The service provider landscape for outsourced trading is made up of an eclectic mix of firms. Boutique independents and the largest financial services providers co-exist in this burgeoning space which has some elements of comradery and others of fierce rivalry.
It’s a world which has a compelling backstory and a future which could veer off in several different directions depending on a range of scenarios which includes growing demand from larger buy-side organisations, M&A activity and an increasing level of investment needed to stay competitive.
In contrast to much of the financial services industry, it is the smaller independent providers who are the stalwarts and the organisational juggernauts who are the newer entrants. There are certainly strengths to each offering, with the long-standing independents synonymous with the concept of outsourced trading and without any suggestion of conflict, while the larger firms have the benefits of scale, investment dollars and the ability to acquire in order to grow.
Behind the scenes – and sometimes publicly – these firms are as keen to point out each other’s shortfalls as they are to promote their own fortes. Trading is in their DNA and their executives are often straight-to-the-point in their communication. They operate in a fast-moving, high-octane, contentious space – certainly when it comes to the existing internal trading desks within the buy-side – and movement of talent between the firms is common and seen as a major coup.
The independents will point out the conflicts of interest within the larger firms, and vice-versa will be the benefit of ancillary services like prime brokerage and research capabilities in attempts to lure clients.
New entrants are pouring into this space as demand increases exponentially with each passing year, and there’s certainly enough business to go around at present.
But there are a number of factors at play which make the future an enticing space to watch as only time will tell whether the independents can continue to thrive among a growing crowd of institutional banking players. Will we see more M&A? Can everyone keep up with the increasing multi-asset and geographic demands? Will the buy-side begin using multiple providers? Could this sticky business start seeing clients switch providers, or even insource? And what happens if the floodgates truly open with the arrival of the $100 billion funds? Each of these factors are set to take this industry script from Sundance to Hollywood as a thrilling landscape shift is unfolding.
Humble beginnings
Outsourced trading began on its growth trajectory post-financial crisis and saw another spike post-pandemic. The narrative of the service being used solely by smaller hedge funds has been replaced by suggestions that outsourced trading is gathering pace among larger fund managers.
Coalition Greenwich points out that from 2018 to 2022 the number of outsourced trading providers grew from fewer than 10 to more than 40. The number now – in 2023 – is said to be over 50 who offer the service in one form or another.
That line-up is largely made up of independent firms, prime brokers and custodians, all of whom are enjoying a piece of the growing pie, with their own strengths and weaknesses.
David Berney and Michael Broadbent run Ergo Consultancy which delivers what it refers to as provider “beauty parades” for buy-side organisations looking to outsource their trading, whereby it presents all the services in the industry to that asset manager, hedge fund or asset owner. This has given them a deep insight across the industry into what goes on during the process and a view of the provider landscape, while they have experience on both the buy- and sell-side to lean on, with Broadbent previously head of trading at a London-based hedge fund.
“There is no single outsourcer that can provide absolutely everything that anyone could ask for,” says Berney, founding partner and principal consultant. “This business model education piece is a large part of what we do, asking firms: ‘do you want independence or do you want scale?’ Because they largely contradict each other. We ask: ‘do you want your name to be published when you trade, or do you want to be anonymous?’ In contrast, they don’t contradict each other.
“These are important things to understand about the business model of the provider and the relationship you’re going to enter into, because unless you got that bit right, you’re going to shoot yourself in the foot with something that’s difficult to change after the fact.”
The process of the beauty parade is interesting, and the pair say that no two processes are the same. Interestingly, the client remains anonymous until it comes down to the final three or four providers to ensure the client is never known to the street. This is critical when there are jobs on the line, and as Berney puts it “you are telling everybody that your current situation is suboptimal”.
Broadbent outlines the risk element in the process in what is a relatively new industry and concept for many.
“Someone in a firm who brings us in to find an outsourcer has at some point taken risk with their own intellectual capital inside of the firm,” he explains. “That could be a trader bringing us in to talk about outsourcing or a COO who’s doing something to replace the trading desk. But they have gone on risk. They’ve had to pitch the idea of outsourcing and they bring us in to make sure they get it right. But ultimately, whoever wins the beauty parade, whoever is selected, is still somewhat of a risk to that person. So getting help, and getting that choice right means less risk.”
Talent war
One constant across the industry is the championing of talent on the outsourced trading desk and the highlighting of relevant buy-side experience. Many point to how ‘juniorisation’ is occurring within the asset management execution space, therefore, to be able to show a roster of ex-buy-side traders is appealing to prospective clients.
The early entrant independents – CF Global, Tourmaline and Outset Global, to name a few – have certainly been visible and vocal over the years, frequently highlighting major personnel additions to The TRADE.
Outset has added talent from rivals Jefferies and JonesTrading over the past 12 months, plus hires from asset managers like State Street Global Advisors, JP Morgan’s Highbridge Capital Management and Bloom Tree Partners.
Raymond McCabe, founder and managing partner of Outset Global, highlights how a dozen of its frontline traders are “pure buy-side” from “big desks”. He adds: “There’s just unique, subtle differences that make our business completely different to the sell-side and how it works in terms of not shopping flow, not crossing flow, not acting like a broker.”
Over the past 12 months, Tourmaline has also tapped rival BTIG and hired from Vantage Capital Markets and Liquidnet. UBS meanwhile points out how its traders in London have an average of 20 years’ experience and in New York it is even higher at 22 years. The banking giant hired Ian Power from Newton Investment Management a year ago, alongside Paul Christophorou, who previously spent 19 years as a senior global trader for Odey Asset Management and Gozde Yildiz, a multi-asset trader focusing on fixed income, equities and derivatives trading. Meanwhile in Frankfurt, Dirk Heim joined as head of EU execution from Quoniam Asset Management, managing the execution of global equity portfolio baskets alongside derivatives.
The list goes on. Each provider, independents and banking giants alike, are stacking their rosters with buy-side experience.
After securing talent, the next battleground for outsourced trading providers is asset class coverage, and to a lesser extent geographic (I say lesser as most providers seem to already have comprehensive locations across timezones and this is simpler to set up in many ways).
The move towards multi-asset certainly shakes up the space and is forcing firms to expand their coverage, while arguably playing into the hands of the largest providers. In the service provider questionnaires, multiple firms point to their expansions into new asset classes.
TD Cowen notes that: “The FX and fixed income solutions we’ve launched in recent years have also served to grow our business as we’ve been able to engage with a broader audience for an outsourced trading solution, importantly including much larger organisations that tend to invest across asset classes.”
Meraki Global Advisors claims it “is the only outsourced trading firm that can trade every single asset class, in every region of the world”. Meanwhile, UBS has introduced listed options to add to its existing global equity and bond product suite and says it will be launching listed futures and FX products in 2024.
CF Global notes it has recently added a pure fixed income client, Jefferies broadened its swap offering to include ID markets and additional international regions, and Northern Trust Securities says it now offers execution services beyond equities, fixed income and ETFs to include global exchange traded derivatives.
Here come the custodians
For some years now, custodian banks have been operating in a thin margin business, stuck in a low interest rate environment and struggling to evolve in a business where clients are constantly asking for more services, data and efficiencies at a lower cost. Subsequently, the industry has sought to capitalise on any other trends it can provide asset servicing for – moving into ETF administration, focusing on servicing private markets and harbouring high hopes for the ascension of regulated digital assets which would require an institutional custody offering.
One of the headline strategies has been plugging in front-office services to its well-established middle- and back-office provision, the middle-office trend a more recent outsourcing shift which saw its own journey some decades back from in-house to third parties.
Much of the front-office strategy entailed partnering with the likes of BlackRock’s Aladdin and other software providers to add OMS/EMS elements into a full front-to-back offering.
A handful also began eyeing outsourced trading. BNP Paribas, BNY Mellon, Northern Trust and State Street are now serious players in the outsourced trading space, albeit with different levels of purchase within the industry. On top of growing customer bases, Northern Trust and BNP Paribas both have four clients in the coveted $100 billion-plus range, while State Street and BNY Mellon are looking to aggressively build out their offerings.
Earlier this year The TRADE Magazine broke the news that State Street was set to buy CF Global, a significant development in the outsourced trading world, to say the least.
“From our perspective, we gain a very experienced trading team around the globe, which rounds us off from a geography perspective,” says Dan Morgan, global head of portfolio solutions at State Street.
“So when all is said and done we have offices in Toronto, New York and Boston in the Americas, we will have London and Lisbon, Portugal – the latter which will be opening concurrently with the closing process alongside CF Global – and then from an APAC perspective we’ll have a presence both in Hong Kong and Sydney with 30/35-plus traders globally.
“We’re excited to do business and from an integration perspective we will have the process just like any acquisition of integrating technologies and that will take some time.”
Morgan believes that given how competitive the landscape has become, firms are going to have to be willing to invest and set aside the necessary investment dollars.
“Trading technology is an area that’s probably not talked about enough, along with governance, controls and compliance,” he adds. “You’re going to want your provider to be able to prove that they are a bulletproof operation and are really invested in, not only the trading piece of it and the governance around that, but all aspects of operational risk etc.”
“I could very easily see a scenario where independents may merge with one another or get acquired by larger firms.”
Custody agreements – and broader asset servicing mandates such as fund administration – tend to be incredibly long relationships – sometimes lasting for decades, with clients seldom jumping ship. This means that many of these custodians have deep relationships with the C-suite of asset managers, hedge funds and asset owners.
On top of these deep relationships, they hope that the move for firms to consolidate the number of providers and vendors they have will help them gain clients – or at least client share of wallet – in this competitive space.
“The landscape has changed significantly over the last few years and will continue to do so,” says Dragan Skoko, head of outsourced trading and xBK at BNY Mellon. “It is important to recognise why the diversity of outsourced trading providers has been evolving rapidly after being relatively stable for the first 15 years.
“As the client need grows in complexity, the relationship has grown beyond that of a portfolio manager with the outsourced trading provider – it is important to match up well, firm-to-firm, to plan together for future needs, and to expand the relationship from one that is mostly transactional to a solutions-based partnership.
“Regarding consolidation, the space will likely consolidate a bit in terms of the number of providers, with clear segmentation within the industry.”
Jefferies’ senior vice president, prime broking, Dean Gray, concurs, adding: “It is our belief that this will continue and the provider landscape will be dominated by a small number of larger players and some small specialist firms.”
Jefferies is one of the many prime brokers in the space which also includes BTIG, JonesTrading, Russell Investments, StoneX and TD Cowen, to name the ones in our inaugural survey, alongside investment banking giant UBS.
The ability to offer the service alongside capital introductions, consultation, financing and the other broad range of services the prime brokerage function offers is seen as a plus.
The industry stalwarts
Despite the chatter, rumours of independent providers’ demise may have been greatly exaggerated. As the larger organisations predict the demise of smaller providers, the independents continuously come out punching. They also still retain some of the largest client bases in the market.
“Prime brokers – and particularly custodian banks – haven’t grown their business in decades and middle management push upstairs ideas that this is the next path to growth,” opines Outset Global’s McCabe. “It’s kind of the shiny new thing in equity trading.
“I wish them the best of luck, because those that are in it who have conflicted businesses – and when I say that, I mean that they are using outsourced trading as a teaser for prime broker cap intro or custodian services etc – they’re not standalone on their own specialisations.
“Forty-two percent of our new revenue last year came from other providers exactly like custody banks and prime brokers; that tells you that people have crossed the philosophical bridge of outsourcing their trading. It is not something that’s to be done lightly. It’s a misnomer particularly for the service that we provide in that – if you outsource a service, you have to stay in control of it, so the regulatory compliance obligations still sit on you.”
Conflict of interest is brought up frequently in the outsourced trading conversations, especially by the independent firms.
One source, who spoke on the condition of anonymity says: “There are definitely bigger conflicts in some of these business models than others.”
They added: “Everyone’s got these things [conflicts]. It’s not right or wrong. It’s a question of do you know the conflicts, do you understand them, and can you make them work for you?”
Another source explains more around potential conflicts: “The same actual person who picks up my order is the person who works on the equity sales desk. They could be working an order to buy something – even something different let alone something the same – for hedge fund X who are a client of theirs. At that point, it’s got nothing to do with skulduggery or underhand behaviour or anything else, it’s about who’s the priority on that ticket.
“Well, the priority is quite simple, is whichever person gives you more fees per year based on a one-year time limit.
“Though some people could not care less that the conflict exists, as long as they get a good service.”
As Capco wrote in a research paper on the matter back in 2020: “Large investment banks that provide research, banking, and prime brokerage services in addition to outsourced trading services could potentially be competing/trading against their own OT client base.”
The consultancy also highlighted that there could be concerns about control over order flow and how the outsourced trading desk will route the orders for execution, while adding that firms could potentially be paying more for an order. “Examining provider’s SEC 606 disclosure document can reveal whether a provider is taking financial incentives from clearing brokers that may negatively affect order price for the client,” Capco added.
All change
Along with State Street’s proposed acquisition of CF Global, there have been a number of other recent changes in the space. TD Bank bought Cowen, though as The TRADE and Global Custodian reported, it had been agreed that the outsourced trading unit would be spun out or sold off, with an announcement seemingly imminent at the time of publication.
Meanwhile, BNY Mellon officially launched its outsourced trading offering in January this year, powered by xBK, the firm’s buy-side trading division, which executes over $1 trillion in volumes annually for its investment management franchise.
Further changes are likely to come in the space with the arrival of larger fund managers (see our feature on the future of the space on page 6) and a shift towards multi-asset offerings. This could shake up the landscape, but most importantly the pressures pushing fund managers towards outsourced trading remain, meaning that while the provider jostling for power continues, there’s likely to be enough of a growing pie to go around.
There were two elephants in the room which have been addressed already in this feature – namely the notion of conflict and whether there is space for everyone in the landscape of the future – but the last remaining tusked giant is the entrance of new players, the biggest of all.
If the business is going to grow at the expected pace of some estimations – an Opimas report predicted a 45% year-on-year increase in revenues in 2023, to the tune of $1.7 billion – then are the biggest of the big going to get involved – JP Morgan, Goldman Sachs, Morgan Stanley – and if so, what happens then?