Olivia Vinden and Alex Heasman of Alpha FMC look at the pressure on trading desks and middle offices that global firms face.
Today’s global asset managers need a global operating model which can support their business strategy across multiple continents and time zones. This presents both an opportunity (increase efficiency, reduce risk, lower costs etc) and a major operational headache. The challenge is to combine responsive and targeted local services with global standardisation, all in an operation that never sleeps. Trading and middle office in particular are two areas where global asset managers can reap significant rewards from globalising their operations, but both typically require major changes to operating models and systems to realise the full benefit.
Making significant alterations to trading infrastructure is easier to justify and harder to avoid than ever. The search for improved trading performance and clarity regarding data from transaction cost analysis has put global trading models under the spotlight. Moving from disparate trading desks to regional trading hubs located geographically close to the markets they are responsible for is increasingly the model of choice.
A situation where trading desks in multiple regions are active in the same stock, at the same time, in the same market is not uncommon. This throws up the question of how to ensure customers are treated fairly, while maintaining execution quality with the different desks effectively trading against each other.
Adopting a model in which orders are routed to a regional trading hub, which has responsibility for all orders to be executed in a given set of markets, leads to a simple model. This allows dealers to focus on ensuring they have the strongest relationships possible with their broker community, and they have the best chance of discovering blocks of natural liquidity. This will lead to optimisation of trading performance by significantly more than fractions of a basis point every time the trader does not have to cross the spread.
The provision of a trading desk set up to specialise in seeking liquidity, staffed by traders equipped with the strongest market knowledge possible, can only improve performance. A consolidated, regionally focused model will help provide this.International order routing
Routing order flow between regions presents its own set of challenges. If a US-based portfolio manager were to invest across UK and Japanese stocks, there would be a requirement for connectivity to the regional hubs that would trade these orders on the manager’s behalf. The issue of linking legacy infrastructure is a thorny one, requiring a focus on standardisation of data and communication protocols. To support this, all business processes across regions should be aligned to ensure the amount of bespoke regionally specific work undertaken by the trading desk is minimised and the maximum benefit is realised.
Once in place, the advantages gained from having a trading desk in the same time zone as the market are obvious: dealers can monitor orders and respond to market events quickly. This improves trade quality, rather than relying on a broker to run an order overnight with no oversight.
One further area of discussion has been the splitting of trading desks to separate liquid vs illiquid flow, allowing dealers to focus on areas where they can add most value. High liquidity flow requires efficiency of execution, squeezing fractions of a basis point where possible through scale and automation. However, illiquid flow requires a different approach.
Illiquid orders, particularly in emerging markets, cannot be handled in the same fashion. When handling a stock that trades only once a month, there is little a machine can do to help. True, best execution requires the human touch of a dealer with a well-established broker network, and knowledge of the likely sources of liquidity, ideally with access to liquidity-seeking tools.
GLOBALISATION OF IBOR
Global trading models need to be supported by a global Investment Book of Records (IBOR). It’s a common complaint that there is no single industry view of what IBOR means, but in very simple terms, it is an investment record that allows investment managers to take their decisions. It therefore needs to be available with reliable and reconciled data at the start of their working day. In the old world, this process would effectively be ‘single-time zone’ – a UK-based investment house would have a start-of-day position followed by a trade cut-off at the end of the day, an end-of-day process would then run, exceptions would be dealt with in the morning and the process would start again.
To enable fund managers to be based in the geographies where they were investing, a new model was required. A UK-based investment house might be running Asian equity portfolios – with a fund manager in the region making the decisions. This meant the IBOR needed to be supported by processes which accommodated this multi-time zone activity. For many clients, this was supported by adding open trades to the start-of-day position and enforcing cut-offs – but fundamentally the IBOR remained single-time zone.
For some investment houses, this single-time-zone IBOR just isn’t sufficient. Global asset managers have therefore looked to implement a ‘global middle office’.
This means the three major operating time zones (Asia, Europe, Americas) each have a start-of-day IBOR delivered to support their local managers, and, at the most sophisticated end of the model, globally managed portfolios that have intraday updates to the IBOR to support multiple start-of-day positions.
A multi-time-zone IBOR requires some additional processes to ensure operational effectiveness. For example, each IBOR delivery will include a valuation based on the time zone that is being delivered, for assets based outside of the valuation time zone this may result in stale prices.
Similarly, controls need to be added to ensure any corporate actions which have been processed are aligned with the updated prices.
IN-HOUSE VS OUTSOURCE
One area in which service providers have seriously differentiated themselves has been the quality of their global middle office services. This year, Alpha FMC ran a study covering investment manager perceptions of outsourcing in which IBOR data was repeatedly noted as an area for improvement. There are a few service providers who offer a truly global middle office service, but in truth the number of clients who require a global follow-the-sun IBOR is smaller than you’d expect.
There are some disadvantages to relying on a service provider to deliver a multi-time-zone IBOR. The handoffs needs to be carefully managed to ensure trades aren’t lost between updates. This often requires the global asset manager to perform a trade reconciliation on the inbound IBOR as they retain the only version of the traded record. Nonetheless, there are also many advantages of using a proven global middle office service, and when done well, asset managers benefit from established global operating hubs that take advantage of low-cost offshore and near-shore centres supporting an operating model that never sleeps.
From aligning middle-office functions with local time zones to addressing the particular requirements of different asset types, a globalised approach offers asset managers many efficiencies. Critically, though, this approach needs to be applied in the right way. Processes have to be aligned across the global operation to deliver the most streamlined order flow between regions and truly global investment reporting is essential. With the right investment and support, asset managers have much to gain.
Olivia Vinden, principal, and Alex Heasman, principal, Alpha FMC
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