The Case For Outsourcing

carl-slesserBy Carl Slesser, Head of Sell-Side Product Management, Market Technology, Nasdaq

Brokers are turning to third parties for support in running their trading operations.

Regulations to promote competition in trading have led to a proliferation of liquidity pools over the last decade or so – many of which are run by large brokers and investment banks. But, these organisations have found that running a trading venue is getting more difficult.

Regulations are changing rapidly, and oversight has become much stricter. Firms need constantly to respond to new demands from regulatory bodies while differentiating to retain a competitive edge. With margins continually squeezed, many sell-side firms realise that their efforts could be better spent on enhancing core competencies aimed at generating revenue rather than on keeping the operations of these venues within regulatory parameters.

Complexity breeds an opportunity for outsourcing. To this end, the market technology division at Nasdaq, which has traditionally served the global market infrastructure operator community as a technology partner, has experienced a huge uptick in interest in outsourcing from sell-side firms. Specifically, they are considering having a trusted third party perform certain trading and operational functions and related services.

Some firms have ambitions to unify their multi-asset trading on a single platform and have us operate it for them, while others want us to help them meet their Markets in Financial Instruments Directive (MiFID) II obligations as a newly declared systematic internaliser (SI) or multilateral trading facility (MTF). In one case in the US, the firm wants us to take on the complete technology and operations of its entire dark pool. As the market structure changes, we see a wider array of use cases for outsourcing, but all with the same underlying need: to re-focus scarce resources on revenue-generating projects and focus on differentiation.

Outsourcing is not new in our space. Not surprisingly, the key drivers are regulatory complexity and cost with the demand for resources, technology evolution and data complexity woven in.

Regulatory complexity
The stiff fines and penalties regulators have levied against brokers for rule violations on their trading venues have been a wakeup call for the industry. In 2016, a major global bank was fined for misleading customers about its equity dark pool platform pertaining to an issue that involved a failure to address known technical problems with its proprietary dark pool ranking model. With various global regulatory initiatives around the corner, these types of sanctions will become more common.

MiFID II provides us one example where regulatory compliance will get even tougher, as the mandate ushers in a new market structure regime comprising regulated exchanges, MTFs, organized trading facilities (OTFs) and SIs.  Ultimately, MiFID II promotes greater transparency and discourages trading in the dark. Broker crossing networks will be eliminated, and firms that internalise trades will have new obligations. As a result, brokers are currently reassessing the way they will service their clients and also the processes, procedures and technology prowess required to meet these obligations.

Because the regulation applies to far more asset classes than its predecessor, MiFID I, firms need to take a hard look at a more holistic approach to their technology and operations. Furthermore, the transaction reporting requirements on these firms are onerous, and pre-trade transparency and surveillance monitoring requirements will undoubtedly bring more technological and resource challenges to organisations that claim new status as either an SI, MTF or OTF.

Cost pressures
Overall, the regulatory compliance burden has increased – whether in Europe in relation to MiFID II, or other regions where regulators are cracking down on dark pools and other internalised order flow. This has put enormous pressure on brokers’ balance sheets, and they need to search for areas where costs can be reduced to achieve capital efficiency. These new demands cannot be executed on aging technology. Firms must either spend the money to refresh it internally, or they must outsource and partner with a trusted third party that can deliver and potentially even run the solution.

When comparing the costs of keeping pace with functional developments, client demands and required regulatory changes, outsourcing may provide an attractive alternative. Working with a technology partner that understands the operational needs of a marketplace can enable brokers and banks to concentrate resources on developing and monetizing their intellectual property, such as their suite of algorithms, instead of developing and operating trading solutions.

Building a case
Outsourcing can be an attractive alternative for firms that are looking for creative ways to better leverage scarce cross-departmental resources and to boost revenues among a complicated, extremely competitive landscape. Outsourcing mission-critical operations to a vendor can be daunting and discomforting, so the choice of partner(s) is critical. Sell-side firms looking to embark on this journey must consider the expertise of their partner, including its technology prowess and its ability to reliably execute on the firm’s behalf, not just tomorrow, but far into the future.

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