There has been no shortage of buzz around the concept of outsourced trading in recent years. The trend towards greater adoption comes up in the financial press regularly, and consultancies have published numerous reports discussing the reasons why funds are increasingly striking partnerships with outsourced trading desk providers.
But there is still lingering confusion as to how outsourced trading differs from traditional broking arrangements. Many funds may not realize the full array of benefits from an outsourced trading solution or how suitable a partnership may be, based on their specific goals and aspirations. In this blog, we want to clear up some of the confusion and explain why a wide variety of firms – from emerging funds to large players – could benefit from exploring what outsourced trading can do for them.
Broking v Outsourcing
It is surprisingly easy to conflate broking with outsourced trading. An outsourced trading desk provider, like a broker, will execute trades. Also like a broker, it can provide much-needed anonymity for moving large or difficult orders. In fact, for those firms that may be wary about not retaining an in-house trading team, it may be helpful initially to consider using an outsourced trading provider as they would a broker, just to try it out. That way, a fund can tiptoe into an outsourced trading partnership.
As a fund tests the waters this way, it can learn about what is on offer. Cowen, for instance, can go well beyond just executing orders. An outsourcing provider also may provide pre-trade compliance or post-trade services as part of the package. It would also offer market color for the portfolio manager to help in the development of trade ideas or decisions on execution strategies. And funds can determine the degree to which they are involved in where orders are directed. For instance, they can leave it entirely up to the outsourced trading provider, or they can require trades to be directed towards certain brokers.
The main difference is in the relationship. A broker performs a specific service, whereas an outsourced trading provider acts as a partner, establishing a running dialogue and regularly collaborating with the fund. As with any dynamic relationship, trust becomes critical. That means more than just trusting the outsourced trading provider to perform its tasks. The fund needs to trust the provider to think and act on its behalf, to handle trades in specific ways, and to align its interests.
Access and Skills
The decision to outsource effectively amounts to replacing or supplementing an in-house function, which is essentially what outsourcing in just about any industry involves. But the outsourced trading provider, for all intents and purposes, is the fund, with the only proviso being that the trading desk is not on site. In that sense, it’s more like a lawyer or barrister representing a client. They become one and the same
Beyond the issues noted above, such as anonymity and the ability to work difficult orders, two of the main reasons funds are attracted to the concept is that an outsourced trading provider adds to the fund’s skills base and broadens its access.
If, for instance, a client wants access to a specialist broker that they don’t currently execute with, they can’t just pick up the phone and ask for a trade to be done. There is an onboarding process, with KYC (know your customer), AML (anti-money laundering), connectivity and contractual matters to sort out. But an outsourced trading provider, because of the business it is in, is more likely to be able to access that specialist broker.
There is also the matter of skills. Your fund may have lots of expertise in equities. But what if there is a sector where your trading strategy would benefit from certain knowledge or experience? Or, what about other asset classes? Cowen, for instance, has a team of veteran fixed income traders in addition to its large stable of equity traders. It can also handle OTC trading, which not every outsourced trading provider deals with.
There is even a case to be made for not having anonymity via your outsourced trading provider. By trading in the name of the fund, the outsourced trading provider can ensure that certain brokers know that the fund is directing flow at them. That is important for establishing a good business relationship with the brokers that you want to target.
Competing for the new breed of outsourcers
There are lots of reasons why outsourcing makes sense for a wide variety of funds. But not every outsourced trading provider is best equipped to address all of them. Some have a one-size-fits-all model that treats outsourced trading more like broking. Others may not offer the full range of services, from pre-trade to posttrade. Or, they may not be able to trade all the asset classes or geographies that a fund currently trades or wants to trade in future.
Cowen is a world leader in outsourced trading solutions, with offices around the world and dozens of traders with long resumes from both the buy side and the sell side. We’re constantly investing in our technology and in designing ways to streamline and customize our processes so that entering an outsourced trading arrangement is as painless as possible.
While we pride ourselves on making it easy for a new client to start outsourcing some of its trade flow, we also recognize that once a firm chooses an outsourced trading provider, there is a big disincentive to switching to a new one. That makes a fund’s initial choice all the more important.
As firms increasingly hear about outsourced trading, we’ve been expanding to meet the growing demand. But we know that for some funds outsourced trading represents a substantial change. That means education is key. We are keen to speak to any fund that wants to learn more about outsourced trading and the benefits on offer.
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