Outsourced Trading: Why Specialist Providers Need Specialist Technology

For those who follow buy-side trends, the rapid rise of outsourced trading – enlisting an outside provider to take on some or all of a firm’s trading activities – has been one of the most fascinating developments in recent memory. While the model has been around for some time, it historically has been a solution for smaller fund managers, many of which lacked the resources to run their own trading desks. Thanks to a host of factors, many larger managers have begun to leverage this established practice in a new way.

The biggest driver, unsurprisingly, is cost. Between the top-down pressure active managers are facing from passive investing and the rising pressure to invest in the latest technology, fund managers often feel their shrinking budgets are being stretched in a million different directions. In addition, MiFID II and other regulations have imposed new best execution requirements, making it more expensive than ever to remain compliant. These forces have added up to an increasing number of buy-side firms deciding that a specialist provider of execution services is the best way to navigate a shifting landscape.

How prevalent is it? A study conducted by research consultancy Opimas predicted that by 2020, 20% of buy-side firms with more than $50 billion AUM will outsource some portion of their trading operations. Far from a niche solution for fledgling funds, some of the biggest names in the business are starting to come around. Ryan Larson, Head of U.S. Equity Trading at RBC Global Asset Management, summed it up well at last December’s Equities Leaders Summit in Miami: “Given all the mounting costs and complexities around reporting and best execution, outsourcing all or parts of trading may increasingly makes sense for some firms in the industry,” he said.

So, while the factors driving outsourced trading are well understood, what often isn’t discussed is the distinctive technology needs these firms have. Outsourced trading firms are hybrids, incorporating aspects of both the buy and sell sides, and they need platforms that support the unique workflow demands that come along with that.

Firms that try to shoehorn a traditional sell-side OMS into their complex workflow will quickly find that such solutions are woefully inadequate. While a sell-side OMS will meet the needs of firms executing trades, which they are, most will not be capable of supporting the many issues they face when acting as a buy-side desk: the intricacies of settlement and trade allocation, firm-specific risk and concentration limits, the special requirements of trading for a UCIT or 40 Act fund, how to handle foreign ownership limits in markets such as Korea and Japan, etc.

In addition, outsourced trading firms often tout their wide reach across the global markets and different asset classes as a primary differentiator, necessitating a platform that’s as nimble as their clients need them to be. Many outsourced trading firms will quickly enter new markets such as Asia, Africa and Latin America when clients require it, so it’s incredibly important to find a technology provider that can spin up support for new markets at a breakneck pace without creating operational issues.

By leveraging SaaS-based technologies from firms such as LiquidityBook, clients can achieve this goal of quickly entering new markets. For example, an outsourced trading client of ours last year opened up shop in Sydney so that it could have a front-row seat in the Asia-Pacific markets, and with our comprehensive solution, it was able to get up and running much more quickly than would have been possible with a traditional deployment by a legacy firm.

Finally, outsourced trading firms are acutely aware that their cost-effective model is a primary reason that larger managers have begun to enlist their services. For this reason, there is all the more incentive to reduce costs wherever possible. Signing on with a SaaS-based provider as opposed to a deployed legacy platform creates myriad economic advantages that help outsourced trading firms keep costs low for the buy side.

Cloud-based solutions help reduce or avoid IT costs – both upfront expenses, such as running data centers and buying and replacing servers, and recurring ones, including software licenses, renewals and maintenance contracts. The service-based model allows for a pay-as-you-go mentality, replacing fixed-cost investments that rarely yield as much as the legacy players would like you to believe. Finally, firms can leverage the cloud provider’s major investments across their deployment, infrastructure and information security teams, making for a robust ecosystem of cutting-edge software and industry expertise.

At this point, the case for the cloud is an old saw, but the unique needs of outsourced trading firms shine an even brighter spotlight on these economic realities. Furthermore, with the regulatory landscape in a continued state of flux, there’s no telling what the next big trend on the buy side will be; but no matter what it is, SaaS-based providers will be well-positioned to accommodate it thanks to their flexibility.

Less than two years after the implementation of MiFID II, outsourced trading firms have shown staggering growth, and technology providers that account for their evolving role in the capital markets stand to benefit immensely. The trend may be new, and the client’s needs unique, but for vendors, the underlying principles – technological know-how, cost effectiveness and a client-first mentality – remain the same as ever.



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