More and more asset managers are turning their focus to their core competnancies and partnering with service providers for the rest. Markets Media caught up with Dan Houlihan, head of asset servicing, Americas at Northern Trust, to discuss what the global custodian has seen regarding the trend.

How would you describe the variety of outsourced trading options that are currently available?

Generally, we have seen three types of providers: small, independent broker-dealers, investment banks, and custody banks. From our perspective, global custodians are best positioned due to their access to large pools of liquidity, global reach, and operational scale. Also, in the case of Northern Trust, we operate on an agency-only basis, so our interests are always aligned with our clients.

The investment banks seem to be focusing on outsourced trading within their prime brokerage services. Historically, the independent broker-dealers focus on smaller, single-market funds and also trade on an RTO (receive and transmit orders) basis. The issue with this approach is that the client’s name is known to the counterparty. However, in our model, as a custodian, we are the street-facing entity providing anonymity and greater scale benefits.

What type of pre-decision checklist should asset managers go through when considering outsourcing a portion or all of their trading desk?

There are several important elements an asset manager should consider, starting with counterparty risk – the strength of the counterparty is critically important. Strong management of conflicts across clients, the depth and breadth of trading expertise and experience; improved access to liquidity; and a modern, efficient technology platform are also significant factors. Asset managers should look for strong governance of internal operations and the ability to adhere to current and future regulatory demands.

I think a sometimes overlooked factor is the provider’s experience with outsourcing and track record of success. Outsourcing should be part of the provider’s DNA and not merely an avenue to pursue profits. Trading historically has been a transactional business, but in an outsourced model it becomes a service business. A provider can build a profitable trading business, but instilling a culture of service within that business is challenging. It’s an essential factor when making a decision. Lastly, do the provider and the solution truly simplify a firm’s operating model and free up time to focus on value-added activities?

How common is it for firms to completely outsource their trading desks?

The current outsourcing trend, what we are calling the ‘third wave of outsourcing’, is evolving still. Since Northern Trust launched its solution in September 2017, the acceptance of outsourced trading as a viable practice is accelerating. We have approximately 50 clients live globally, and a strong pipeline of interested firms. A reduction in cost and transition from a fixed to a variable cost model are viewed as the traditional benefits of outsourcing.

However, when implemented effectively, an outsourced trading solution can improve overall perform by expanding coverage for global markets to regional trading desks and through access to deeper liquidity pools.

If an asset manager has outsourced trading and operations to a partner that can handle any product, asset class, and jurisdiction, then they are in a much better position to execute on their business strategy. That’s how Northern Trust’s business has changed. We are no longer only a global custodian; we are a platform company through which clients can execute their business strategy.

Is Northern Trust’s model one-size-fits-all, or can clients have a bespoke offering regarding asset coverage and which portions of the trade lifecycle they could outsource?

It’s a modular service that can be customized. We have clients who want to outsource their entire trading function across all markets and asset classes. We also have US-based clients investing globally who decide to outsource their Ex-US trading.

There is a notion that outsourcing is favored by the smaller firms, is this what you are seeing?

We have been engaging with prospects and clients that range from startups to firms with over $100B in AUM. The commercial imperative is driving this; it is not so much a function of size. Additionally, there is an assessment of how much value your trading function is delivering. Based on this, I fully expect we will see a very diverse market both from a jurisdiction and size perspective.

How long is the typical onboarding process once the ink is dry on the contract, and when do firms start to see ROI?

Deciding to outsource a trading desk and have it up and running is much less complicated than other outsourcing relationships like switching custody providers or outsourcing middle office functions. We have worked with clients to execute a transition in approximately four weeks. While each situation is unique, we would expect a transition to typically take anywhere from three to six weeks, depending on complexity.