Buyside Focus: Outsourcing – Best Execution



Outsourcing has been on the buyside agenda for some time, but Covid-19 has moved it right to the top as firms grapple with the pandemic fallout along with ongoing competitive and margin pressures. While whittling down costs remains a key driver, so too are bolstering the infrastructure backbone, enhancing front office functions and generating value-add opportunities for clients.

There have been several studies demonstrating this trend. The latest is Brown Brothers Harriman & Co’s (BBH) inaugural C-Suite Asset Manager Survey which found that 38% of the 50 senior executives canvassed, responsible for over $18tn in assets under management (AUM), were looking at outsourcing the middle office to drive efficiency. It has been well documented that Covid-19 and the shift to remote working exposed the operational weaknesses and manual processes that can hinder an organization’s growth.

Northern Trust also published two studies – From Niche to Norm as well as Driving Growth in Asset Management: Solutions for the Whole Office in 2020 and Beyond. The latter report revealed the changing attitudes towards the previously sacrosanct trading desk. Around 85% of the 300 global asset managers polled have either hived it off to a third party or are contemplating doing so over the next two years.

In addition, in Europe, a survey of 30 investment managers conducted on behalf of BNP Paribas Securities Services, also showed that 20% of the firms had already handed over part or all of their dealing activities. A similar number – 21% – were considering following suit in the next 18 to 24 months.

It is easy to understand the motivations. Andrew Walton, head of European business at specialist outsourced trading firm Tourmaline, cites research from leading investment banks that found from March to June the implicit costs of trading skyrocketed two and a half to five times as volatility gripped global markets.

He notes that, while explicit costs are important, firms should drill down beyond such headline figures – e.g. the actual trading commissions – and examine “the implicit costs of execution which include market impact, latency, slippage, etc. These are not always assessed in great detail and are just as important, if not more so. They need to understand the true cost of every trade and the impact that each and every one has.”

The benefits
By outsourcing, proponents argue that firms not only save asset managers money but also reduce the number of broker relationships, provide better market access and deeper liquidity with more reliable exposures to counterparties. “A move to variable from fixed cost is still a driver, but outsourcing is no longer just seen through the lens of cost saving,” says Gary Paulin, global head of Integrated Trading Solutions at Northern Trust Capital Markets. “It is also viewed as a way to gain greater flexibility, increased governance and control around business continuity.”

Paulin also points to the Niche to Norm Paper which notes that the pandemic has challenged old assumptions about outsourcing especially when it comes to the dealing desk and the need for traders and portfolio managers to sit in the same room. “Asset managers are looking for capital light models and to future proof their businesses,” he adds. “They are now asking question about the value that they are getting from their trading desks.”

Eric Bernstein, president at Broadridge Asset Management Solutions agrees, adding, “Covid-19 has accelerated things that were in flight and forced the industry to do things it had never contemplated. Outsourced trading was a bit of a taboo topic. However, now if a trader does not generate alpha or save a firm money, then it would look at outsourcing.”

While this is particularly true in the Covid world, the industry had been rethinking their business models long before the pandemic hit. This is due to the changing dynamics that has brought intense competition, plummeting fees, sliding revenues and an onslaught of seemingly never-ending regulations. This has not only led to increased investment in state-of-the-art technology but also experienced compliance staff to deal with the burdensome task of regulatory reporting.

As Gianluca Minieri, deputy global head of trading at Amundi Asset Management, notes “MiFID II and all the pieces of legislation have had an impact on the industry, especially in trading. It has moved from being one of the least regulated to one of the highest regulated and firms need the resources to support this. Margin pressure has been another challenge. There is a race for yield and investment managers are looking much more closely at investment opportunities.”

Search for yield
This is no wonder given the ongoing depressed interest rate environment which is likely to continue in the post pandemic world for the foreseeable future. Active managers have especially come under scrutiny from regulators such as the Financial Conduct Authority for over promising and under delivering returns. This has triggered a move to exchange traded and index funds and explains why over the past ten years, active managers have suffered outflows of over $1.5tn, while their passive brethren have enjoyed inflows of more than $2tn, according to data provider EPFR.

Overall, separate figures from Morningstar note there is now over $12tn in index funds globally – either passive mutual funds or the increasingly popular exchange traded funds.

“The result of buyside firms investing in these more passive styles of stocks is that trading has become more electronic and commoditized,” says Michael Horan, head of trading, EMEA, at BNY Mellon’s Pershing. “This makes it easier to outsource because there is no difference between an internal or external trader trading ETFs. We all use the same algo racks from the same providers.”

Not surprisingly, there is no one size fits all solutions. While some are looking to divest their entire trading desks, others want more of a component approach and may keep the harder more esoteric orders. As Paulin puts it, “firms are on a different part of the journey. It depends on the client and it is not for everyone.”

As the Norm to Niche paper points out, firms that are the most likely to outsource, for example, the dealing function are those that have the sufficient scale and size, are delivering sustainable alpha, and/or gain value which can also be evidenced. By contrast, firms that do not have the depth or breadth or expertise to deliver optimal client outcomes and cannot build comprehensive control and oversight models should consider going down the outsourcing route.

Not surprisingly, there are a range of different propositions on the market with around 20 key providers, according to Clare Vincent-Silk, partner at consultancy Sionic. “For example, in France there is Amundi Asset Management and Natixis TradEx Solutions (NTEX) which have adopted a model known as RTO (reception and transmission of orders) while Northern Trust has more of an Anglo Saxon, agency broker model,” she adds. “There are also independent and single asset class providers such as Tourmaline which specializes in equities.”

Looking ahead, as with any offering, clients will expect an ever longer list of both customized and generic options. “It starts off with execution and access to the market but today that is not enough,” says Laurent Albert, global head of execution at NTEX. “It is important to have a front to back solution because clients now expect other services such as predictive models as well as pre trade and post trade analysis for reporting and compliance which all require huge amounts of data.”