Outsourcing Client Connectivity

Published by Global Trading

Pressures from regulation, technological complexity and burgeoning costs are a wake-up call to sell-side firms to optimise their client connectivity management.

Approaches towards client connectivity are in flux. The challenges of new regulations and increasing electronification along the trade process and across product lines are at best forcing modifications of some sell-side systems, and at worst reducing others to obsolescence.

In general, the momentum towards greater automation in asset classes such as fixed income and foreign exchange is prompting banks and brokerages to consolidate their systems, applying and integrating the technology and processes already used in equities and derivatives trading in order to curb costs and check complexity.

Meanwhile, regulation and in particular the launch next year of Markets in Financial Instruments Directive (MiFID) II will make trade reporting obligations more onerous, enhancing order execution visibility for clients, counterparties, exchanges and other trading platforms.

MiFID II means that client connectivity needs to be modified, for example to validate that new data items required by the legislation are being correctly sent by clients. Large global banks and brokerage firms usually have dozens of front- and middle-office systems, siloed by product and business division. But, with the implementation of MiFID II, it will make sense to centralise these operations in one place, rather than modify multiple, disparate systems.

They might choose to consolidate their systems internally. However, if they choose instead to use an external specialist they can not only deploy their human resources elsewhere (and more productively), but also amortise (as well as lower) their costs.

Manging order flows and aggregating data is an increasingly complex, costly and time-consuming business. For about a decade, many organisations have outsourced the post-trade operations that were previously tasked to the back and middle offices.

Vendors are well positioned through economies of scale, critical mass, and concentrated expertise and technology investment to perform post-trade functions in a standardised, efficient way. Third-party service providers can collate orders and disperse allocations automatically communicating to all channels via the FIX protocol, and also compute fees such as stamp duty and exchange charges.

In the past, mainly small- and medium-sized firms turned to third-party vendors. However, more recently large sell-side firms have started to outsource the management of their client connectivity. In practice, this involves both the hardware and software infrastructure. It includes linking the sell-side with the buy-side for electronic FIX messaging; routing client orders internally through order management systems (OMS) to trading desks; and on-boarding clients and validating them within the OMS.

Hybrid model

Now a trend for outsourcing the front office’s direct links with clients is rapidly gaining momentum. For instance, brokers’ indications of interest (IOI) targeted via the FIX protocol to select buy-side firms can be handled by vendors. And the re-emergence of systematic internalisers (SIs) is likely to escalate the demand for external services, as buy-side requests for quotations (RFQs) increase the sell-side’s workload

The economic case for outsourcing many of front office functions is compelling. Millions of dollars can be saved if standardised procedures are adopted, while the obligation to implement regulatory compliance across a multitude of platforms within any sell-side firm is an incentive to minimise complexity as well as reduce expenses.

Certainly, there are some areas that sell-side firms, whatever their size, are unlikely to outsource. Client relationships, both the on-boarding and maintenance processes, are critical to a brokerage, and often nuanced to give a firm what it perceives as a competitive edge. So, although it might it use leveraged centralised services for some trade functions, it is likely to retain other added-value elements. The preference is for the adoption of a hybrid solution or partnership.

Vendors should recognize this trend. Successful providers will be those that offer a package that combines a managed service with the provision of the tools and technology for a client to control sensitive aspects of the client relationship. Moreover, Ullink differentiates its managed connectivity service through its independence of a firm’s OMS, even if it is provided by a rival vendor.

Indeed, there is a raft of vendors offering FIX engines and hosting services, and brokerages’ IT project management teams are typically keen to advocate an internal solution to any process and platform consolidation. The key to providing a credible alternative is expertise, flexibility and lower costs.

Recommended reading

Impacts on Technology Beyond Mifid II

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Managed Connectivity Service