REBOOTING THE BUYSIDE.
The traditional split between the buyside and the sellside is blurring at the edges. Stringent new regulations and ongoing cost constraints are driving asset management firms to assume greater control of the trading process.
|It’s a tipping of the scales that’s been underway for some time but will only intensify with the implementation of MiFID II in January 2018. This new directive places a weighty obligation on buyside firms not only to secure best execution – in terms of price, liquidity and transparency – but also to provide evidence that they are doing so to regulators and end investors. That in turn will require the capture and analysis of a far greater amount of data than ever before.|
At the same time, squeezed margins and spiralling compliance costs mean that buyside players are looking to make economies wherever possible and to target far higher levels of operational efficiency.
One option for large asset management firms is to take the DIY route and build a sellside operation in-house within a buyside infrastructure, as Deutsche Asset Management has done.
For smaller and medium-sized firms, however, the option of investing substantial resources is neither practical nor affordable. Growing numbers are therefore taking a more à la carte approach, keeping some proprietary activities under their own roof, while putting out the rest to specialist outsourcing services.
The trading landscape is also continuing to evolve, with a rise in the number and variety of trading venues, as well as possible new instruments and markets. There are also likely to be new types of collaborative initiatives, such as Project Neptune, a platform created by 42 buyside and sellside firms to enhance liquidity supply.
A new era then for the buyside. But are firms ready and willing to embrace what lies ahead?
SHARING THE LOAD.
Paul Walker-Duncalf and Richard Lilley, Joint Managing Partners of Linear Outsourced Trading Ltd, explain the merits of a fully outsourced solution.
Is the empowerment of the buyside a new development?
From a trading perspective, the buyside has been empowered for some time. Most medium to large managers have a sophisticated array of proprietorial or broker-provided tools to aid execution. Those firms are also unbundled and have discretion to execute with a firm or in a venue to provide best execution rather than in order to pay for other services. Many smaller managers are not yet unbundled and so may not yet be empowered with the same discretion. That will change as we move towards the implementation of MiFID II.
What is the advantage of opting for a fully outsourced solution?
Where portfolio managers deal for themselves, the advantages of outsourced trading are improved quality of execution provided by experienced dealers, compliance with regulations and allowing portfolio managers to concentrate on adding alpha rather than being distracted by execution.
For those investment managers with a trading desk, outsourcing removes the cost of running the desk and replaces it with a variable one, as charges are only incurred when trading commissions are paid.
Traders in many buyside firms are not located with portfolio managers and, as trading has become increasingly electronic and commoditised, it doesn’t matter if it is remotely located.
The inevitable rise in electronic trading has meant that trading skills are being lost and in-house trading is not adding the value to justify the cost.
Any manager outsourcing should see the Linear Outsourced Trading desk as an extension of their own firm, offering a bespoke service and the level of contact they would expect with in-house dealers.
What is the profile of your client base?
Our business is most likely to appeal to smaller and medium sized asset managers which cannot afford the capital outlay and ongoing running costs of a trading desk.
Which activities are buyside firms most likely to outsource?
Many investment management functions other than front office have been outsourced. As asset managers attempt to control costs in a period of challenged performance and lower earnings, they are searching for other areas of cost reduction, including trading. Many portfolio managers perceive thatthe research service they receive from brokers will deteriorate if they outsource trading. With changes to the pricing of research and the unbundling of execution and research commissions being fully implemented across Europe under MiFID II, this concern should no longer be valid.
Where do the cost efficiencies of outsourcing lie?
The fully loaded cost of a buyside trader is independently estimated at £300k. In challenging times, this is a cost many asset managers simply cannot afford. Outsourcing transfers everything to a variable cost.
How do you see the outsourcing market developing?
We are seeing interest from clients in the outsourcing model and Linear has everything in place from trading, mid and back office and CSA capabilities to meet client demand.
Mark Pumfrey, Head of EMEA, Liquidnet, explains how the trading network supports the buyside
How will MiFID II affect the buyside trading desk?
MiFID II will introduce significant changes for the buyside, in particular in the areas of dark pool trading and the ‘unbundling’ of payments for research and execution. As the industry prepares for its implementation, we will see a rise in the use of execution-only venues and probably fewer but larger trades executed.
Research providers will also have to focus clearly on their unique selling point and the price they will charge. Full unbundling will assist asset managers to meet best execution obligations as they would be able to trade unencumbered by research commitments.
What are buyside firms doing to prepare?
Under the new rules, the buyside will need to understand what is happening with their order flow and forensically analyse execution data provided by their brokers to prove best execution. As a consequence, buyside firms are intensifying their scrutiny of their brokers and trading venues’ execution performance.
Where does Liquidnet fit into the trading ecosystem?
Liquidnet helps institutions protect the performance of their portfolios by allowing them to trade more efficiently – minimising market impact and maximising price improvement.
We are building a complete execution ecosystem for the buyside which includes matching blocks through our core negotiation product; seeking blocks by uncovering deeply hidden liquidity sources; and building blocks using our Next Gen algos and decision-making tools.
How can you address the problems of inefficiency in sales trading on the buyside?
Much of the current inefficiency results from buyside traders struggling to unlock liquidity. We enable institutional investors to find a match and execute within its own community, centralising institutional liquidity. Independent research from LiquidMetrix shows we deliver, on average, 90 basis points price improvement compared to volume-adjusted prices in lit markets at the time of trade. When investment returns are low, this can make a huge difference to the fund’s overall performance and return.
What kind of trading activity is the platform currently witnessing?
Liquidnet EMEA had its best ever first quarter performance in European equities this year and continues to see strong market share gains. As institutions gear up for MiFID II, where best execution is paramount and natural parent order block liquidity becomes even more valuable, we expect to see further strong growth in our core block business, Next Gen Algos and Fixed Income offering.
Will other initiatives arise in the marketplace?
Over the next few years we expect to see new venues, order types and systems being created to help solve some of the problems the industry is facing, but only those which offer value to investors will survive.
What is Liquidnet’s focus for the future?
We are continuously innovating and bringing new efficiencies to the market. Our focus in 2016 is to deliver what the buyside needs in equities and fixed income: tools that allow them to source block-trading opportunities, real-time data, and analytics to make smarter trading decisions.