Outsourced trading is not a new phenomenon but one that is being hotly discussed in buyside circles as Covid-19 disrupts markets and office life. Historically, firms were reluctant to offload their trading activities to a third party but they are now mulling over their options. However, it still may take time before current conversations translate into future concrete transactions.
As Clare Vincent-Silk, partner at consultancy Sionic puts it, “We see Covid-19 creating increased interest in outsourcing trading desks and there are a lot of people talking about it, but so far few have put pen to paper. One reason is that everything has moved so fast and firms have had to cope with lockdown and working from home. This has meant new ways of working, and people have realised that they can function and execute orders from home. It has made it acceptable to have the dealing function remotely and this will help move outsourcing forward.”
There have been several studies showing that the intent is there. The most recent is from Northern Trust which recently published a White Paper – Driving Growth in Asset Management: Solutions for the Whole Office in 2020 and Beyond. It found that, 85% of the 300 global asset managers polled have either already outsourced their trading desk or are interested in doing so over the next two years.
In Europe specifically, a recent survey of 30 European investment managers conducted on behalf of BNP Paribas Securities Services showed that 20% of the firms canvassed had already hived off all or part of their dealing activities. A similar number – 21% – were considering this type of service in the next 18 to 24 months.
Cutting costs
Cost savings and the requisite investments in technology to build scale are always the top of the agenda when fund managers deliberate the outsourcing route. However, they came into sharper focus after markets plunged in the first quarter as the virus took hold, leading to spiralling trading costs. A study by Virtu Financial showed that in the US, they surged 42% compared to the same period last year, with March costs increasing to a high of 63.7 bps. In the UK, the figure was a staggering 76% increase during the period while in continental Europe it was 55.2% and 78% in Asia Pacific – excluding Japan.
“Covid has only accelerated a trend that was already happening,” says Thomas Castiel, head of dealing services within BNP Paribas Securities Services. “It created different market conditions with greater volatility, trading volumes and risk. Some firms found it difficult to cope with market conditions and some faced capacity issues to trade. Outsourcing is able to provide this additional capacity.”
Gary Paulin, global head of integrated trading solutions, Northern Trust Capital Markets, also believes that Covid-19 highlighted the need for different business continuity and disaster recovery plans because traditionally companies would decamp to a second location during a crisis.
“Working from home was ancillary but now companies are looking at how traders can best replicate their business,” he says. “Providing traders with three screens, a Bloomberg terminal and surveillance technology comes at a cost especially when the industry is also under severe margin pressure. However, even before Covid, firms were focused on operational resiliency especially with the UK’s Senior Managers and Certification Regime (SMCR). They were weighing the cost of retraining and hiring against outsourcing.”
SMCR which came into force late last year, is part of the UK’s Financial Conduct Authority’s push to raise standards and improve culture, governance and accountability within financial services firms. The regime shifts the responsibility of activities within a firm onto senior managers and brings into scope non-executive directors.
Most outsourced firms will perform roles set out in SMCR, but the jury is out though as to whether all outsourced firms can fully perform the role as set out in the SMCR, according to Brian Charlick, Principal Consultant at CGI. “Where the regulatory compliance of trading and reporting is concerned however, the established outsource providers are well equipped to manage because it is part of their core business,” he adds. “In fact, outsourcing can increase the compliance. It has yet to be seen, but I suspect in addition to being a core requirement, compliance has been maintained partly due to increased regulatory focus, but also partly through a desire to prove themselves to potential future clients.”
There have been other regulatory drivers, most notably MiFID II and its onus on fund managers to obtain best execution for their end investors, taking into account price, costs and speed. “The costs of trading have increased because the market has become more complex due to MiFID II,” says Michael Horan, head of trading at BNY Mellon’s Pershing. “There is a difference between executing an order and then having to be accountable and reporting under RTS 28 requirements. This is a burden, particularly today when many fund managers would rather spend their time managing money, gathering assets and attracting new clients.”
This has taken on new meaning in the post‑Covid world with temperamental market spikes and interest rates cut to the bone by many central bankers across the world. Generating returns has become that much harder and as Castiel says, “increasingly, what we are seeing is that investors want their portfolio managers to focus on the investment decision making and to outsource the post trade as well as the execution.”
Variations on a theme
As with any investment solution, size does matter and the behemoth players typically have well-resourced internal teams while the small to mid-sized firms with shallower pockets will look more carefully at outsourcing solutions.
However, as Andrew Walton, head of European business at Tourmaline Partners points out, the decision also depends on the size of the funds, turnover, strategy, whether they need a specialist execution firm and how much they cut their broker list in the post MiFID II world. “The question that fund managers have to ask is what is the impact and cost of my trading and do I have the right tools,” he says. “What Covid did is expose those managers who were not able to access the liquidity they needed.”
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