A new report from Northern Trust has claimed investment managers of all sizes and strategies have been prompted to undertake a comprehensive review of their operating models, and has led to an increase in outsourced dealing and other functions, such as foreign exchange and transition management.

The research from Northern Trust highlighted how the COVID-19 pandemic has accelerated the challenges faced by firms across the globe, compounding pressure from competition, fees, regulatory and compliance challenges, technology costs and shifting product demand.

These combined factors along with an increasing pursuit of greater efficiency and transparency, new client demands and data analytics as set to drive, what the custodian is referring to as, a ‘fourth wave’ of outsourcing.

“The pandemic has challenged a range of operational assumptions. Working from home has, for example, questioned the need for a portfolio manager to be in close proximity with the dealing desk,” said Gary Paulin, global head of Integrated Trading Solutions at Northern Trust Capital Markets.  

“Previously considered essential, the pandemic has effectively forced firms to outsource their trading desks to remote working setups and the effectiveness of this process has disproved the requirement for proximity, in turn, easing the path to third-party outsourcing. Many investment managers are actively considering outsourcing to a hyper-scale, expert provider as a potential, cost efficient solution – one that maintains service quality and, hopefully, improves it whilst adding resiliency.”

The paper added that while cost savings remain a core driver, and indeed are one outcome of outsourcing, they are no longer the only focus. Far from being solely a defensive reaction to increased pressure on margins, the white paper describes outsourcing as part of the target operating model, or moving toward the ‘Optimal State’ for many investment managers. It explains how the focus “has expanded to the variety of other potential benefits offered – enhanced capabilities, improved governance and operational resilience.”  

Northern Trust’s research also compares outsourced trading to software-as-a-service stating: “instead of carrying the cost and complexity of running an in-house solution, firms move to an outsourced one, free up capital to invest in strategic growth and move costs from a fixed to a variable basis in line with the direction of travel for revenues”.

“The opportunity to deploy capital to build new fund structures, develop new offerings, focus on distribution and enhance in-house research has been taken up by several of our clients to the benefit of their investment approach, and to the benefit of their investors,” added Guy Gibson, global head of Institutional Brokerage at Northern Trust Capital Markets.

“Additionally, in the last two months alone, many firms have recognised that outsourcing to a well-capitalised, global platform has enabled them to take advantage of cost-contained growth opportunities in new markets.”

In May, Northern Trust partnered with BlackRock as part of a new end-to-end investment ecosystem for both its asset manager and allocator clients that will encompass everything from trading services and operations to data insights and analytics.

The launch of Whole Office, an open architecture strategy, is aimed at providing clients with offerings at all points of the investment lifecycle through a combination of proprietary services and partnerships.

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The paper highlights the onset of a ‘third wave’ of outsourcing, which will not only include trading desks but all front-office functions, such as foreign exchange and transition management.

“This third wave is likely to establish a new status quo across the industry – helping asset managers enhance their resources and focus on specialist skill-sets by drawing on external best-on class asses servicing and fund operations expertise,” the paper said.

Outsourced trading was once considered a niche solution that appealed primarily to smaller or emerging funds, however the paper suggests this concept has emerged as a viable solution for larger funds looking to enhance their scale and reduce costs.

Costs for North American asset managers have increased by an average of 5% per-year, and 6% in the last 12 months, according to McKinsey.  Figures from Morningstar and Mercer also predict a 35% fall in active management revenues by 2023.

At the same time, passive funds now represent over 50% of all stock ownership in the US.

The Northern Trust report forecasts a potential cost saving of 25% from outsourced trading among asset managers and asset owners. This will be achieved through reduced headcount, as well as reduced technology, transaction and regulatory costs.

“We believe that, over time, many asset managers will at least look to outsource some or all of the costs and complexities of trading to a third-party, one that replicates the function of the trading desk, not just in their office and not on their P&L,” the report added.

“In our opinion, the trends to outsource will evolve similarly to that of cloud computing, where IT companies, for example, in-house their intellectual property, and where all the high-capital, intensive, non-core functions are outsourced to a safe and secure hyper-scale provider like Microsoft or Amazon.”

Custodians see these trends as a perfect opportunity to evolve their outsourcing business model and leverage new technology to accommodate front-office solutions.

Northern Trust launched its Integrated Trading Solution last year to capitalise on smaller-sized European asset managers, pressured by MiFID II, to outsource their front-office operations. It now expects this trend to migrate to the US.

Elsewhere, State Street is also planning to launch an outsourced trading service and will use the technology it acquired when it bought Charles River.

“As traditional methods of doing business have changed, global custodians have similarly evolved, and are leveraging their many years of expertise in working with data, security, and technology to create innovate solutions for clients,” the report said. “For them, outsourced trading is a natural progression of other outsourcing trends over the past few decades in the back and middle-offices.”

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Regulations, such as MiFID II, have highlighted to buy-side firms that they are responsible for compliance and data quality, regardless if they use a third-party provider for certain non-core functions.

“Relying on any partner is a challenge, especially when the regulations have made it clear that we are responsible for the service regardless if we outsource. If that service fails, we have to demonstrate that we can step in and fix it,” said John Marsland, chief operating officer, investments, Schroders at the InvestOps Europe conference in London.

“It doesn’t matter whether your supplier has the best business continuity plan or how many sites they operate across, you have to be able to operate your business without it. The only way to do that is identify overlapping providers and partner with them strategically.

“This means deepening partnerships with a smaller number of vendors, but the expectations of monitoring and governing them is quite enormous.”

Asset managers have to also ensure the data on their funds is accurate, both for regulators and their own end-clients.

Fund administrators and custodians have come under fire from regulators about the soundness of their outsourcing services, prompting buy-side firms to adopt governance procedures in the event that their providers do not provide a sufficient service.

Earlier this year, JP Morgan’s fund administration business in Ireland was fined €1.6 million for three breaches of the country’s outsourcing requirements. The UK’s Financial Conduct Authority (FCA) has also conducted thematic reviews of the business models of third-party outsourcing providers.

However, some providers have brought new solutions for buy-side firms to enhance the governance process of their outsourced providers. Last year, Brown Brothers Harriman (BBH) launched a new tool allowing asset managers to oversee the new asset value (NAV) function performed by their third-part administrators.

At the start of 2019, technology vendor Temenos partnered with Bloomberg to allow its asset manager users to generate their own NAV estimates independent of, and in parallel, to their fund administrators, enabling accurate daily oversight and ensuring continuity of operations in the event of an outage.

Earlier this year, The TRADE took a closer look at how outsourcing providers really operate and differ from agency brokers, and examined what benefits opting for outsourced execution can offer to the asset management industry.

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CTIM will use Northern Trust’s Integrated Trading Solutions for trade execution, matching and settlement services, as well as excess to global markets and trading locations.

The mandate also includes use of Northern Trust’s assisted MiFID II transaction reporting service.

“Our Integrated Trading Solutions are designed to help asset managers like CTIM drive business efficiencies and alleviate operational pressures while supporting their risk management requirements. At the same time, our reporting solution offers a cost-effective, streamlined way to help them meet their transaction reporting obligations under MiFID II,” said Guy Gibson, global head of institutional brokerage, Northern Trust.

The new mandate expands on CTIM’s current relationship with Northern Trust, having also has been a custody and fund administration client.

“Working with Northern Trust provides us with scale, expertise and first-class technology support – allowing us to focus on our core capabilities and alpha-generation for our client base,” added Anthony King, chief operating officer, Charles Taylor Investment Management.

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There are underlying issues with the front-office outsourcing industry, and these take many forms. To begin with, there is general confusion amongst market participants as to how these providers actually operate, primarily in terms of how they differ from agency brokers.

Alongside this, buy-side traders often view the outsourced dealing desk as a potential threat to the future of their careers. However, those asset managers venturing down the outsourced trading path are supposedly seeing a number of practical benefits.

Outsourced trading providers essentially act as a buy-side trading desk, with very similar operating models in terms of how they transact on behalf of clients. For a typical arrangement in the UK, the buy-side client has a single relationship with the outsourced trading provider, while the provider has individual relationships with the sell-side and trading venues, meaning that the client is transacting with the outsourced trading desk and they are the counterparty risk. Ultimately, the provider is standing between the market and the client.

Most outsourced trading providers will accommodate methods and arrangements in terms of anonymity based on the needs of the individual client because, as with most things in this industry, this is not a one-size-fits-all type of deal. There can also be differences according to region. Some parts of Europe, for example, have adopted a model known as RTO, or reception and transmission of orders, which has proved to be popular in major financial districts such as Paris.

With the RTO method, the outsourced trading provider deals in the name of the buy-side client, so the counterparty risk remains between the institutional investor and the broker. Focusing more on the typical UK model, anonymity is an aspect that providers of outsourced trading agree can bring huge benefits to many funds.

“Standing between the buy- and sell-side means that we can protect the end client by allowing them to remain anonymous, and conversations our clients would have previously had with the sell-side are now handled by us,” says Andrew Walton, head of European business development at outsourced trading provider, Tourmaline Trading.

“The sell-side is happy to have those conversations with us because they understand that we are not crossing orders or competing with them, and there is no potential for information leakage. If we were to get buy and sell orders in the same name from a bulk of clients, we aren’t taking that away from the sell-side table, we are taking it to their table.”

For smaller asset managers in particular, anonymity created through a typical UK outsourced trading arrangement could prove useful in terms of minimising market impact, reducing information leakage and preserving alpha. Such an arrangement also removes the need to establish separate and individual relationships with brokers, which can often be legally complex, costly, and difficult to both attain and maintain due to potentially lower business flowing from smaller funds.

But for the larger asset managers that most likely have the appropriate sell-side relationships embedded, anonymity doesn’t always provide a competitive edge. If a secondary relationship with an outsourced trading provider was established and that provider was trading on behalf of the larger asset manager, the market would likely see a sizeable shift in volumes and far less flow coming from that particular buy-side firm.

“CF Global has clients that want to trade anonymously, and others that want to be visible with their counterparties,” says Steve Blackburn, partner at outsourced trading provider, CF Global. “Anonymity can be helpful for some funds, whilst there are benefits to others of facing the street. It is a fluid situation that is constantly evolving as the sell side continues to change and as the market moves away from bundled commissions. The final outcome remains to be seen, but we are active in both types of workflow and the service is bespoke. Each client can have their own default, or change trade by trade, the flexibility is theirs.”

Buy- or sell-side?

Larger asset managers or hedge funds might not be as enthusiastic about outsourcing execution to a third-party. Speaking at TradeTech Europe in April, the head of trading at $975 billion asset management firm Invesco, David Miller, told delegates during an Oxford-style debate that, at this stage, his firm would not consider outsourcing its execution processes.

Citing Invesco’s expertise and in-house capabilities, Miller added that he doesn’t believe an outsourced trading provider could execute better than his traders can. “I would say some of the traders we have are best-of-breed anyway,” he said. “We’ve got the experience, the technological back-up as well, we’ve got the systems and the support, so, no, we wouldn’t consider outsourcing our trading.”

Where the front-office outsourcing provider could potentially add value for buy-side firms of all sizes is sourcing liquidity and market access, and this is where the difference between an outsourced trading desk and an agency broker emerges.

For example, if a UK-based asset manager sent an order to an agency broker for execution in Asia, that order will only interact with the flow that the agency broker sees in Asia. An outsourced trading provider, on the other hand, will have access to broader parts of the liquidity spectrum through various relationships, including with the agency broker.

“In most cases, we actually have better access to the sell-side than asset managers building those relationships on their own because of the sheer volume of our desks globally,” says Daniel DiSpigna, chief operating officer at Tourmaline Trading. “We’re trading with more than 350 brokers in the world now. We use broker electronic trading tools and access high-touch desks and so we are considered an algorithmic client as well as a cash desk client.

“When you put that altogether, that is effectively one massive buy-side desk because we are acting in that capacity, far greater than most trading desks. We use our economies of scale to access liquidity on the street, and for a fund to get that kind of access to a bulge bracket there’s usually a large price tag attached. The large banks aren’t going to reveal their flow to anyone for free and commission budgets can be unclear because funds won’t know until they get access to the liquidity they need.”

Some providers are indeed registered as agency brokers, mostly those that are part of larger institutions offering other financial services such as investment banking, custody or prime broking. But ultimately, the outsourced trading desks are acting as buy-side trading desks, not agency brokers, and they are deeply embedded in the workflow of the asset management client.

There has been reluctance from European sell-side firms to embrace outsourced trading desks due to this misunderstanding, with many brokers identifying outsourcers as competitors offering similar services on an agency basis, but this perception is shifting. Ultimately, and providers continue the battle to clarify this, the outsourced trading desk represents the fund managers rather than competing for sell-side business.

Giving up control

There is an element of fear when considering outsourcing front office activities, referred to by some funds as ‘giving up control’, that it could potentially leave them in the dark in terms of market insights.

Heads of desks, and even portfolio managers, are intrinsically linked to the execution element of asset management. Execution is a key part of the business for most firms, from dealing right through the trade lifecycle to settlement, so carving out that piece and handing it to another firm can initially seem troubling.

Border to Coast is a UK asset manager established by local authorities to manage pension funds as part of the move towards the pooling public sector pension schemes. It chose to outsource its dealing after contemplating the monetary resources needed to establish a trading desk in-house and determined that the outsourced model was operationally more efficient for the firm. This is a typical case for many long-only funds that already outsource execution to a provider, but for Border to Coast, taking a step back from the execution and relying on an outsourced trading provider certainly left some members of the team with concerns.

“The portfolio managers were worried they would lose market flavour by not being as close to it,” explains Mark Lyons, head of equities and alternatives at Border to Coast. “But now they say they haven’t lost anything, and in fact, they probably have more market insight than they previously had. I imagine this is because they were sourcing insights from various individual brokers, but having outsourced our trading, they are getting the information from one central counterparty that is seeing the wider market and feeding that back to us.”

For other asset managers, it’s the lingering potential for conflicts of interest that dominate concerns when handing flow to a provider. UK equity fund Fundsmith was seeking expertise in execution and access to liquidity pools when it outsourced its dealing following its launch in 2010 to a well-known, although no longer operational, provider.

Similar to Border to Coast, Fundsmith opted to outsource its execution having considered the costs of running an internal dealing desk. But Simon Godwin, partner and chief financial officer at Fundsmith, says that when the firm engaged with outsourced trading, removing any potential conflicts of interest was of paramount importance.

“It’s imperative that outsourced trading providers do not trade as principal,” Godwin says. “They need to have clarity of strategy, and I think that’s why some prime brokers will struggle to get into this space because they will have to leave trading in principal behind. You have legal agreements in place and tonnes of oversight, but for me, it’s about telling me that you are a house that is never buying as principal, never unknowingly on the other side of a trade from me.”

Cost benefits

There can be no doubt that managing costs has played at least some part in almost every fund’s decision to outsource front-office activities. At a time when regulatory upheaval has substantially increased costs and squeezed resources for the buy-side, fee compression in the asset management industry has created a perfect storm of unease about the profitability of running an active trading business.

The industry is at a point where small funds seem to pay disproportionally more for having an in-house dealing desk than larger funds, which in turn pay disproportionally less relative to their assets under management. The all-in costs to establish and maintain a three-person dealing desk, according to industry estimates, are up to £1.5 million per year, including compensation, technology, software, Bloomberg Terminals, data feeds, storage, and all the other elements required to operate an efficient desk.

When entering into outsourced trading arrangements the cost impact for the buy-side, regardless of size, is significant, albeit in an unexpected manner. Costs are not necessarily realised in terms of hard dollars or pounds, but in terms of who, or which part of the business, is paying for the outsourced service. Through an agreed basis point commission on trades that are executed by the outsourced trading provider, the fund that is most active and trades the highest volumes within an asset management firm foots the bill. The bottom line is that it is the fund that pays for the outsourced trading service.

This fact may come as a surprise to some, particularly in relation to European regulations which prohibit buy-side firms from using funds to pay for a number of internal costs. The impact of this has seen the majority of operational costs shift from the fund to the management company. But buy-side firms that have outsourced trading and execution could hypothetically remove in-house dealing desks – along with the associated costs – and pay for outsourced trading out of commission that is in the fund.

One might call this a ‘rebundling’, or reverse of unbundling under MiFID II, bringing about huge cost savings for an asset manager. With competitive rates offered at outsourced trading providers, and the most active fund at an investment firm paying for the service, it’s not as dubious as it perhaps initially sounds. Outsourcing advocates point to a potential positive impact for buy-side firms grappling with increased costs under the regulatory burden.

“Prior to MiFID II, we had been relatively low cost because we had low transaction volumes and our research didn’t really cost that much given the transactions we were doing, but moving to a new model post-MiFID II we realised it would be a much bigger cost to us, so we were looking for the most efficient way of reducing our dealing costs,” Border to Coast’s Lyons explains.

“We aren’t making a saving per se, we still have to pay for execution and research, but under MiFID II it’s more expensive for us to run the business. Although we are paying more for research now than we used to, I would say we are probably getting broader coverage. But we avoided that additional cost by outsourcing our trading, rather than making a saving.”

Movement under MiFID

MiFID II has resulted in a downward trend for commissions and counterparty numbers are being slashed at a time when buy-side firms need to see more liquidity and more information to appease the best execution mandate. Providers of outsourced trading say that now even larger asset managers are turning to them for assistance in navigating the new European trading landscape, as well as a managing costs and market access.

“Historically, larger funds have considered their asset size as a reason not to use services like ours, building out in-house desks. But now, funds are getting much more pragmatic about the explicit and implied cost of trading and firms are more open about their internal priorities and how they allocate resources and cost,” says CF Global’s Blackburn.

Scott Chace, co-founder and managing partner at CF Global, says that the firm has seen a steady increase in interest from prospective clients, with MiFID II playing a key role in raising the standards for best execution.

“It’s a difficult operating environment for both the buy- and sell-side, where most institutions are looking to reduce costs,” he explains. “There has been a lot of focus on the research side of MiFID II since it came into force, and we think taking further steps to ensure best execution will become more important to regulators as the cost of poor execution is effectively an additional fee that the underlying client pays.”

Where outsourced trading providers are already beginning to make headway, particularly with the larger investment firms, is in the hybrid trading desk model. Referred to by some providers as supplemental trading, the model differs from fully outsourced trading that smaller funds tend to lean towards by integrating in-house dealing desks with an outsourced trading desk.

The idea behind this is that the buy-side client can use the outsourced trading desk, integrated into the buy-side workflow under the hybrid model, to cover geographies that its internal desk does not currently trade, access parts of the liquidity spectrum out of the internal desk’s reach, or deal with difficult transactions that require anonymity for minimal market impact and to preserve alpha.

Hermes Investment Management, a UK-based asset manager with just under $50 billion in assets under management, has long-been an outspoken advocate for the hybrid trading desk model after entering into an agreement with CF Global to form a desk focused on emerging market and non-Japan Asia equities.

According to Hermes, the decision to outsource was taken primarily for the investment teams trading outside of UK times zones. Equity transactions related to Asian and  emerging markets portfolios are executed by CF Global and all other transactions are dealt with by Hermes’ in-house dealing team.

It’s this approach that is expected to spearhead the rise of outsourced trading and those on the buy-side will perhaps breathe a sigh of relief to learn that providers are focused on empowering in-house dealing desks. The historically negative aspect of front office outsourcing, often associated with being a threat to buy-side traders or general confusion around how they operate, appears to be changing, while fees continue to decline, as costs continue to surge.

Technology will help with this battle, but it will only get firms so far. Change is in the air for outsourced trading, with industry estimates that by 2022 at least 20% of investment managers with assets under management more than $50 billion will outsource some  portion of their trading operations. Perhaps it’s the outsourced trading route that could prove to be a key differentiator among buy-side firms in the future.

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During an Oxford-style debate on outsourcing execution services at TradeTech Europe, David Miller lauded Invesco’s in-house capabilities and systems when asked outright if the company would ever consider the concept.

“I would say some of the trades we have are best of breed anyway,” said Miller. “I don’t think anybody can do it better than we could.

“We’ve got the experience, the technological back-up as well, we’ve got the systems and the support, so, no.”

The debate was moderated by Glenn Poulter, head of business development, global markets at Northern Trust Capital Markets, the firm which launched an outsourcing trading service for asset owners and asset managers six months ago. The move made it the first custodian to take on buy-side trading functions.

Miller’s stance showed how some larger asset managers are wedded to in-house execution, despite the widely touted benefits of outsourcing, such as cost and risk reductions, along with leverage of technology and platforms.

For an asset manager with the size and scale of Invesco however, its own capabilities and systems mean it is less likely to seek out outsourcing opportunities for equities execution.

Miller said it’s “possible that FX could be” outsourced but was firm on his stance on equities.

Speaking from the perspective of an asset manager who has outsourced its execution, Karen Zachary, chief operating officer at CRUX Asset Management, described the benefits of the decision, including the aforementioned cost and risk reduction, access to markets and efficiencies during the introduction of MiFID II.

“MiFID II impacted us pretty significantly, having outsourced all the trade execution there was support through all that, but the cost of research, external reporting and everything that needs to be controlled, cost has been pretty substantial.

Zachary added that it did take a while to get fund managers used to not having a trader sitting beside them. “There is a line between us and the external trading activity and that’s a line that you can’t cross,” she explained.

Taking a neutral perspective on the debate, Greg Faragher-Thomas, director at Alpha Financial Markets, believes that the new regulatory environment will force even the largest of firms to at least consider outsourcing.

“MiFID and regulations has forced firms to look at what the objective is of the end client – a passive product, an active product, multi-asset products, solutions-based product – you really have to hold yourself accountable to that full lifecycle,” he explained.

“That’s where we are seeing, even the larger firms, looking at the entire value chain from fund manager, order generation all the way through to settlement as to the full costs around the process and dealing is no exception to that.”

Faragher-Thomas described the decision to outsource or not as an ‘emotional’ one. “If you remove the emotion you can look at how you can measure the value chain. People comfortable with outsourcing, back-, middle-office and custody. You start to see what’s valuable.”

Research from consultancy Opimas in February this year suggested that front-office outsourcing is expected to surge over the next couple of years, as asset managers struggle to keep on top of regulatory and cost pressures according to new research.

The study predicted that by 2020, around 20% of investment managers with assets under management greater than $50 billion will outsource at least some portion of their trading desks.

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The bank has named Guy Gibson as global head of institutional brokerage, and Anna Ranaldi as global chief operating officer for the business.

Based in Chicago, both will report to Michael Vardas, global head of Northern Trust Capital Markets.

“These newly created positions mark an important step in the evolution of Northern Trust’s institutional brokerage business,” said Vardas.

“Guy and Anna’s leadership and extensive experience will be invaluable as we continue to grow our global capabilities in response to significant client demand.”

Gibson previously led Northern Trust’s institutional brokerage unit for Europe, Middle East and Africa (EMEA) and Asia-Pacific. He also co-founded Aviate Global, an institutional equity broker, which was acquired by Northern Trust in 2016.

Ranaldi is a 30-year veteran of Northern Trust and has held a number of leadership positions in asset servicing and asset management, before moving to its markets business in 2009.

Alongside her new role, Ranaldi will retain her responsibilities as president of Northern Trust Securities, its US broker-dealer business.

Northern Trust recently launched its Integrated Trading Solutions service, a front-to-back outsourced trading service which combines its equities and fixed income trading capabilities with its access to global markets, trading venues and liquidity.

The custodian bank stated at the time of the launch the new service will help asset managers meet their best execution obligations, set out by MiFID II.

“This is an exciting time for our brokerage business with our recently launched Integrated Trading Solutions now supporting multiple clients across the globe, from sophisticated asset owners to boutique funds, to hedge funds, through to large global asset managers,” added Vargas.

“The cost and operating model efficiencies achieved through this outsourced trading capability are recognised by our clients and we expect this solution to continue to grow strongly in 2019 and beyond.”

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Asset owners are slowly emerging as serious competitors for traditional asset managers should they opt to take assets in-house for greater control and to battle rising costs.

Speaking at InvestOps 2019 in the US, Northern Trust’s director of strategy for asset servicing, Marc Mallett, told delegates that asset owners are a hidden and less obvious competitor for asset managers, at a time when costs are rising for the buy-side.

He added that for a long time in Canada, around 80% of pension funds have managed their assets in-house, and then can outsource everything from trade execution, IBOR, to fund accounting, to service providers with significantly lower costs. Although there is currently no rush for the majority of US pension funds to do the same, Mallett said that over time and as cost pressures continue, something will have to give.

Outsourcing has been a major theme at this year’s InvestOps conference in Florida, with many market participants debating the pros and cons of undertaking the process for various front, middle and back office functions.

Speaking during a fireside chat, COO of investments at American Family Insurance, Vincent Pasqualicchio, told delegates that his company used to outsource most of its assets, but recently reversed this.

“We had 70% of our assets externally managed, but we went through a business transformation where our focus was on bringing the right technology and skill sets onboard so that we can make decisions on what we continue to outsource,” Pasqualicchio said.

“We looked at people, processes and technology from front to back office, and looked at the opportunities of insourcing versus outsourcing. Now, 70% of our assets have from being externally manage to internally managed because we think we can do it better ourselves. We are looking for that to grow to 90% over the coming months.”

Despite a surge in electronic trading, automation and the use of technology to bring those costs down, buy-side trading desks are still seeing costs rise. Citing a report from Greenwich Associates, Mallett said that costs on buy-side trading desks are set to increase by a further 10% this year alone.

Assets under management have been growing just as fast as costs, a recent change for the industry, but it’s no longer the case that growth means profit. Mallett warned that asset management operating models may not be able to support a market correction, recession or stall in asset growth.

“For asset managers, maintaining a strong performance will help but it won’t be enough because the real focus is on cost. You have to become more efficient to compete. Automating processes, outsourcing and reviewing compensation are the most effective ways of reducing costs,” Mallett stated.

“Those that can reduce costs will create a disincentive for asset owners to insource. Traditionally, outsourcing always started at the post-execution phase, but now, we can help you outsource from post-order generation. Agency execution is also critical when outsourcing, because you need someone that is trading only on your behalf and in your direction.”

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As the industry shifts from meeting best execution requirements towards smarter execution processes, foreign exchange (FX) market participants have agreed that outsourcing will play a key role for both buy- and sell-side firms.

Speakers on a panel at TradeTech FX USA told delegates that the trend towards outsourcing portions of the smart execution process to specialists will become more prominent, as firms often don’t have the resources to build technology or develop the smart execution process they need in-house.

“It’s about working with vendors who specialise in things like aggregation, analytics, smart execution, and that has to be part of the evolution because it’s impossible to do everything in-house,” said Danielle Caravetta, director of global sales at Pragma Securities. “It takes too much time, too much money, and everyone is dong more with less, so you have to be smart about who you partner with. Most of the specialists are faster, cheaper and will help you get the best result with less time and less money.”

The panel added that firms looking to work with technology vendors or certain aspects of their execution processes should seek a company that will act as a partner. But the outsourcing question ultimately comes down to how bespoke or unique a firm’s need is.

“For me, it’s important to selectively outsource where you don’t have the expertise to do certain things,” Michael O’Brien, global head of trading at Eaton Vance, told delegates. “I don’t know how to code, so if someone can build something that will help me with a particular task then great. But when it comes to the execution process, you have to be extremely sensitive about who you work with. Away from execution, it’s easier to choose your partners.”

Panellists also agreed that it can be challenging to navigate the array of technology providers currently available in the market. Trust was also labelled a key aspect when choosing which technology vendor to work with, with O’Brien adding that often times vendors can “promise the world”.

“I’m not suggesting they are misleading us, but they may not completely understand our challenges,” he said.“That initial conversation ahead of partnering and moving forward is crucial because it’s about building the trust. We can talk to references and they’ll have a reputation in the marketplace, but there’s really no way of knowing if they can solve my problem. It’s an ongoing process for both sides, but it’s important that you choose carefully and take your time.”

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A survey of senior buy-siders carried out by BackBay Communications and Osney Media found that 76% of respondents have already automated or outsourced at least some compliance functions.

Although 58% of asset managers polled stated that they intent to outsource or automate more compliance functions within five years, while 42% said it would remain the same. No respondents said they plan to reduce automation or outsourcing for compliance. 

The study also found that a majority of 68% of buy-siders expect company budgets on regulation to increase, with 28% stating between 3-5% of total revenues will be spent on compliance in five years.

Robotic process automation and machine learning or artificial intelligence were jointly identified by 30% of those surveyed as technologies which could have the biggest impact on compliance in the future.

“With the advent of regulations like GDPR and MiFID II, it’s become clear that many firms are still unsure of how to best meet the ever-changing regulatory standard and what technology’s role should be,” said Bill Haynes, CEO and founder of BackBay Communications.  

“These uncertainties also present great opportunities for asset managers to proactively put the processes in place to make the most of what these new technologies and platforms have to offer in terms of client service and engagement. Although it poses a challenge for asset managers, this survey and others like it provide valuable insights to track the change.”

In terms of compliance with MiFID II and despite it being a European regulation, 80% of asset managers surveyed – over half of which were based in North America – said they had been impacted to some extent.

One in four added that MiFID II presents a significant challenge for their business, while 15% said it had negatively impacted their competitiveness.

“The regulatory landscape for asset management has been in constant flux since the financial crisis began a decade ago,” added James Hatwell, content producer at Osney Media.

“As such, it is no surprise that many of our survey respondents believe compliance costs will continue to rise in the coming years. As new technologies begin to take centre stage, firms are presented with both opportunities for cost-savings and additional compliance challenges. It will be interesting to see which firms can make the most of these emerging platforms.”

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