For True TCA, Buy Siders Must Pierce the Cloak of Secrecy Around Tech Fees

Legacy. It’s a word we often use to describe systems and applications that have been in place for a long time. Too long, in many cases. These systems were great back in their day, which is how they became so deeply woven into operations. But when they don’t keep up with the pace of change, they’re usually headed for replacement.

It’s less common to hear “legacy” used to describe a business model. That’s because when they get outdated, market forces naturally pull business models into line with the current market. If they don’t change, business models get disrupted by products and services that are faster, better and cheaper than the old alternatives.

But this isn’t always the case, as evidenced by what’s currently going on in the order management system (OMS) market today.

Legacy OMS vendors have managed to keep their business models and pricing structures in place for years. The reason is that OMS deployments are among the most ingrained systems inside most fund managers’ operations. They touch almost every department in the organization, from trading and compliance through the middle office to clearing and settlement. Changing out an OMS system requires a great deal of work and involves substantial risks, so the case for doing so must be incredibly compelling.

Legacy providers have banked on this and have benefited well from it. The “heavy lift” factor alone has enabled these vendors to keep very rich revenue streams flowing in. That said, a combination of business, regulatory and technological factors is beginning to shine a light on those OMS vendors’ opaque commercial models. As more clients see the egregiousness of many of their pricing practices, change in the OMS space is afoot – and the case for replacement gets stronger every day.

[Related: “State of the OMS: A Time for Change?”]

To gain a proper perspective on the state of the OMS market, it’s helpful to look back at its history, examine how it has avoided change for so long, and then look at the change drivers that that are finally coming to the fore.

Business Terms from the Pre-Crisis Era

The traditional OMS revenue model has always been subscription-based; a monthly fee for a software license. When FIX became the standard for transmitting and executing orders, the buy side pressured OMS vendors to adopt the protocol, and most did what their clients asked. Doing so created additional work and support responsibilities for the vendors, with which they justified “some” additional fees.

Those legacy vendors quickly realized that they could generate even more revenue under this model and put it on the backs of sell-side firms. When equity trades were being done at 3 or even 5 cents a share, it was very easy to take 5-10 mils of the commission. Besides, since these brokers were also eager around that time to get their new algorithmic trading platforms in front of clients, the OMS – which traders used all day, every day – represented the perfect vehicle to do so. Therefore, they were happy to pay the vendors a small percentage of their total commission.

But fast forward to the present, where that same pricing model still exists, and it’s a major problem. Charges of 5-10 mils, or 5-10 cents on a future or option contract, is a huge percentage of the overall commission today – sometimes up to almost 40%. Why no pricing relief? Because the OMS is “sticky” – i.e., it’s very difficult to swap out for something else – which legacy vendors know very well and consequently have zero incentive to change. Moreover, many have built entire business models on this premise, making it near impossible to change even if they wanted to.

Buy Side’s Efforts to Assess Operations

For more than a decade, buy-side firms have been working to improve their trading efficiency and performance by analyzing their implicit and explicit trading costs. Early on, these efforts tended to focus on pure trading cost analysis (TCA). More recently, with the launch of firms like Dash Financial and Clearpool, buy siders have expanded their analyses to cover detailed order routing analysis, which has since become de rigueur in most buy side firms’ operations.

At the same time, analysis of ancillary costs incurred to support trading – those that make up a trading platform’s total cost of ownership (TCO) – are high on the buy-side’s radar because now these costs are not escaping the eyes of asset owners. Through these TCO analyses, awareness of these opaque, transaction and connectivity fees borne by brokers is now more widespread. Despite this growing awareness, the non-disclosure agreements (NDAs) that some large OMS vendors subject their brokers to prevent the buy side from fully understanding these costs. In most cases, these NDAs prevent brokers from discussing the amounts of (or, in some cases, even the existence of) the payments they are making on their buy-side clients’ behalf.

What’s remarkable is that even in the post-crisis market, where nearly every firm speaks of transparency being of paramount importance, these agreements remain, in many cases despite significant pressure from the buy side. Consider the case of Voya’s global head of equity trading, Nanette Buziak, who reportedly had to involve the firm’s general counsel to pressure their OMS vendor to disclose the fees they were charging Voya’s brokers.

In an environment where the total buy-side commission pool has shrunk by 40% since 2009, according to Greenwich Associates, the large percentage of commissions taken up by these third-party OMS fees is making it increasingly difficult for the buy side to meet their brokers’ commission requirements. As a result, sell-side firms have had to actively cut some of their buy-side clients’ OMS connections, which adds risk since many of them are to backup platforms.

MiFID II – Another Disruptive Factor

The introduction of MiFID II earlier this year adds additional wrinkles. For example, there are now stricter rules covering inducements. These requirements aim to further protect investors and bring greater clarity to the quality of services they receive. Now, beyond an asset manager’s obligation to act honestly, fairly and professionally in the best interest of its clients, the regulations prohibit firms from accepting monetary or non-monetary benefits from the sell side which could be considered inducements to trade. Having some of these OMS connectivity costs subsidized by a broker – particularly when the vendor itself does not operate the FIX network – appears to run afoul with this part of the regulations, according to a July 2017 policy statement issued by the UK’s Financial Conduct Authority (FCA).

The stricter inducement regulations also require sell-side firms to disclose to their buy-side clients any monetary or non-monetary benefits they receive in relation to the provision of its investment services. Here it would seem the NDAs would get in the way of the buy-side firm knowing exactly how much those sell-side firms were paying to their OMS vendor on their behalf. Many in the industry anticipate that regulations similar to MIFID II will eventually become a reality here in the U.S. It’s just a question of when.


The sub-optimal business practices and pricing arrangements this subset of OMS vendors wants to keep in place make them seem a lot like Blockbuster right before Netflix came on the scene – legacy players ripe for disruption.

That said, the depth of penetration that OMS systems have within most investment management firms’ operations is significant, making a “rip and replace” strategy challenging. But that’s exactly the choice that more buy- and sell-side firms have begun making. One big reason for this is availability of much-improved technology. When one combines improved functionality with the opportunity to get out from under archaic fee structures and business practices, an OMS replacement looks not only less daunting, but downright attractive.

Industry participants from both sides of the Street are watching developments in this corner of the FinTech world closely. What they are seeing is a new, nimbler group of OMS vendors with completely transparent business models and SaaS-based platforms (including us here at LiquidityBook), many of whom are gaining momentum.

Bring on the OMS market disruption!



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