Dealing desks: a strategic choice
Faced with increasingly complex markets and upcoming regulations, today's investment managers are looking more and more to streamline and optimise their dealing processes. Mobilising resources to match core business requirements is the new competitive challenge, and devolving this function to external desks brings concrete solutions to strategic questions.
If MiFID I already led to major changes in the structure of European markets, MiFID II will mean a thorough overhaul in the way they function, impacting stakeholders in numerous domains, and more particularly investment managers and their dealing processes.
MiFID I's best execution obligation requires that investment managers take all "reasonable" steps to ensure the best possible results for clients. The future directive takes this obligation to the next level where the notion of "reasonable" is no longer adequate and "sufficient" is the new criteria. Policies governing best execution and the best selection of brokers and counterparties will need to be extremely detailed, providing proof that measures taken are indeed "sufficient".
The infrastructure of markets as we know them today is going to change dramatically, particularly as the "pre-trade transparency" obligation for new asset classes comes into play (bond, forex and derivative markets). Investment managers will need to adapt to the emergence of new stock exchange categories (Organised Trading Facilities) and new trading platforms (buy-side to buy-side, all to all, etc.).
Given these changes, asset managers must already adapt their front-to-back processes. To meet their regulatory best selection/best execution obligations, they will need to review their reporting processes and internal organisation.
From now on, investment managers will need to improve their capacity to provide adequate reporting as to the quality of execution, and must be able to justify their controls with concrete and objective methodologies, notably when it comes to the appraisal of broker and counterparty performance.
Meeting best selection/best execution criteria will require increasingly sophisticated and expensive infrastructures and platforms. In addition, the upfront investment to the annual cost of operating a station is substantial, estimated at close to two million euros for a team of four. As a result, certain large Buy-side operators are beginning to envisage outsourcing their dealing activities to an external provider.
If access to liquidity is a key concern, the matter of costs is an issue for an increasing number of COOs who, based on the concrete numbers (direct costs, allocated costs, growing price of market data), are submitting the option of outsourcing to their executive committees.
The need to optimise dealing functions can no longer be side-stepped and the barriers to outsourcing are progressively being raised as asset managers perceive more and more value-added in outsourcing their dealing desks.
In this new environment, outsourcing the dealing desk is a way for investment firms to clearly delineate their role. By bringing in a third party provider to streamline the operational management of regulatory constraints (best selection/execution, reporting, benchmarking of orders, traceability of transactions, broker appraisal, etc.), they are able to better concentrate on providing management services.
The successful outsourcing of a dealing function also means privileged and efficient access to market intermediaries – via specialist dealers, optimised connectivity, access to trading platforms, in-depth understanding of Sell-side players – and therefore to liquidity.
The significant reduction in operating costs is another benefit, related to economy of scale for the service provider as well as the substitution of fixed costs with variable costs.
Lastly, outsourcing means that investment managers can cut back on their own operating risk, giving them the added flexibility they need to rapidly expand their activities to new asset classes and new regions.
As outsourcing dealing to external desks implies significant changes, implementation phases are a decisive step. A large number of departments are stakeholders in the process, from management to compliance, operations, and information systems. Robust governance and strict project management are crucial in this key phase where the procedures for placing orders, interfaces and operational processes are defined. Governance is the backbone for quality partnerships over the long term and ensures the efficient control of delegated processes.
The appropriation of the new organisational framework by asset managers is absolutely vital. "Manager/dealer" dialogue is required from the outset if dealers are to rapidly familiarise themselves with investment styles and the types of orders required, and to understand the manager’s preferred style of working and decision-making process.
Finally, the seamless continuity in relations and contacts with market intermediaries is necessary in ensuring that managers continue to benefit from all of the value-added expected from their Sell-side services.