Following the recent webinar exploring the key outsourced trading trends presented in The TRADE’s digital feature, Battle for the trading desk, participants answer questions asked by the audience.
Is the market demand stronger for supplemental dealing or for full outsourcing? What are each of you experiencing?
Dan Morgan, global head of portfolio solutions, State Street Global Markets: We are seeing demand for both, and it’s important to note that ultimately it isn’t a choice between full outsourcing or supplemental dealing. Clients can establish their outsourced trading arrangements to be flexible and even establish relationships initially across a subset of the portfolio without the need to commit to full outsourcing. For those establishing their own capabilities for the first time or establishing an execution capability in a new asset class or geography, a full outsourced model may make more sense.
Jack Seibald, global co-head prime brokerage and outsourced trading, Cowen: Our experience has been quite different depending on the client. For new launches, spinouts from larger platforms, the overwhelming interest (> 80%) has been in a full outsourced solution, often times also including middle- and back-office support, trading technology support, portfolio reconciliation, other pre- and post-trade functions.
With larger and well-established investment managers, our experience suggests that supplemental or partial solutions appear to be as much of interest as a full solution. Examples of this include outsourcing one or a few asset classes (i.e. equities, options), while maintaining others internally (i.e. credit), or maintaining home countries/regions internally, while outsourcing other markets/time zones.
What is your view on conflict of interest if the outsourced dealer belongs to an investment manager/investment bank? What are you doing beyond policies to ensure no conflict?
Dan Morgan: Conflicts of interest need to be managed with both models and it is important to understand the nature of the provider and how their internal processes, control frameworks and conflicts policies might affect an execution outcome.
With an investment manager, conflicts may arise from their execution team managing both internal and third-party orders at the same time. It is imperative to understand the policies and procedures in place for order handling and prioritisation of client orders versus internal portfolio trading. With an investment bank, there are potential conflicts if the bank has incentives that are not aligned with the client. Examples might be management of information content, internalisation of flow and crossing with proprietary liquidity. An investment bank may also not have the ability to source liquidity from other banks and liquidity venues.
We believe it is important to use a ‘pure agency’ provider with no interests in proprietary liquidity as a destination where a conflict may arise. State Street is a multi-broker, counterparty and liquidity agnostic agency execution provider. We have 100+ counterparties that we use and our trading process is aligned with our clients.
Jack Seibald: Conflict, or perception of a conflict, is a serious matter, whether the service is offered by an investment manager or investment bank. It’s critically important that investment managers considering an outsourced solution come to understand whether those providing the outsourced solution at such institutions are solely dedicated to this service or whether they are part of a centralised trading desk that services other constituencies – internal portfolio managers at asset management firms and institutional clients at investment banks.
To the extent that they are not segregated, managers should require clear explanations of the policies and procedures such firms have in place and the segregation of system deployed to ensure that outsourced trading flow is managed discretely, and that client information is secured. In order to avoid even the appearance of conflict, Cowen’s outsourced trading platform is managed by a separate team that is physically separated from the institutional trading desk and utilises buy-side order management systems (OMS) in contrast to the sell-side systems deployed by the institutional team. Additionally, we provide full transparency to our outsourced trading clients as to the counterparty executing each trade on behalf of the client.
When supplementing the internal dealing desk, which is more important for clients: business continuity, overflow management or asset class/market coverage?
Dan Morgan: We are mostly seeing demand for asset class and market coverage rather than contingency.
Jack Seibald: Our experience has been that in the overwhelming number cases when clients are looking to engage us in a supplemental manner that it’s for specific markets/time zones or asset classes.
What is an expensive internal dealing desk in bps AuM? Anything above 10bps?
Dan Morgan: This is very much a firm specific consideration. The costs for an internal trading desk can include execution staff, trading technology and data as explicit costs, however, the implicit costs associated with a trading desk must also be considered. Implicit costs include staff, technology and third parties that may perform functions across operations, IT, legal, compliance, controls, audit and risk departments. Buy-side firms should also consider contingencies for operational error events. A further aspect to consider is the costs of a desk not being fully utilised, such that there might be a minimum headcount required, multiple locations and coverage for holiday, sickness and other situations.
Jack Seibald: This is a difficult question to answer as it will vary dramatically based on an investment manager’s AUM and investment strategy. There’s a minimal acceptable level of coverage a manager would require based on consistency and continuity of coverage, and this will impact the size and composition of the trading team as well as the trading systems deployed. Between payroll, benefits, real estate, and technology costs, it’s reasonable to assume that an internal trading desk could cost between $350,000 – $500,000 per seat.
What sectors use outsourced trading solutions more than others? Is it pension funds, mutual funds, family offices?
Dan Morgan: We have seen strong demand across the board from all types of institutional investors and there are a variety of needs and applications of outsourced trading across each of these.
Jack Seibald: In our experience, the primary clients for outsourced trading services have been emerging hedge funds. In recent years, however, we’ve seen a sharp increase in the inquiry and subsequent uptake of these services by established hedge funds, and more recently we’ve seen family offices and traditional long only managers looking into outsourced trading as well.
What is the average notional in global cash equity trading that an outsourced trader will trade in a year? Do they only trade one market or are outsourced traders responsible for more than one market/trading session?
Dan Morgan: State Street has a team of senior multi-asset class traders, in multiple locations, focussed on developed, emerging and frontier markets. We have invested heavily in our people, technology and connectivity with our customers. Our execution staff operate across regions, rather than a singular market. The value of activity, number of orders and liquidity profiles of trading events tends to vary based on market circumstances and client cash flows.
Jack Seibald: At Cowen, we employ traders across the time zones in the US as well as in London and Hong Kong. As such, our clients have the ability to trade markets around the globe seamlessly with traders experienced in the respective markets. Additionally, our trading team includes specialists in derivatives, FX and credit, offering our clients the ability to trade across these asset classes in addition to global equities. The notional values traded vary considerably depending on client AUM and investment strategy.
How do you ensure fair treatment to all of your clients in IPO’s/ new issues?
Dan Morgan: We can participate in both primary and secondary offerings. We access the brokers on our broad panel and seek to leverage these sizable relationships to assist with access to IPOs and new issues.
Jack Seibald: Our clients are known to the Street and as such will get allocations based on the relationship they have with the respective banks. As we manage the wallet four clients, we make sure to communicate indications timely.
What tools are PMs looking for daily from the outsourced trading desk?
Dan Morgan: PMs are typically looking for pre trade analytics, execution/TCA reporting, market insights, operational support and research from the outsourced trading desk on a daily basis.
Jack Seibald: Every client is different and requires a level of service appropriate to their specific needs. As such, our traders will tailor the relationship to each manager they cover. In most instances, in addition to trade execution, clients look to our traders on a daily basis to keep them up on news flow and market activity in issuers held in and related to those in portfolios.