It could also result in ETF issuers placing higher fees on future offerings to cover their increased costs.

“One of the greatest things about ETFs is they are mostly a meritocracy,” said Eric Balchunas, an ETF analyst with Bloomberg Intelligence. “The products are out there, the customer chooses and you can see. This is taking a step back.”

To contact the reporter on this story:
Sabrina Willmer in Boston at swillmer2@bloomberg.net

To contact the editors responsible for this story:
Margaret Collins at mcollins45@bloomberg.net
Alan Mirabella, Eric Weiner