There are real opportunities for Custodians to provide value added services to clients that are both profitable to their bottom line and address significant issues within investment organisations. Trade order management services is one of them.
Order Management Services – an opportunity for Custodians
Life is pretty tough for Custodians in Australia. Fierce competition to win new mandates combined with the scale back of high margin activities such as stock lending, cash management, and FX execution has made the environment difficult for Custodians in the Australian market.
But there are real opportunities for Custodians to provide value added services to clients that are both profitable to their bottom line and address significant issues within investment organisations. Custodians have certainly not been ‘asleep at the wheel’ to this idea and the need to ‘ratchet’ their services up the value chain has been a key driver behind the concept of ‘middle office outsourcing’.
The conventional thinking is that providing trade order management services to clients is a bridge too far for Custodians. Clients like to run this process as it contributes directly to delivering investment returns and is highly dependent on the type of front office trading platform deployed.
However, the reality is that maintaining an investment order management process requires substantial investment in technology and operations. But the ability to deliver investment returns depends on the quality of people employed to make decisions, not the technology and infrastructure used to execute trades.
Super Funds could benefit
Superfunds that are contemplating a move towards managing funds in-house are required to deploy expensive new systems, hire new teams and demand new data from their Custodians. Whilst the business case for managing investments in-house may be clear, the operational implications are significant and, with no current outsourcing options available, businesses have no choice but to kick off expensive and time consuming projects, often with limited internal expertise available.
Data is a driver
Finally, managing investment portfolios internally gives rise to new requirements for investment data that is timely, accurate and granular. In many cases, the current Custodians are unable to fulfill these needs, requiring the client to either develop their own (expensive) data management capability or to go shopping for a new Custodian.
So what would the model be like if Custodians were to offer order management to their clients?
Custodians provide the systems and data
Firstly, investment organisations would not need to deploy expensive systems to manage the trade process and instead would access the platform provided by the Custodian. Importantly, this does not mean that the actual execution of trades would need to be ‘given up’ to the Custodian, but instead the investment’s organisation dealers would simply access technology provided by the Custodian
Operational capability to manage the trade process would no longer be required in-house as responsibility for all trade related activities such as trade matching, collateral management and trade settlement would be assigned to the Custodian.
Secondly, by having visibility of the entire trade cycle, Custodians would no longer need to react to the challenging requests for data imposed by their clients to supply their varied and bespoke order management systems. Controlling the ‘end to end’ trade cycle provides the Custodian with the opportunity to develop standardised processes to manage and report investment data to clients. Additional services tied to the order management process such as pre trade compliance and counterparty exposure reporting could be offered to clients.
Custodian as broker?
Finally, whilst external brokers will always continue to play a role in trade execution, by offering order management to clients Custodians could potentially act as the ‘broker’ for certain trades. This not only provides investment organisations with an alternative trade counterparty but also gives Custodians a new ‘transaction based’ revenue stream.
There is no doubt that some significant challenges exist with this concept, with the lack of current technology and/or expertise within Custodians probably ranking as one of the highest. The current ‘retention first’ sales strategy that responds to short term client demand vs long term client need can also often be a significant inhibitor to getting traction on these sorts of initiatives. That said, this type of model could significantly benefit both Custodians and their clients.
Figure 1 – Operating Model Supporting Outsourced Order Management