The buy-side dealing function is facing a number of pressures that are causing investment managers to reconsider their strategic approach to dealing. In addition to cost challenges and pressure on fees, they are having to consider:
- Technology advances – The use of algorithmic trading is increasing with firms either using broker developed algorithms or developing their own. To compete effectively, the dealing function needs to be highly skilled, with the right technology giving greater connectivity to a wide range of markets and venues.
- Regulatory change – MiFID II has facilitated the use of algorithmic trading through finally removing conflicts of interest through unbundling payment of research with execution commission. However it has introduced increased regulatory reporting demands for market abuse monitoring and market transparency.
- Competition – In order to compete successfully, firms are developing new investment strategies and investing in additional asset classes and new geographies. This is placing challenges on the dealing function to increase capabilities and to operate in more real-time in other time zones.
Some firms have invested substantially in the development of technology using machine learning to develop analytics that can make trading recommendations and identify the most effective means of execution. The benefit being to reduce the number of brokers, commission rates and the number of dealers.
Firms are also setting up dealing functions in other regions to enable “live trading” in for example, Asia. This can mean significant costs such as acquiring a new office, employing additional staff, authorisation and approvals with local regulators, putting in place local broker agreements. There is also the challenge of internally connecting the technology, data and processes between the offices.
Outsourced dealing offers an alternative approach. For at least two decades, growing numbers of investment managers have included elements of outsourcing in their operational mix. More firms are now realising this and globally the rate of adoption is increasing, although it is worth noting that the UK appears to lag behind the US and other parts of Europe, particularly France. We see increasing numbers of established providers offering scale and capability for those ready to evaluate the benefits for their clients and businesses.
As well as an alternative to a dealing desk, outsourcing can provide a complementary service to the existing dealing team, providing greater breadth of asset class coverage and / or geographical presence.
Having worked widely in this field with a range of clients, it’s our experience that the relatively slow uptake is not lack of appetite or imagination, but rather lack of understanding of the providers and services on offer. This hampers objective understanding, evaluation and appropriate adoption of this important, proven approach.
The types of provider have emerged from different backgrounds. For example:
- some have historically serviced the hedge fund community
- others are building on transition management skills
- and others are asset managers, with extensive dealing capability who are offering their service to third parties.
The outsourced dealing services on offer are also non-standard, their offerings vary by:
- geographical location
- asset class coverage
- regulatory permissions.
Firms need to make well-informed decisions not only about who to select, but also about which business model is most appropriate: do you wish your counterparty to the trade to be the outsourced dealer or the executing broker?
With increasing numbers of established providers now offering this service, we believe that investment managers can be confident in considering outsourced dealing as an effective alternative to, or a complementary service to support the internal dealing teams.
In addition to capability, it can help to:
- move fixed to variable costs
- lower operational risk
- reduce execution cost
- provide a clear segregation of duties between fund management and execution.
Ultimately, a degree of circumspection is sensible in what can quickly become a surprisingly polarised debate. Despite growing acceptance by many, for others, outsourcing still seems conceptually a step too far. Outsourcing undoubtedly has the power to enhance the way some buyside firms trade; equally, it may not be right for everyone.
In summary, costs and value for the end-client are under increasing scrutiny and new advances in technology are driving the pace of change. Along with growing business complexity requiring a flexible and agile operating model, is this the perfect storm that will drive strategic change for the dealing function?