Welcome to our podcast series, Thinking Aloud with BNP Paribas.
In this special edition we turn our focus to the buy side as Clare Vincent-Silk, Partner at management consultancy firm @Sionic is joined by our Head of Dealing Services, Thomas Castiel to discuss our research on the growth of outsourced dealing.
[00:05] Kate Spencer:
Welcome to Thinking Aloud by BNP Paribas, a series of podcasts on financial services. Today's podcast looks at the topic of outsourced dealing and explores our latest research paper: “Outsourcing: a new dawn for dealing desks?”. My name is Kate Spencer. I'm the Head of Content Strategy at BNP Paribas Securities Services. I’m joined today by Thomas Castiel, the Head of Dealing Services at BNP Paribas Securities Services, and Clare Vincent Silk, a partner at Sionic, a management consultancy firm. Thank you both for joining me. We will perhaps start by setting the scene. Dealing - the buying and trading of assets - can be conducted by institutional investors in-house. So, that's investors such as asset managers and pension funds. Clare can you tell me who and what's involved in in-house dealing and what role it plays in the investment value chain please?
So dealers have a responsibility for obtaining best execution as defined by their execution policy. They decide which broker services and execution venues to use, to find market liquidity for the orders. A centralized internal dealing function provides a way of aggregating orders from different investment managers for the same security, so orders are placed more efficiently in the market. This also ensures clients are treated fairly by preventing any in-house front running. Segregating the function of investment management and dealing helps demonstrate that dealing is unbundled from research received and really allows fund managers to focus on managing their portfolios.
So Clare which elements can be outsourced? Are there parts of the function that can be outsourced or the entire function? How does it work?
What we are seeing is that some firms will outsource all of their dealing functions across all their different asset classes or regions. But, some are being very specific about areas where they need to enhance their capabilities, so, specific asset classes where it might be just Asia or just the U.S. depending on where they are lacking in location.
So Thomas based on your experience, who generally will be involved in making that decision to outsource dealing services?
Well Kate, generally speaking it's a decision that is taken at the c-level, so it's either the COO, either the CIO or even the CEO as it is a structuring decision. The COO will be mainly looking at costs, on ways to streamline their operating model and making sure at the same time they comply with regulations, which is mainly MiFID II, best execution and trade transparency requirements. As a reminder MiFID II investment firms are now required to take all sufficient steps to obtain, when executing orders, the best possible results for their clients, taking into account a certain number of execution factors. The CIO will be more interested to free up their portfolio manager from non-core functions such as dealing, and ask them to focus on the investment strategy, which is their primary duty. They will also look at adding new asset classes or new regions to capture alpha generation. And this could internally be a long and costly project where outsourcing provides a plug and play solution as it is already live for other clients. And last but not least, the CIO also looks at ways to improve execution performance and outsourcing may be one of the possible solutions as pure outsourced dealers are expert in their field.
Clare, in your role, you focus on the client front office finding more efficient and effective ways to support the investment management process. With regard to outsourced dealing how has the market evolved in recent years?
Outsourced dealing has actually been available for at least 20 years but it has actually been a less mature as a service compared to other outsourced services such as investment operations. There isn't really a standard model for it. The outsourced dealing service providers differ in the way they operate so some will act as agency brokers, others as RTOs. There is also different regulatory permissions and also differences in the way that they charge. So, it started really with hedge funds and start-ups then moved on to asset owners and now we’re seeing the asset managers and wealth managers starting to use these services. They are also using them to support dealing in different time zones over specific asset classes. The market has actually been slow to evolve because there has been a limited number of established providers. There has also been a lack of knowledge and understanding of the services on offer by the asset managers and then a lack of visible flagship clients to really encourage firms to embrace this.
So Clare just for our listeners, do you mind telling me the difference between an RTO and an agency broker, the different models?
So the agency broker model will have the direct relationship with the investment managers so that will be a principle relationship in terms of the execution. With an RTO - that stands for the reception transmission of orders - it's a regulatory term, and that is where the investment manager will pass the order to the outsourced provider who will then pass the order on to the execution broker so the relationship, the counterparty relationship, is between the investment manager and the executing broker in terms of settlement.
Clare you recently undertook some research on behalf of BNP Paribas Securities Services on the question of outsourced dealing, can you tell us a little about this?
So the purpose of the research was to describe the current state of the market for outsourced dealing. And so to do this as well as talking about what is outsourced dealing and the models, we wanted to get the market attitudes to outsourced dealing and we went as broad as we could, so we spoke to 30 different investment managers across Europe. We did this back in February/March time 2019 and so, we wanted to get geographical opinion so we spoke to representatives in the UK, France, Belgium, Switzerland, the Netherlands and Portugal. We also thought it would be interesting to explore by size in terms of assets under management so we grouped firms together. So, those that are between 2 to 30 billion euros asset under management and 30 to 60 billion, and then those that were much larger, [from] 60 billion up to about a trillion. We then also took firms by their type, so in-house pension schemes, wealth managers and institutional fund managers; and then by role, so, fund managers, COOs, heads of compliance, heads of dealing. We wanted to hear what they have to say from their perspectives. We found that really in terms of role, we had half of those that were operational in nature and half were investment professionals. So we had a good understanding then of opinions across Europe.
And what were the main findings from the research?
So from our sample, 20% of firms had actually outsourced some or all of their dealing. I was actually surprised that it was that many to be honest. All of those though, were less than 30 billion AuM. A further 21% said that they would consider outsourcing in the next 2 years so we are seeing an increase in interest and I think it has really picked up, especially in this year. And the drivers for this are predominantly, gathered around cost reduction but also to get better capabilities especially coverage for other time zones. There are still concerns though, mostly around dealers being remote from fund managers, not really then being familiar with the investment strategy that is trying to be achieved. And also therefore reduction of market awareness, fund managers don't feel that they are so in touch with what's going on in the market. So we are seeing an increase in the number of providers offering a broader service across multiple asset classes which is bringing confidence to the investment managers to outsource their dealing. We are also seeing execution services now being bundled with other services such as custody and also technology such as order management systems. Those firms without an existing dealing team or with a single location dealing team are likely to benefit most in the short term but we are also seeing those that are larger looking for flexibility and agility to move into new asset classes or regions seeing the benefits that can be achieved by this type of service.
So Thomas, can you talk us through the advantages for investment managers of outsourcing their dealing function?
Yes, sure Kate. There are multiple benefits of outsourcing the dealing function. The first one, as margins are squeezed due to increasing costs and higher competition, investment firms are looking at ways to reduce and manage their cost structure more efficiently. According to research the cost of running an internal desk of four people is somewhere between 1.5 and 2 million euro a year. Delegating to an outsourced dealing provider allows firms to benefit from a best in class platform at mutualized cost as it is shared by multiple entities. The second one is regulatory; it allows firms that outsource to benefit from a fully compliant platform inclusive of all regulatory reporting around trade transparency or RTS 28, audit trails and so on, and as well benefitting from strong regulatory support and regulatory watch. As a reminder the processes, tools data and reporting that must be put in place and monitor the execution quality and to comply with regulation are quite heavy. The third one is flexibility on time to market. Outsourcing allows investment firms to avoid a long and costly internal project, either to equip themselves or when they review their target operating model. The fourth one is performance, investment firms who decide to outsource will benefit from better liquidity thanks to connectivity to a wider range of markets and the news, and this ultimately will generate improved execution performance. And last but not least the operational risk on execution is de facto transferred to the provider and the associated cost as well.
Thank you Thomas, that's really interesting. So are there any areas of concern that are holding investment managers back from taking that step to outsource their dealing function?
Generally, the two main concerns for investment firms that we see are, number one, the market awareness: investment firms may fear losing proximity with their brokers and banks and de facto loose some investment opportunities. But I believe this question is more related to the outsourcing model that Clare was referring to - either RTO or agency broker – and which can provide different pros and cons. The second concern is dealers being remote from the investment managers. This is an important topic, which is addressed during the project implementation phase as part of the change management stream to avoid this kind of issue.
Thank you Clare and Thomas for your insights. It's been a pleasure speaking with you. For our audience please be aware that if you'd like to find out more on this topic you can download our research paper from the BNP Paribas Securities Services website and the name of that paper is “Outsourcing: a new dawn for dealing desks?”. I hope you join us again soon for our next installment of Thinking Aloud, thank you.