In a recent survey conducted by Northern Trust, 85% of 300 global asset managers responded that they have already outsourced their trading desk or are interested in doing so in the future.
In a webinar hosted by Funds Europe, Gary Paulin of Northern Trust Capital Markets discusses the trends that have driven the rapid adoption of outsourced trading and the role of COVID-19 in accelerating the impact of these trends.
Outsourced trading may have started as a cost-efficiency exercise but has rapidly evolved and now resembles an optimal state offering diverse benefits in terms of efficiency, operational resiliency, governance and managing technological complexity.
So says Gary Paulin, Northern Trust Capital Market’s global head of Integrated Trading Solutions. In 2019, the market was at an inflection point as margins seemed to stop rising despite strong markets. Competition from passive funds continued to surge while regulation added huge pressure leading many firms to consider outsourcing as a way to buy scale on a variable cost basis and level the playing field against large competitors as a consequence.
Since then the market has had to deal with the disruption of Covid-19. But while the pandemic has had an impact on the outsourced trading market, Paulin believes it has been an accelerant for changes that were already happening rather than being a change agent itself.
The first impact of Covid-19 has been technology-based says Paulin. “This has big implications for the dealing desk.”
Aside from intensifying existing cost pressures, the pandemic has also highlighted the inadequacies of traditional business continuity plans with their big back-up trading floors that have remained unused during the pandemic as well as operational resilience issues. “Clients were already concerned about their exposure to Key Person Risk - say if their head of dealing was sick or out of office. Another area of concern was duplicate or improvised roles – say where the portfolio manager is also the dealer
“And finally, many firms felt uneasy with the lack of control and oversight when it came to off-shore orders, say where a London based firm is trading in Japan overnight, but with no boots on the ground – and so relies on a sell-side broker or a network of brokers to transact on their behalf but with little way of knowing if they act in their best interests,” says Paulin.
Consequently, a growing number of firms are now comparing these costs and complexities to what they would face from an outsourcing vendor.
But, says Paulin, where costs were once the sole reason for outsourcing, things have evolved. “Outsourcing has moved from being seen solely as a defensive or reactive measure to cut costs to one that resembles a more optimal future state and a way to streamline efficiencies, provide for cost-contained growth and enhance systems of governance and control.”
But for this evolution to continue there needs to be a complete change in fund managers’ thinking. “Some people are simply anchored to a way of doing things and will never accept change until it’s forced on them - they become the laggards in the adoption curve.
This is not to say that every firm is going to move to a fully outsourced model overnight, says Paulin. “There are still some firms that get value from their dealing function but, says Paulin, it does mean that wherever a firm perceives gaps or weaknesses in their operations, there are now credible alternative providers of those services who can perform those functions better and more cheaply than if they were to be kept in-house. And that’s a big a change.”
Nor do firms have to take an ‘all or nothing’ approach to outsourced dealing, says Paulin. “It’s about flexibility and not every firm will want to outsource their entire trading stack. Instead they may look to outsource their overnight dealing function.”
Whole office outsourcing
That said, Paulin is seeing a growing number of managers wanting to outsource all post-decision functions to a single, hyper-scale vendor who can do everything, everywhere – something that tallies with Northern Trust’s strategy to deliver platform solutions for the ‘whole’ office rather than just back, middle or front office functions.
“Those overarching trends we have discussed earlier are likely to continue and we will see a move from front office to whole office outsourcing where even greater cost synergies can be provided by asset services by bringing more of their internal processes to bear in a single platform solution,” says Paulin
Despite the apparent direction of travel, there are still some stigmas that need to be overcome for outsourced trading to thrive, says Paulin, as was evident by the questions from the webinar audience. For example, many firms may feel that by outsourcing the trading function, they will lose their connection to the street.
“If you have spent years building up relationships with street-side brokers there is no reason to give these up simply because you are moving to an outsourced model,” says Paulin. “Indeed it makes more sense for the vendor to support and enhance these relationships for then everybody in the eco-system wins. That’s a stigma based on an out-dated view of the vendors, which for the bigger vendors, no longer exists.”
What happens to headcount and to roles like the head of trading? Do they simply become the head of trading oversight instead? “As the oversight function in any outsourced relations is critical, who best to provide that but someone who intimately knows the role of a dealer and best placed to ensure the vendor shows continual improvement,” says Paulin.
“The regulator will like that from a control perspective, funds will like it from a transaction cost analysis perspective, managers will like it from a risk perspective and asset owners will like it from a P&L perspective. We are even finding more and more heads of dealing approaching us to discuss this very point, from the perspective of improving operations, not displacing them. That’s a big change.”
And what about concentration risk, should the outsourced trading market be dominated by a handful of providers, as has been the case with global custody? Given the sheer number of providers that currently exist, it is unlikely any concentration risks will emerge in the short-term, says Paulin.
“When or if those risks do materialise, they will be weighed against the value they bring to the end customer who demands greater transparency, value for money and lower costs,” says Paulin.
You can watch the webinar on demand on our Webinars Channel.
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