Outsourced trading, though undoubtedly a contentious topic, is something that has been around in capital markets for decades in some form or another. However, an undeniable surge has occurred across the trading sphere over the last few years, with decidedly mixed results.
Achieving the same (or better) outcomes as trading inhouse is undeniably difficult. Buy-side heads of trading at this year’s TradeTech Europe conference explained that while of course “there will be cases for outsourcing” there are certain aspects of the trading process which are inherently convoluted and thus difficult to execute.
“Our trading group are viewed as part of the investment process with interaction and culture aligned. That’s difficult to replicate using outsourced trading,” asserted the senior panellists.
It is for this reason that only the most dedicated providers are set to reap success. Speaking to The TRADE, Dean Gray, head of EMEA outsourced trading at Jefferies, explains: “It has been well documented that the past few years have seen a significant shift in the mindset, especially of the larger funds, towards the adoption of outsourced trading. As larger funds utilise the service, other groups such as sovereign wealth and platform providers are becoming increasingly involved.
“These groups have an inherent nature of complexity that require outsourced trading providers to heavily invest in human capital and technology to meet all of their requirements effectively.”
Despite a degree of caution being exercised by the buy-side, the fact that around 40-45 firms across the industry identify as utilising outsourcing trading in some capacity, is telling. And the number is climbing.
In tandem, 50 providers are now dedicated to handling the gamut of trading needs. This is a significant reality, and a true sign that the industry is changing irrevocably.
As Rebecca Crowe, managing director and chief operating officer, BNY Markets, previously told The TRADE, “Years ago, it was the middle-office who were contemplating outsourcing and people couldn’t even consider that you would allow somebody into your books and records in that way.”
Broadly, the providers are independent firms, prime brokerages, and custodians, all with their own pros and cons, unique approaches, and distinct strategies.
The frontrunners across this space are clear to see. The next step for key industry players is now more important than ever as the gap between market leaders and ‘the rest’ seemingly widens.
Cost must be balanced with effectiveness
When it comes to outsourcing trading, seeking offerings with clear value-add and a smooth operational set-up has been front of mind for firms.
Brendan Burke, Brown Brothers Harriman’s (BBH) managing director and head of Americas FX sales and business development tells The TRADE: “Managers need to be comfortable that execution via an outsourced platform is comparable to managing the process in-house. It is important to be clear in terms of identifying activities that are in and out of scope to consider outsourcing.”
However, though execution quality is of course front of mind, the cost saving aspect is becoming an ever-more important consideration for the industry as participants are increasingly forced to juggle mounting regulatory, technological and data-related burdens.
Fees are mounting and when it comes to business strategy, this factor is demonstrably taking precedence – but at what ‘cost’?
Aaron Hantman, chief executive of Tourmaline, agrees that, despite the pursuit for quality, the decision to outsource – specifically where to outsource – often comes down to economics, explaining that in some cases this can have negative repercussions.
“If firms can receive front, middle and back-office solutions packaged as one and have to sacrifice the trading quality to get those economics they often do it,” he explains.
This can in many ways be put down to the decision to outsource generally coming from the c-suite and other senior leadership individuals – a controversial reality which many in the market have openly criticised for being an approach which omits important insight from trading teams.
“In terms of who makes that decision [to outsource] of course it is down to the people who are motivated by, and tasked with, looking at overall operating model transformation and cost efficiency – which are generally COO’s and CFO’s,” said Crowe.
She added that even when it comes to how decisions are being made as to the structure of outsourced offerings, capital considerations are commonly at the fore, specifically cost efficiency and more variability with costs.
Of course, this is an understandable reality, given the current state of the market, however, potentially sacrificing trading quality in the pursuit of capital saving is a high price to pay. Advice about cutting off noses to spite faces comes to mind, but as Hantman tells The TRADE, many times this situation arises not through any nefarious means, but because of a certain degree of naivety.
“People truly do not understand in many cases just how badly trading could be compromised,” he says. “Those who make wholesale changes without understanding the impact at the trading level will soon have to reverse out of them a year or two later.”
As firms continue to place a growing degree of trust in these providers, this should theoretically work to foster effectivity.
“Like many managed services, a provider needs to have scale and be able to deliver a quality offering combining client service, technology and trading expertise. It can’t simply be shifting trading responsibility from a manager to the provider,” highlights Burke.
The buy-side agree and discussions at conferences across this calendar year have focused on the importance of alpha retention in this space.
As one TradeTech Europe buy-side panellist affirmed: “Understanding the clients and the markets you trade is essential. You need to think of the trading desk as the engine that drives the room. Those conversations around news flow and pricing are central. An active manager needs an active desk.”
However, the crux is that this is not so easily achieved by an outsourced trading provider. Across the outsourced trading space, the barrier to entry has historically been low, but the barrier to success arguably remains high.
As Gray explains, “as the industry has begun to mature, each offering is becoming more clearly defined. The reality is many are not prepared to make the significant investments required to maintain or grow their share of the market.”
The important impact of changing market sentiment
Demonstrably, things are ramping up and outsourced trading providers are highly cognisant of the importance of keeping up with the pack in this high-stakes game.
However, importantly, various sources speaking to The TRADE have confirmed that a shift of market sentiment has contributed to the development of this space. What started as a foot in the door, has widened into a significant entryway, with market participants – who were at one time not just hesitant, but hostile – now tuning into the importance of embracing change.
A recent LSEG and Coalition Greenwich report from Q4 2023 highlighted exactly this uptick in views around outsourced trading, wherein 66% of buy-side respondents confirmed their belief that outsourced desks could provide them with better access to liquidity, while 63% highlighted improved execution quality and trade performance.
The responses included views from 45 buy-side equities market participants across the US and Europe, of which 28% expect their firms to ‘at least consider’ adding an outsourced provider over the next two years. One respondent specifically commented that “outsourced providers act as an extension to the trading desk and understand our trading goals”.
Hantman tells The TRADE: “Between 2017-2019, especially in the UK and Europe, there was a lot of pressure for traders to justify their worth, especially considering things like Mifid II unbundling. At that time, the last thing that a trader wanted to hear about was the wonderful attributes of outsourcing.
“If you look at the last couple years there has been an evolutionary rate of acceptance which has accelerated recently. It suggests that the concept of outsourcing or supplemental trading has become institutionalised.”
Traders, and portfolio managers, across the industry are seemingly eager to be part of these conversations – not just about the dawn of outsourcing but also when it comes to technological change across the market.
When it comes to those truly at the coalface of the trading processes, overlooking their acumen should be done at a firm’s own peril.
“We as an outsourced trading community are always going to come up against the ‘fear factor’. However, by not being present in the set-up of a new regime [buy-side traders] are missing opportunity to have a say and effectively create even greater job security with a hybrid approach,” asserts Hantman.
Across firms, senior executives appear to be increasingly taking this on board, attempting to find the perfect balance between saving costs and weighing the true, long-lasting impact of making those big moves.
The market is moving, keep up
Against the backdrop of the growth of the outsourced trading industry, the landscape is set to continue its evolution in marked ways.
Gray predicts two key developments, which are now beginning to emerge: “That growth would lead to new entrants and to more consolidation amongst providers. This would result in polarisation, with a few key players and a larger number of smaller specialists leading the growth.”
Recent times have seen swathes of bigger and bigger firms turning to outsourcing in one way or another, however The TRADE understands that some of the largest firms have been embracing this strategy for quite some time and big moves have already transpired.
Examples just from the last six months include UK-based investment management firm Waverton – which has £9.1 billion AUM – outsourcing some of its trading to Northern Trust Integrated Trading Solutions (ITS), Nordea outsourcing the portfolio management of its emerging market bond funds to Metlife Investment Management, Singapore-based investment manager New Silk Road outsourcing its trading to Northern Trust, and most recently Stifel and Marex unveiling a new outsourced trading partnership under a broker referral scheme.
From Tourmaline’s perspective, Hantman asserts that the firm has been trading for multiple trillion plus asset managers for years, though these are unwilling to be named publicly.
Similarly, Crowe confirmed to The TRADE earlier this year that BNY “absolutely” has large scale clients on its books already. BNY announced a partnership with Goldman Sachs Asset Management in March concerning global trade execution services in EMEA, the US and APAC markets across fixed income, FX, derivatives and ETFs.
Speaking to The TRADE about the FX space specifically, Burke shares that BBH has also seen continued interest from larger managers who have FX resources and technology in-house.
“Many of these mangers are multi-asset class who may manage FX related to fixed income in-house, then lean on a provider to solve for equity related FX, coverage of restricted markets, or for rules-based share class and portfolio hedging programs,” explains Burke.
In The TRADE’s inaugural Outsourced Trading survey, it was discovered that around 72% of clients had less than $5 billion in assets under management, 15% had between $5-10 million, 8% were in the $10-50 billion category while 2.5% were in $50-100 billion and another 2.5% in the $100 billion-plus range.
While historically, this has very much been a space taken up by smaller funds – some large funds are demonstrably turning, or have turned, to these solutions. So, with ever-larger players making real moves in the space, what’s next on the agenda?
“Many articles have reported that better execution and cost-effectiveness are the principal motivations behind outsourcing, but we have noted the ability to cover multiple regions and asset classes are just as important,” Gray tells The TRADE.
Looking ahead, he shares that he foresees the next phase to be towards key players investing significantly in their offerings, providing services in a wider range of asset class coverage, such as fixed income, and also, importantly, emphasises the potential for further consolidation in the market.
Speaking from the Jefferies viewpoint, he shares that “from a technology standpoint, the ability to not only access but develop your own proprietary trading software will continue to be important.”
In the same vein as Gray, Crowe also highlighted a trend of expansion into further asset classes, away from just equities: “Fixed income is probably the next most logical volume traded asset class in the market […] but there’s also a lot of further interest in derivatives and other instruments.”
In terms of consolidation, the market has seen a range of key moves in recent times as firms seek to further deepen relationships and widen their reach.
Earlier this year, State Street acquired CF Global, a significant development in the outsourced trading world, which allowed the firm to considerably expand its geographic reach. Just prior to this, commodities specialist Marex completed its acquisition of TD Cowen’s outsourced trading and prime brokerage business.
Both transactions, among others, could fairly be considered a net reduction in the community, however the synergistic approach has been widely hailed as the future as the industry continues to battle costs, keep up with increased global correlations, and maintain effective processes. The industry will therefore likely see consolidation continue.
Evidently, the gap between the most successful players in the space and ‘everyone else’ is continuing to grow ever wider. As the market ramps up in terms of the size of key players, heavier expectations on providers, and the consistent battle to strike the best balance between costs and effective trading, outsourced trading strategies are set for continued and significant evolution. The future landscape looks set to be markedly different to what the market is seeing today.