What if the execution management system (EMS) you depend on for day-to-day trading were to disappear without warning? While this may sound unlikely, the terms under which EMSs, analytical systems and data are provided to the buy-side could make it a reality.
In some pricing models for such services, the sell-side effectively subsidises clients as part of the business relationship. For example, a broker may provide its proprietary EMS to buy-side traders at little or no cost depending on the amount of order flow the traders send to the broker.
Equally, with some third-party systems, a broker may subsidise the buy-side’s bill by paying the vendor a network or connection fee, leaving the client to pick up a smaller licence fee. In some cases, the broker may absorb more or less of the total cost of the EMS depending on how much business it gets from the asset manager in question.
The difficulty arises if the broker feels it is no longer getting enough flow from the client to justify subsidising their trading technology use – a very real prospect in today’s environment of diminished order flow, greater use of agency brokers and the buy-side’s desire to rely less heavily on individual counterparties.
“These systems could be mission-critical. However, some people in the firm may be unaware of how they are funded, and a company conducting an internal audit may discover that it is reliant on something their broker could take away,” says Clare Vincent-Silk, principal, operations at investment management consultancy Investit. “The question is, what happens if the flow to the broker decreases and it tries to take the system away?”
Reliance on broker subsidy of trading technology according to flow can also make it difficult for buy-side desks to determine what they are paying for its use.
“In doing EMS assessments, I would talk to brokers and they would offer services for ‘free’ but on the condition that the firm in question increased the amount of business going their way,” says Vincent-Silk. “There is an unwritten price for these services.”
A further point of confusion for buy-side desks is the sheer variety of ways the various vendors and brokers providing EMSs can charge. If a vendor has a global connectivity network, for example, it can charge the broker for access to this as a way of paying for the EMS.
Some EMS vendors, however, eschew charging on an order-flow basis. Fidessa, for example, charges the buy-side the exchange market data costs and the sell-side a connection fee to the buy-side EMS, which is charged either by the number of client screens or per client.
“We do not charge any transactional fees for order flow. We keep the costs fixed so both sides of the trade know exactly what they are paying,” says Russell Thornton, EMS product manager at Fidessa. “There are no instances where the buy-side would feel they had to send more flow down to the broker to cover increasing costs.”
Thornton acknowledges that it is possible for a broker to close a client connection if it feels it is not receiving enough business through it, but asserts that it is rare. “That has probably only happened once or twice – we have over 200 clients,” he says.
Despite fears that the buy-side may lose mission-critical trading functionality because of reduced order flow to the brokers that are helping pay for it, some on the sell-side believe such a situation is highly unlikely. “The buy-side firm that puts itself in a position where it is fully dependent on a single broker system or expensive vendor system needs to be careful. However I haven’t seen any instances of this happening,” says Tim Wildenberg, head of direct execution services, EMEA, at UBS “We are all commercial people, and nobody gets any brownie points for putting a customer out of business. I can see the potential threat, but I can’t see a model where that would happen.”
Nevertheless, Wildenberg says that service cutbacks could result from diminished order flow. “We are now being much more aggressive at managing our EMS costs,” he says. “If we are paying vendors by screen and only two of a clients’ five traders trade with us we will probably turn three off.”
Another area that could be cut back is market data. “With our PinPoint EMS application, if we have a client who is not trading with us very much, one of the things we will do is limit the amount of market data we give to them,” says Wildenberg.
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