By Michael Ross

If Wall Street has a patron philosopher, it may well be Friedrich Nietzsche. After all, he has a book called “The Will to Power” and his famous aphorism “that which does not kill you makes you stronger” has been the guiding philosophy of risk managers, analyst training classes, associate all-nighters, and, to some, regulatory policy. Nietzsche is even given a cameo, of sorts, in the movie “Wall Street.”

Near the end of the film, just after Bud Fox has defeated Gordon Gekko, and just before his comeuppance in turn at the hands of the SEC, Lou Mannheim, the old timer, takes him aside and says, “Man looks into the abyss, and there’s nothing staring back at him. At that moment, man finds his character, and that is what keeps him out of the abyss.” It’s an odd moment, Bud Fox himself is bewildered by it. He nods his head, says he thinks he understands, walks into his office, and is promptly arrested.

It turns out, Mannheim is misquoting something Nietzsche said in “Beyond Good and Evil,” a work of Wall Street philosophy if ever there was one. The actual quote is “if you look long into an abyss, the abyss looks into you.” Oliver Stone, who wrote and directed Wall Street, certainly knew the actual quote and it’s likely the misquote is intentional. Intentional or not, Mannheim’s error and Nietzsche’s actual quote, when taken together, contain an important insight into the way that trading is being conducted today.

On the one hand, Nietzsche is correct: something Wall Streeters have long been looking into is now looking back into them. On the other, Mannheim is correct: what they are discovering is their character. What they are looking at, that can finally look into them, is nothing so terrifying as an abyss: it’s their transaction cost analysis reports.

The History of TCA

This is because the profusion of accessible data, and the advance of computing power and machine learning, have transformed TCA from a check the box exercise meant to satisfy the regulators to something else. TCA has reached a level where it can see beyond the basic elements of transaction costs and into the decision-making process. It can now see where human nature itself is its own worst enemy and still worse, the enemy of alpha.

The origins of this revolution are distant and humble. They lie in the Investment Advisors Act of 1940, which established a fiduciary duty for Registered Representatives. “Best execution” did not even exist as a concept prior to that. Even so, the definition of “best ex” has been left purposely vague. Both the regulatory authorities and FINRA say explicitly that “best ex” is not “best price.” They focus on process more than result:

they require firms to show that care was taken rather than that a specific outcome was achieved.

Still, Wall Street minds are very much focused on outcomes. The first data driven, quantitative tool for TCA was developed shortly after “Wall Street” premiered. In 1988, a paper by Berkowitz, Logue and Noser defined a new benchmark, the “volume weighted average price” or VWAP. VWAP is the average price of a security over the course of a day weighted by the volume traded at each price. It’s the price you would achieve if your order was a fixed percentage of the traded volume over the course of a day.

The creation of VWAP fundamentally altered the way the markets approached TCA and best-ex in several ways. First, it established the utility of benchmarking executions to some objective, quantifiable standard.

This remains the most popular single use of TCA to this day. Second, it established a multi-dimensional perspective on best-ex, taking other factors into consideration besides price, such as time and volume.

Finally, it established the capacity of large amounts of data and real time analytics to make concrete commercial use of something that had heretofore been a soft regulatory burden of care.

“What You Can Measure, You Can Manage”

The utility of TCA was sharpened further when Wayne Wagner and Mark Edwards extended the maxim, “what you can measure, you can manage,” to best execution in a 1993 paper. Wagner had defined “best-ex” as “the process of maximizing the investment idea.” This extended the definition beyond price and extended it into the entire investment process. Robert Kissell in his 2013 book, defined three categories of transaction costs across this spectrum: investment costs, trading costs, and opportunity costs. Trading costs are the explicit and implicit costs of execution: fees, spreads, market impact and the like. Investment and opportunity costs are costs of the road not taken, the costs of not transacting, either the delay inherent in the investment process or the cost of not executing the investment in full or at all.

In parallel with the expansion of the concept of best ex to include the whole of the investment decision-making process, came a better understanding of decision making itself. Starting in the 1970s, psychologists have invaded the realm of economics and have offered insightful critiques of theories that had relied too heavily on assumptions of perfect rationality on the part of economic actors. These critiques have been highly effective, winning Nobel prizes and capturing the popular imagination with books like “Thinking Fast and Slow. ”

One of the most effective critiques, and the one most useful for understanding the investment process, was “Prospect Theory: An Analysis of Decision Under Risk” by Daniel Kahneman and Amos Tversky. Prospect Theory is an alternative to “Expected Utility Theory.” Under Expected Utility, when decision makers are weighing outcomes, their preferences are weighted by their probabilities. That is, a rational actor would see reality for what it is and act accordingly. What Kahneman and Tversky found, however, was that when actual human beings, not hypothetical rational actors are involved, this is not the case. They found that people’s preferences over-weighted certainty, and underweighted outcomes that were merely probable.

This meant that people were systemically risk averse when there were certain gains, but risk seeking, when faced with the certainty of a loss. What’s more, they found that people have inconsistent preferences when the same set of probability-weighted decisions were presented in different forms. That is, presented the same set out outcomes, and the same probability weighting, the language used to describe the distribution, would cause people to choose differently among identical options.

They investigated this further in a 1981 paper called “The Framing of Decisions and the Psychology of Choice.” In this paper, they combined the idea that people are risk seeking in the face of certain losses and risk averting in the face of certain gains and the inconsistency of decision making depending on framing.

What they found, in experiments on real people, often with real money, was that risk behavior they observed in the case of certain outcomes could be extended into probabilistic outcomes as well. Most importantly, they found these decisions were significantly impacted by framing: people are risk averse when they perceive things to be going well, a “gain frame” and risk seeking when they seem to be going badly, a “loss frame.”

TCA Today

Today, the accessibility of data, and the computing power that can be applied to it have enabled firms to synthesize the advances in transaction cost analysis and behavioral economics. Firms now have a much fuller understanding of how transaction costs are created: not merely through fees, spreads and market impact, but in the ways that the cognitive biases affect the ways in which the orders themselves are placed.

Take for example this paper by Trade Informatics. Tversky and Kahneman make a novel suggestion in their paper on framing. They suggest that people limit their freedom of action, along the lines of Odysseus’ tying himself to the mast in order to resist the call of the sirens. Trade Informatics writes about the effects of constraints on trade execution, through the use of limit orders. They find that limiting firms to limit orders has the same effect as what Tversky and Kahneman find: it promotes risk aversion in gain frames and enhances the effects of risk seeking behavior in loss frames. That is, as prices are going your way, “a gain frame,” you’re more likely to get filled. As the market is moving away from you, a “loss frame,” you’re more likely to seek risk by not adjusting your limit, resulting in worse execution. In other words, you’re doing the opposite of the trading maxim “cut your losses short, and let your winners run” suggests. What’s more, you’re doing it not because you’re irrational, but because you’re human.

What is true for the use of limit orders is true for all aspects of the investment process because what is at issue is not the incentive structure, but human nature itself. What’s more these effects are cumulative and can be monitored throughout the transaction process. The fund mandate places constraints, which limit the decision set, on the PM. The PM, by choosing a security limits the decision set of the trader, the traders decision set is constrained in his choice of brokers, the broker by his choice of algos, the algos which, though machines, are really the encoded human preferences of their authors, have decision sets constrained by their choice of venues. It’s now possible, to examine in minute detail the decisions made at each level of the decision chain, to watch for the effects of human nature, and to adjust for them. So, in the end, Nietzsche and Mannheim are both partially right. It might be better to say, “Man looks at his transaction data, and the transaction data looks back at man finds his character, and that is how you save your alpha from the abyss.”

The data reported in this document reflect solely the views reported to Greenwich Associates by the research participants. Interviewees may be asked about their use of and demand for financial products and services and about investment practices in relevant financial markets. Greenwich Associates compiles the data received, conducts statistical analysis and reviews for presentation purposes in order to produce the final results. Unless otherwise indicated, any opinions or market observations made are strictly our own.

Michael Ross is Executive Director Market Structure & Technology at Greenwich Associates

Daniel Andemeskel, head of innovation management & strategic initiatives at AXA Investment Managers, said introducing technical innovation has been hardest in the front office where the firm wants to accelerate investment decisions and optimise alpha.

Andemeskel gave a presentation today at The Summit for Asset Management in London.

AXA IM launched an innovation strategy four to five years ago. He said: “When I started the job I was inspired by the Back to the Future movies which showed the need to think completely differently.”

Andemeskel said most progress has been made in marketing and sales. “We want to enable clients to buy funds like they buy books on Amazon and provide the same kind of recommendation engine,” he added.

This month AXA IM took a 10% stake in Dreams, a Swedish fintech whose app uses artificial intelligence and cognitive behavioural techniques to encourage users to save and invest money.

In the two years since launch, Dreams has attracted 300,000 users – the equivalent of 14% of the total 20 to 40 year-old target group in Sweden, according to a statement from AXA IM.

The partnership marks the beginning of a phased roll out of the platform across continental Europe, including German, Belgian, French, Italian, Dutch, and Spanish markets and the two firms will also run an innovation lab to conduct research on millennials’ savings and investment habits.

Joseph Pinto, global chief operating officer of AXA IM, said in a statement: “This partnership is a key milestone in our digital strategy to open up new digital distribution channels, starting with one targeting millennials – who are already today’s investors.”

Andemeskel  described Dreams as the WhatsApp for finance. He said: “We will distribute funds through this channel this year.”

In the middle and back office AXA IM has been able to cut costs through the increased use of robotics and new technology for regulatory compliance to remove repetitive workflow and improve efficiency.

In contrast, progress in the front office related to accelerating investment decisions and optimising alpha is still challenging.

“We have invested in a lot of alternative data, sentiment analysis and artificial intelligence but they are difficult to integrate into existing processes,” said Andemeskel. “However our quantitative team are building new products driven by artificial intelligence and machine learning.”

He continued that everybody should look at digital assets, which are being approved by regulators across Europe.

“Digital assets will dramatically change our business,” Andemeskel added. “There is a  lot happening under the radar.”

There is an opportunity for fintech firms to provide artificial intelligence offerings to portfolio managers so it is easier and quicker for the buy side to use. That’s according to Stu Taylor, Managing Partner at Firenze Partners and previously co-founder and chief executive of fixed income technology provider Algomi.

In June last year Algomi, which was set up to improve the search for bond market liquidity, announced that Scott Eaton, former chief operating officer for MarketAxess in Europe, Middle East and Africa, would replace Taylor as chief executive.

Taylor told Markets Media that big trends in fintech are artificial intelligence, particularly in equities, and machine learning.

“There is an opportunity to provide AI to portfolio managers so it is easier and quicker for the buy side to adopt – companies like Exabel are delivering AI as a Service to make these new technologies much easier for investment managers to incorporate into decision making.”

Exabel was founded in Oslo in 2016 to make state-of-the-art AI technology accessible to investors worldwide.

The fintech firm said on its website that it closed its second seed round in August last year to support going to market.

We are excited to announce that we closed our second seed round this summer, raising 38 million NOK (~4.7 million USD)! Read all about it at 👉 https://t.co/xOSnq1jomZ pic.twitter.com/yDdeschDKd

— Exabel (@exabel) August 21, 2018

Last month Exabel announced that three Norwegian financial institutions had joined its pilot program to test Exabel Intelligent Monitoring – DNB Asset Management which has more than €60bn ($68bn) assets under management; Folketrygdfondet and Arctic Fund Management.

Exabel Intelligent Monitoring detects abnormal market price movements and price-driving news events in real time, and is an AI-based companion to human workflows.

“Going live with the pilot program is a major milestone for the company,” added Exabel. “With invaluable pilot feedback to validate the product direction, we are on track to go to market with our first product in 2019.”

Taylor has launched Firenze Partners, which advises entrepreneurs and fintech companies on how to be in the best shape for fundraising including issues such as positioning, potential market value and scalability. He said: “Experience analytics are also critically important to measure progress, whether ideas are working and how users experience the product.”

Taylor continued that using the cloud allows fintech firms to develop and scale products much more quickly.

“I am on the advisory board of Insignis Cash Solutions who act as a virtual private bank,” he said. “Using the cloud means that the speed at which they have built the business is transformative.”

Investment

Taylor added there is still huge venture capital demand for fintechs in London and the Cambridge Science Park despite the UK leaving the European Union this year.

The UK leads the way in Europe with record levels of investment in 2018 according to the latest Fintech M&A Market Report from Hampleton Partners, a technology mergers and acquisitions advisor. Overall, there was record investment in fintech start-ups last year with a total disclosed transaction value of $30.8bn.

“Yet despite these start-ups capturing a growing share of the market, even the biggest British fintech firms are dwarfed by America’s Stripe, Robinhood and SoFi,” added the report. “These, in turn, are outclassed by China’s Ant Financial, recently valued at $150bn.”

Global investors double fintech funding to record $31bn in 2018 – @AltFiNews @rbaird1234

Investors clamour for fintech startups showed no sign of quietening down last year. #Fintech #Scaleup #Startup #Fintech #Payments #Apps #Lending #FinanceAppshttps://t.co/y9utx2QcAt pic.twitter.com/VEayzxlZAS

— Hampleton Partners – Tech Dealmakers (@TeamHampleton) February 6, 2019

The average funding round doubled in size from 2017, with the average venture round in the Asia-Pacific region reaching almost double the global average.

Jonathan Simnett, director and fintech specialist at Hampleton Partners, said in a statement: “In the latter half of 2018, the UK continued to lead the way in fintech in Europe, breeding a new generation of innovators with record levels of investment following the lead of new unicorns like Monzo and Revolut.”

The report said that although AI continues to show promise, change is more likely to resemble a gradual process than a quantum leap into new data sources and methods.

“Going forward, it is anticipated that the largest fintech firms will soon realise value through IPO in 2019,” added Simnett. “Meanwhile, most start-ups that have grown large enough to gain traction, attract a strong customer base and produce a profitable balance sheet, will remain small enough to be acquired by fintech and traditional incumbents leading to an ongoing process of consolidation and M&A.”

The requirement to exchange initial margin on uncleared derivatives will affect ten times as many market participants in 2020.

Regulators began implementing the mandate to exchange initial margin on uncleared derivatives in 2016 in annual phases, with the fourth stage in September this year and the fifth in September next year. The implementation thresholds are based on firms’ notional amounts of outstanding contracts of the derivatives that fall under the regulation.

Consultancy Celent said in a report: “While 2018 marked the chronological halfway point of the initial margin regulatory rollout, the next two years may see a more than 10-fold increase in the number of firms subject to the regulation.”

The final phase of initial margin regulation will represent a big bang expansion of the IM regime, and it will take effect in less than two years from now — in September 2020. – Don't Miss the latest from @nkatkov https://t.co/W9fLSUbDul

— Celent (@Celent_Research) February 26, 2019

Business information provider IHS Markit commissioned the study, Crunch Time for Initial Margin: Challenges and Solutions for the Uncleared Margin Rules.

Phase four in September this year, with a threshold of $750bn ($690bn), is expected to apply to a number of hedge funds and pensions.

“Although official global estimates are not available, the CFTC estimates 20 US firms will be in-phase for Phase 4,” added the survey.

Neil Katkov, SVP and research director overseeing risk management & compliance at Celent, estimated in the report that the first four phases apply to approximately 100 firms globally. In comparison, the fifth phase will apply to more than 1,100 additional firms, involving 9,500 bilateral counterparty relationships, and 9,000 negotiated agreements.

“Phase 5 thus represents a veritable big bang expansion of the initial margin regime, and it will take effect in less than two years from now — in September 2020,” added Katkov.

The consultancy estimated that most of the work needed to implement the regulations will go toward negotiating agreements with counterparties, 40%, and carrying out the necessary calculations, 30%.

Implementing and maintaining systems for initial margin operations has been costly with Celent estimating that a dealer from the first phase may have invested $10m in the initial build and testing stages. Additional costs such as development of backtesting capabilities and annual revalidation of models may represent another $3m in annual spending.

Dealers that participated in the first three phases have made progress in moving from a manual infrastructure to more automation and straight-through processing, and buy-side firms now face with similar challenges.

“The question is whether buy sides, many of which have traditionally been reluctant to invest in collateral management automation, will take advantage of the available technology ecosystem to inject straight-through processing into their IM operations,” added Celent. “Factors that may prod buy-side firms into investing in automation include potentially higher funding costs.”

The report continued that large fund managers are leading the way in adopting vendor-provided solutions and services, and this may encourage smaller firms to follow suit.

“At the current rate of adoption, however, many buy-side firms are likely to greet IM deadlines with a heavy reliance on manual processes,” said Katkov. “This will undoubtedly cause pain in the aftermath of IM adoption and drive such firms to consider vendor options for automating collateral management processes.”

Shift to central clearing

Clarus Financial Technology, the derivatives analytics provider, said in a blog that the first few years of the roll out of uncleared margin requirements has only led to a small shift in outstanding notional of derivatives into central clearing.

Jon Skinner said on the blog that a surprisingly large portion of the residual uncleared outstanding notional is exempt from the regulation, such as deliverable foreign exchange derivatives. The notional for uncleared foreign exchange derivatives that are exempt from the margin rules is $93 trillion versus $114t trillion for interest rate derivatives.

Will UMR lead to a further material shift to clearing? https://t.co/HdxJrWVO00 pic.twitter.com/eXRUSOcAme

— Clarus (@clarusft) February 27, 2019

Skinner highlighted that foreign exchange volatility is much higher than rates volatility.

“Anecdotally, foreign exchange value at risk is approximately 10:1 with interest rate value at risk in a typical cross-currency swap which is a product which comprises both an FX swap and an IR swap,” he added.

His noted that some foreign exchange clearing is available at LCH’s ForexClear and HKEx in Hong Kong but there has been no new incentive to shift. “Perhaps Basel III incentives will reach the senior management pain point in banks ?”, he added.

FX linear non-deliverable swaps are caught by the margin regulation but are not covered by a clearing mandate. NDFs are derivatives that are used to hedge or speculate against currencies where exchange controls make it difficult for overseas investors to make a physical cash settlement, for example, the Chinese renminbi.

“NDFs in non-deliverable currencies have shifted to clearing but are small scale compared with G10 deliverable forwards, cleared notional outstanding is up to $1 trillion with vast majority at LCH ForexClear,” said Skinner.

In the rates market, Skinner said there has been progress with some smaller notional products such as inflation swaps and non-deliverable interest rate swaps moving to clearing.

“I expect there’ll be some shift of the $62 trillion uncleared to clearing as phase 4 and 5 kick in and clearing becomes the cheaper rather than more expensive approach for buy-side firms,” he added.

He continued that moderate further clearing shifts are possible in single name credit default swaps, and likely in foreign exchange NDFs.

“This will lead to FX deliverables becoming a greater and more singular blot on the landscape of uncleared counterparty risk,” said Skinner.

Here today and gone tomorrow.

Bank of America Merrill Lynch – the firm born as a result of the shotgun marriage of Bank of America and brokerage Merrill Lynch during the financial crisis is about to shorten its name, according to CNN business news.

The Bank said that it is phasing out the Merrill Lynch brand for some businesses – namely its investment banking and trading divisions. Instead, these businesses will form a unit called BofA Securities.

Also, the investment and wealth management businesses will be re-branded “Merrill” products, though the wealth management team’s logo will still include Merrill Lynch’s famous bull.

The main financial advisory unit will still operate as “Merrill Lynch Wealth Management,” according to the company.

CNN reported that in a statement, CEO Brian Moynihan said the changes would take place over the coming months.

Merrill Lynch was founded in 1914 by Charles Merrill and Edmund Lynch. The company grew into a massive retail brokerage that aimed to expose everyday investors to the stock market, and its brokers became known as the “thundering herd.”

Merrill Lynch was sold to Bank of America for $50 billion in September 2008.

Derivatives trading costs could nearly double if volatility increases, which requires firms to ensure they have an efficient hedging strategy in place.

High volatility could increase initial margin by up to 94% for some portfolios according to derivatives risk analytics provider OpenGamma. These portfolios calculate margin requirements using a standard portfolio analysis of risk (Span) methodology for futures and options.

Peter Rippon, chief executive of OpenGamma, said in a statement: “No fund manager wants to be posting more margin than they need to. Understanding how to control initial margin costs will be key for firms to maintain liquidity, as they may need sufficient cash to buffer against unpredictable market conditions.”

OpenGamma’s research also found that by hedging appropriately, the initial margin increase would fall to a much lower 14%.

The analysis calculated margin requirements through stress testing fixed income futures using a time series for margin rates for contracts traded on exchanges, including CME and Eurex, from 2008 to 2018. However, clearing houses are moving away from the Span model and using Value at Risk (VaR) instead.

OpenGamma said: “Eurex leads the way with its ‘Prisma’ methodology and other CCPs are developing their own VaR-based algorithms.”

Using the VaR methodology, initial margin requirements could increase by almost 70%, but decrease to 35% if appropriately hedged.

Rippon continued that with the UK’s departure from the European Union and the ongoing trade war between the US and China, volatility is likely to increase.

“This is why, during these periods of market turbulence, understanding which positions are likely to incur a larger increase in margin requirements is imperative in order to reduce costs,” Rippon added.

Costs have become critical for the buy side due to increased competition from low-fee passive funds.

In addition to the potential increase of margin costs due to volatility, another phase of the margin requirements for uncleared derivatives is due to go live this year. In September uncleared initial margin rules will apply to many more smaller asset managers as regulators encourage the market to shift towards trading on regulated venues rather than over-the-counter.

The amount of additional margin posted per trade is predicted to hit $2 trillion by the end of 2020 – mainly as a result of uncleared margin rules. Click the link to find out more on our latest infographic >> https://t.co/DowExyjA6G pic.twitter.com/4DLlyNx0t8

— OpenGamma (@OpenGamma) February 14, 2019

Equities

In the equity markets, increased volatility in the final quarter of last year led to the highest global trading costs in the previous three years according to research from broker ITG.

Trading in all regions became more expensive, with the exceptions of emerging Europe and Middle East & Africa. ITG said in a report that commissions per share decreased slightly in the US and remained flat for the global traded universe over the same time period.

For Europe ex-UK, the implementation shortfall in the fourth quarter of last year rose 16%, driven by mid-caps, which became 44% more expensive to trade. The implementation shortfall last year for mid-caps in the region rose from 74 basis points in the first quarter of 2018 to 103.9 by the fourth quarter.

Outsourced trading?

Where have you gone Gordon Gekko? Bud Fox?

Outsourcing – it has happened in so many industries. Much like manufacturing, customer service and staffing, trading is no longer a holdout but rather joining the list of industries seeing this phenomenon.

In the fourteen months since it went into effect, MiFID II has proven to be a disruptive force for the financial services industry, upending existing business models and ushering in a new era of scrutiny in how firms spend their money. In Europe, trading and research can no longer be sold together as one service; even in the U.S., the global impact of MiFID has led many firms to explore full unbundling, leading to difficult questions about which costs are necessary and what it means to seek best execution.

Where there is disruption, however, there is also opportunity for growth. In this case, that opportunity can be seen as buy-side traders and hedge fund managers are increasingly enlisting outsourced trading firms to help them navigate this new normal.

A recent survey of Traders Magazine readers, representing a broad spectrum of buy-and sell-side professionals, found that 28% work for firms that have either already outsourced some of their trading and back-office operations or are actively considering doing so. That may not sound like a big number, but given outsourced trading’s longstanding reputation as a niche service for hedge funds only, it qualifies as a significant figure.

Also, research consultancy Opimas noted that though outsourced trading desks have existed for some time, interest in such offerings has increased in recent years as the asset management industry faces increasing pressure in terms of fees, fund performance, and regulation. Octavio Marenzi, researcher at Opimas, said this is leading even larger asset managers to outsource at least part of their trading desks. He forecasts that by 2022 about 20% of investment managers with assets under management greater than US$50 billion will outsource some portion of their trading desks.

Marenzi also noted several things when it came to outsourced trading:

• The majority of small, start-up funds have long outsourced their trading desks to their prime brokers. There are clearly exceptions to this: Some new hedge funds‘ strategies are heavily dependent on trading, and these funds tend to establish trading desks and hire traders from the very beginning.
• A newer phenomenon is that large, established asset managers are considering outsourcing all or part of their trading desk to an external provider. This reflects tougher cost pressures, as changing economic realities force asset managers to weigh which functions are essential and which can be outsourced at a potentially lower cost.
• The basic rationale for outsourcing revolves around reduced operational costs and improved execution quality. While improvements in execution quality in the range of 15-20 basis points have been demonstrated, this is typically only for very small funds that do not have the necessary scale to deploy highly professional traders and systems. Execution quality improvements for larger trading operations are very limited, if discernible at all. In practice, Opimas has found that the reduction in operational costs is far more important than execution quality.
• A large number of outsourced trading desk providers exist. While most outsourcing providers are registered as agency brokers, they frequently are part of larger institutions, including custodian banks, other asset managers, prime brokers, or investment banks. The future for these offerings looks bright, and we expect to see revenue growth in the range of 20-30% annually for the next few years.
• Asset managers looking at providers to outsource their trading desks to should consider regional coverage, instrument coverage, number of traders and experience in instrument class, number of similar clients, number of connections to relevant brokers and execution venues, systems architecture, including review of the order management and execution management systems in place, system used for transaction cost analysis, review of historical execution quality, commission management program, trade allocation policy, and any conflicts that the provider may have, including proprietary trading or asset management.

One firm that is focusing resources and assisting institutions with outsourced solutions is Dallas, Texas-based Capital Institutional Services (CAPIS). An independent agency broker offering global execution services and commission management solutions for institutional investors, CAPIS also has an outsourced operation and services it offers to clients, said Chris Hurley, Director of Institutional Sales, who is charged with leading CAPIS’ Outsourced Trading sales effort.

“CAPIS has acted as a de-facto outsourced desk for decades” Hurley told Traders Magazine. “The difference now is technology enables an outsourced desk to direct commissions to other brokers on the manager’s behalf.  Our independent research and agency-only brokerage model was a natural fit for expansion to dedicated Outsourced Trading.”

Hurley said that he finds clients are drawn to an unconflicted trading model where incentives are aligned with the goals of clients, who recognize the value of technology, high-touch trading expertise, and stealth in sourcing liquidity while offering a high level of engagement and customer service.

“An effective outsourced trading provider has the process, relationships, and resources to efficiently manage each client’s unique needs and provide best execution beyond U.S. cash equity and into the international equity, fixed income, and derivatives markets,” he said. “Managers looking to maximize their resources gravitate toward partnering with an outsourced provider who can seamlessly facilitate their current needs and growth plans while minimizing disruption and costs, and who can also consult on projects such as outsourcing middle and back office functions.”

While outsourcing is gaining steam in both the U.S. and Europe, the growth has progressed in different ways. In the U.S., where the practice has a longer history, larger funds have followed the hedge fund vanguard and are now choosing to supplement their established trading desks, while in Europe, the interest began with the largest firms adapting to the shifting regulatory landscape, with the smaller firms then following that example.

But no matter why they make the decision, firms that choose to outsource some or all of their trading operations are seeing strong results. “Given all the mounting costs and complexities around reporting and best execution, outsourcing all or parts of trading may increasingly makes sense for some firms in the industry,” Ryan Larson, Head of U.S. Equity Trading at RBC Global Asset Management, said at the Equities Leaders Summit in Miami last December.

And in the 2018 report “Outsourced Trading: Helping the Buy Side Improve Execution and Enhance Operational Efficiency,” Greenwich Associates found that among participating institutional investors using outsourced trading desks, 71% were extremely satisfied with the service.  Among the study participants were 10 firms with at least $10 billion in assets under management.

Tim O’Halloran, Managing Director at Tourmaline Partners, another outsourced trading firm, said that today’s landscape increases the benefits of outsourcing for large and small managers alike.

“Historically, outsourced trading has been popular with emerging managers at launch, because those firms are less likely to have the resources to support an in-house trading desk,” he said. “As a result of new regulation, changes in technology and a host of other factors, we are now seeing larger funds experience some of these same cost pressures. In addition, larger firms that do employ traders are starting to realize our global scale and expansive network of sell-side relationships can supplement their in-house trading activities. The result is that outsourced trading has become a much bigger tent.”

Whatever forces are driving firms to outsource their trading operations, one thing is clear: running a full desk internally, with no outside help, is no longer a prerequisite for being a large manager. The buy side is facing tremendous pressure, and if present conditions persist, outsourced trading’s transformation from a specialized service to a standard practice may have only just begun.

And its not just limited to the front office or trading desk. A cottage industry is being born at the middle- and back-office as well. Stephen Dora, Director at Conformity 360,  explained how his firm fits into the outsourced trading ecosystem.

“Our platform is focused on small and midsize hedge funds, where traders may take on multiple roles and responsibilities,’ he began.” An independent compliance managed service like us can be an affiant while being cost effective way to adhere to the stringent requirements that Funds must comply to.”

Due to the increased demand for soft dollar relationships and the pressure builds to lower costs, Dora added he felt this is a great opportunity for his firm to be able to partner with outsourcing desks to be able to offer a valuable service at a significant lower cost within their platform.

By Storm Copestake

What comes over you when you get in to a trade? You are a have solid knowledge of the markets, you can clearly see your trade coming up, and all of your trade requirements are fulfilled, but as you’re about to enter the trade your heart rate increases, your palms get sweaty, you start to second guess your decision and look for excuses not to pull the trigger. Maybe you do get in to the trade, but now, instead of sitting back and following your trading plan, you look for the first opportunity to move you stop loss, even though you know you shouldn’t! The story goes on.

You know and understand that winning or losing is a part of trading. You accept it, and you are prepared for it before your day starts. Then something happens when you get into a trade, and you become powerless to stop your destructive behaviours. What has happened to your logic, and what is happening in your mind?

Every person holds subconscious habits and beliefs about money, and you may or may not be aware of them. These are most likely rooted in your childhood experiences, things you overheard or were told as a child. Do any of these sound familiar?

“I’m scared I won’t have enough money”

“Money is the root of all evil”

“Money is not important. It’s only money”

“The rich get richer and the poor get poorer”

“I’m just not good with money”

“My family has never been rich”

“Money is a limited resource”

“You have to be either rich or happy, you can’t be both”

“It’s selfish to want a lot of money”

“Easy comes easy go”

This is what is happening: your subconscious beliefs create your thoughts, your thoughts create your feelings, your feelings lead to behaviour, your behaviour creates results, ad your results strengthen your subconscious beliefs. It’s a perpetual pattern.

You consciously want to be a successful trader, you have all the ability and knowledge to achieve that, but your subconscious keeps pulling you down. These beliefs are driving your trading when you are under pressure. The only way to over come this is by clearing those unhelpful negative beliefs and creating new trading beliefs that allows your brain to manage the uncertainty.

Examine your own beliefs about money. Are they helping you or hampering you as a trader? You need to become aware of and change those negative, limiting beliefs that you hold about money, that keep your trading account from shrinking or remaining at break even.

During an RTT session, under hypnosis we uncover exactly what your limiting beliefs are, and where they have stemmed from. We then resolve the issues, using a couple of different tools and then reprogram the subconscious with new, affirming and positive beliefs. For more information you can book for a call here.

*Traders Mindset Top Tip*

Getting in to the right mindset

Before you start your trading day, try following these suggestions so that you begin in the right frame of mind.

Get up early – give yourself enough time to ensure you have everything set up and you are not rushed.
Get your head in the right place – take a few minutes to meditate or do some deep breathing so that you have a good positive mental attitude before you start.

Storm is a qualified Rapid Transformational Therapist, and Certified Hypnotherapist specialising in helping traders overcome mindset and psychological blocks.

The UK Financial Conduct Authority warned that asset managers should transition their hedges  from Libor before the reference rate disappears and liquidity in related derivatives begins to decline.

The majority of fund managers, 80%, use Libor-based derivatives for hedging and 90% use the rate as a benchmark for at least one fund according to a survey from the Investment Association last week.

Megan Butler, executive director of supervision – investment, wholesale and specialists at the FCA, gave a speech on the shift from Libor to the Investment Association in London last week.

She said: “We strongly encourage asset managers to transition their hedges and positions over to Sonia before Libor disappears, and before liquidity in Libor-derivatives begins to decline.”

The UK has adopted the Sterling Overnight Index Average (Sonia) as its new risk-free reference rate to replace sterling Libor. After the financial crisis there were a series of scandals regarding banks manipulating their submissions for setting benchmarks across asset classes, which led to a lack of confidence and threatened participation in the related markets. As a result, regulators have increased their supervision of benchmarks and want to move to risk-free reference rates which are based on transactions, so they are harder to manipulate and more representative of the market.

Butler described Libor as an anachronism as the unsecured interbank lending market has dwindled and the eurocurrency markets no longer exist as a distinct entity. She said: “Meaning Libor is essentially measuring the rate at which banks are not borrowing from each other.”

She compared transaction volumes underpinning Libor and Sonia reference rates. Overnight cash transactions supporting the calculation of Sonia are an average £50bn ($65bn) a day. In contrast, transactions feeding the calculations of three and six-month sterling Libor average £187m and £87m a day respectively. In addition, large floating rate bond issuers are referencing Sonia instead of Libor.

“So far this year, we’ve seen 15 issues (from banks, sovereigns, and supranationals) that have referenced compounded Sonia, with a total value of about £8.7bn,” she added. “This already exceeds the £6.9bn issued in the six months prior.”

According to Butler 130 investors have purchased the £15.6bn of Sonia issuance.

Megan Butler, Executive Director of Supervision at the FCA, gives update @InvAssoc on UK firms’ preparations to transition away from LIBOR: https://t.co/OXD0W1zcgY #Libor pic.twitter.com/5Txp4RM84J

— Financial Conduct Authority (@TheFCA) February 21, 2019

She continued that in the derivatives markets, the monthly average of Sonia cleared over-the-counter derivatives was £2.1 trillion in 2017 but grew to £4.2 trillion a month last year.

“The notional traded monthly in Sonia cleared, over-the-counter derivatives is now broadly equivalent to that of sterling Libor,” added Butler. “Albeit it’s important to remember that there is still heavy use of Libor, including new contracts. There’s currently £60bn in bond issuance that references sterling Libor, and matures post-2021”

Butler noted that transition is slower on the buy side than on the sell side but asset managers will have exposure to Libor in multiple areas including hedging strategies using Libor-referencing interest rate derivatives, and investments in bonds or other securities in which interest payments that reference Libor.

“In terms of floating rate notes, we have seen industry estimates that – looking across all five Libor currencies – there are around $870bn in outstanding bonds that reference Libor mature after end-2021,” she added.

She continued that reducing this stock of outstanding bonds is not straightforward.

“But we’re also conscious that a lot of the market believes that in the future, liquidity will be concentrated around the overnight rates. This is already the case for Sonia-based swaps and futures,” she said. “It is also the case for Sonia – and indeed Secure Overnight Financing Rate (SOFR)– based bonds. Waiting for term rates is not, in our view, a reason to delay transition.”

She stressed that firms need to end their reliance on Libor by the end of 2021.

“Billions of dollars-worth of financial contracts needs to move on to a new benchmark rate,” she warned. “If this transition is chaotic, it could have serious repercussions.”

Roadmap for asset managers

The Investment Association, which represents UK asset management, and consultancy  Oliver Wyman, launched a roadmap to guide asset managers through the transition from Libor.

Great to be at the @InvAssoc's #LIBOR transition seminar. Some interesting and thought-provoking comments to takeaway. Megan Butler: "LIBOR is an anachronism… essentially measuring the rate at which banks *don't* lend to each other."

— Bovill (@Bovilltweets) February 21, 2019

The report outlined the steps designed to help asset managers complete the transition by 2021, the date by which the FCA plans to retire the benchmark rate.

Galina Dimitrova, IA director for Capital Markets, said in a statement: “The transition date is fast approaching and we are encouraging firms to set their plans in motion to ensure a smooth switch to Sonia. Each jurisdiction is moving at its own pace, with slightly different rates coming out of the end of the process. Firms must therefore not only focus on Sonia, but other global benchmarks as well.”

The survey found that almost three-quarters of asset managers said they had already invested in Sonia instruments in 2018.

US SOFR

The US has selected SOFR as the new risk-free reference rate to replace US dollar Libor, which began to be published in April last year.

The Alternative Reference Rates Committee said in the minutes for its meeting last month that volumes in futures trading have grown rapidly in the short period since SOFR began production, and that further development of the SOFR swap market would be facilitated by increased hedging activity that would result from a higher volume of SOFR-linked cash instruments.

The minutes said: “The ARRC Chair suggested that the outreach working group should work with CME, ICE, and LCH in order to publicly disseminate metrics around current activity in the SOFR derivatives market.”

In addition Federal Reserve economists intend to publish a staff working paper on indicative forward-looking term rates derived from SOFR derivatives in the first quarter of this year.

“It was also noted that derivatives were expected to use and fallback to a compound average of the overnight risk-free rate,” said the minutes. “Members agreed that many market participants could use compounded or simple averages of SOFR and that it would be counterproductive if they delayed their transition of cash products away from Libor in waiting for a robust, IOSCO compliant forward-looking term rate that could be recommended by the ARRC.”