EYE ON Outsourcing

EYE ON

Outsourcing November 2014

George Rosenberger, Connex

CONTENTS 3 6 9 11

Outsourcing: Unlocking Value George Rosenberger, Connex

Constant Evaluation J.T. Cacciabaudo, Sterne, Agree & Leach

Playing with the Big Boys Mike Abbruzzese, Dominick and Dominick

Partners, not providers: the vendor relationship as a two-way street John Vrettos, Pershing LLC

EYE ON Outsourcing

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EDITOR’S NOTE Dear readers,

As industry-wide trends go, the push towards moving technology towards specialist providers and away from in-house development is one that is affecting both the buy-side and the sell-side. Technology is becoming increasingly commoditised as firms realise that many of the areas that were previously competitive advantage are now just staple offerings with little to no differentiation. On the other end of the spectrum some areas such as FIX connectivity have become such a vital part of a firm’s infrastructure that they essentially have to be outsourced to a dedicated team run by specialists in order to absolutely minimise down-time risk and minimise time to on-board new clients.

In this supplement we examine the ongoing trends in outsourcing. We look at the origins of a decision to outsource, and what analysis firms need to undertake prior to moving any technology to an outsourcing firm. We then move onto the different factors affecting what gets outsourced, how much trust is placed in an outsourcing provider, and just what should be outsourced.

As a final consideration we examine how the decision to outsource technology to an external firm results in project development and reach, and how the outsource provider role develops into one of consultancy.

The long term pendulum swing of build versus buy is one we have examined multiple times in GlobalTrading, but in terms of core technology the balance appears to have been decided; outsourcing is a long term answer to technological issues. How far the balance goes and just what technology can be outsourced remains to be seen.

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Outsourcing: Unlocking Value With George Rosenberger, Managing Director, Head of Trading Services, Connex

Today, firms continue to use outsource providers to create value for their businesses. It is not that every firm is still in a mass cutting phase, but a lot of big firms have cut pretty deep and no longer have the resources to quickly complete new projects. We’re starting to see programs and initiatives in our space that used to get approved very quickly now taking longer to get off the ground. Firms are starting to implement a formal review process where procurement groups have become a business committee that analyses whether or not a project is viable and a strong enough bet for firms to invest resources toward development.

That tells us that there are finite resources available at sell-side shops to get things done. They’ve had to cut so many people over the last few years to maintain profitability and market share, and in many instances it’s obvious that they have now cut too deeply to properly address their evolving business needs.

When the market is doing well, everybody is bullish and new expenses are not heavily scrutinised. When business slows down, everybody retools and focuses on

expense reduction. However, I think this last downturn has been so dramatic that it has caused many firms to formally implement procedures that they didn’t have before. These new procedures relate to new development items, how they get rationalized, approved, onboarded, and ultimately how resources are allocated to them. And, for better or for worse, depending upon your perspective, the trend is here to stay.

The nature of our industry is that our clients continuously and increasingly demand new tools and services. If we need to slow down development of new functionality for existing clients in order to be compliant with changing regulations or to deliver tools to new clients, existing client relationships may begin to deteriorate. Clients will demand that firms get more done with less. And, the way to do that is to outsource.

Regardless of whether it’s onshore/offshore outsourcing, firms continue to see the value in outsourcing to a knowledgeable provider who can create value for their firm. Often outsource providers offer access to dedicated resources that have expertise in a particular EYE ON Outsourcing

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Outsourcing: Unlocking Value

“Development is what we do professionally so we understand the resources, the investment and the effort required to initiate and finalize a project.“ market/segment. That expertise, coupled with their scale, often allows firms, who leverage outsource partners, to get on par with their bigger competitors.

In recent years, there has been an increase in need assessments that are now conducted within big firms. The challenge for firms is that now all new projects go through ROI analysis and need sign off at the committee level to get done. Part of the analysis is to decide whether it is a core competency for their firm. Then they bid internal resources against external. Recently, we were competing against one of our prospect’s internal development teams. The firm was looking for bids to analyse whether we could get their project done cheaper, faster and with better results. We have an edge when competing against internal resources. Development is what we do professionally so we understand the resources, the investment and the effort required to initiate and finalize a project. Competing against internal stakeholders and development teams is opening up doors to prospective clients who would otherwise not necessarily consider outsourcing as an option.

The client relationship Obviously, we want to try and bid for as much work as we can. If firms are now opening up those channels of communication with us and initiating a dialogue with new outsourcing partners, that’s great for us and great for the outsourcing industry as a whole.

Certainly every client is different. The size of the firm is relevant because of their resource availability and/ or the quality of resources is always important, and we along with other providers need to adjust our services to meet the specific requirements of clients of all shapes and sizes. The mid-tier brokers and smaller brokers have always had the mind-set of outsourcing their initiatives because they don’t typically have their own

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George Rosenberger, Managing Director, Head of Trading Services, Connex

technology. Unlike the bulge bracket firms, the second and third-tier brokers don’t have the resources, the personnel, or the cash to build these things directly.

As a result, they white label technology from other solutions providers. And, the bigger banks and brokerdealers that thought that they could deliver projects better on their own originally are now seeing the value in outsource providers as their internal resources are scaled back, and/or working on other initiatives.

Earning new business depends on the type of relationship we have with clients. Is it a pure software development relationship, or do we also have a hosting and support relationship with them as well?

What we started to see was that we began to get development work from clients who we initially started a relationship with by hosting and supporting software for them. We also have relationships with clients where we initially built software for them and they hosted it, and then later in the engagement, we end up hosting it for them as well.

We often like to start a relationship, with a new client, through a limited engagement whereby clients “try before you buy”. A client can see how we, as their outsource provider, deliver and what our service level is like over time. Do we live up to our reputation?

What type of product do we deliver? How is our support model different from other providers? Is it a timely billing cycle? Once firms are comfortable with all of those things, they often leverage us more. We regularly find that we initiate a relationship providing one particular type of business, product or service, and it quickly grows into other opportunities that we did not initially discuss as part of the engagement. Later in the relationship, there is ultimately more trust between us and our clients. We are increasingly finding that building trust with clients leads to greater opportunities.

“We regularly find that we initiate a relationship providing one particular type of business, product or service, and it quickly grows into other opportunities that we did not initially discuss as part of the engagement.“ New uses for the data Our core business is FIX connectivity and risk management. That is still the foundation and why clients come to us. But once a client is onboarded, we start to do more customized development work for them. We can build custom MIS reports and business intelligence studies to help clients grow their business.

Today, we are showing clients powerful information that they have never seen before. They can use it in a variety of different ways. With our consultative approach, we work with clients to deliver reports that show which clients are trading, how they’re trading, and what they are trading. Once clients have the data, it is of course limitless in terms of the number of data points that they can leverage to their advantage.

We can create custom MIS reports that help clients

look for new revenue opportunities, which of their clients are using what execution tools, which clients were sold nine different strategies and only use two, etc… We have the ability to deliver valuable data to our clients that they can use with their clients to create greater revenue opportunities. By delivering the valuable insight and data to clients, relationships continue to grow organically. And, as clients continue to work with us they notice how much value we add.

The right type of provider With outsourcing, clients should closely consider the type of provider that they are looking to use for particular initiatives. There are niche providers and general providers. With some providers you have geographical issues with multiple time zones that make it challenging to firms. There are often critical details lost in translation between the groups. If a client selects the wrong provider for their needs, it can lead to a disappointing engagement. Furthermore, the switching costs are high. There can also be commercial costs for switching from the current provider as well as timing risk. Building on this idea of organizational trust is critical because, in our space FIX is the lifeblood of trading firms. In order to get a large firm to trust us to handle their FIX connectivity, we have to convince them that we will treat them with the utmost care and the same attention to detail that we would our own business. This is why clients have to rely and leverage providers’ existing clients to get referrals. Firms should look at the longevity of the provider’s business, how long have they been in the space and take a close look at their track record for their engagements with their clients. Doing research is an important step in selecting a provider.

What is next stage for outsourcing?

There’s always going to be a need for vendor outsourcing. Broker-dealers trade and some of them provide equity while others provide research. None of them are in business to manage technology and development. Technology is a means to an end to deliver on a business goal. In that respect, there’s always going to be a need for more technology, and what we offer is specialized technology for a specific part of your critical business functions. FIX and risk management is often underserviced by internal stakeholders. We understand it through and through, and we provide state-of-the-art outsourced FIX connectivity and FIXrelated services to our clients. Our team are experts in their respective fields and understand the nuances required to manage and build out newer and better products and services for our clients year after year.

EYE ON Outsourcing

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Constant Evaluation With J.T. Cacciabaudo, Senior Managing Director, Head of Trading and Sales Trading, Sterne, Agree & Leach

In this world of regulatory scrutiny, as well as from a risk management point of view, it’s best for the buyside to have FIX connectivity, no matter what the cost, with two main consequences. Firstly, there is never an error that cannot be identified as far as the broker is concerned, because if the order is on the wrong side or quantity, it was entered by the client.

Secondly, as far as transparency is concerned, the buyside see every execution: they follow every execution in this world of high frequency trading and they’re concerned about toxic order flow. They want to know whether it is being executed and what size of their order’s being executed in the exact executions.

Because of that, a firm like ours has to factor in a much larger expense on FIX connectivity. The buyside client has their capital line, the buy-side Execution Management Systems (EMS), and then they have their OMS, the complexity of which will be based on that firm’s size and the expense of the system. Chances are when launching, a firm wouldn’t go for the most complex system. There are a lot more of the smaller networks entering this space to provide differing levels of functionality to the buy-side, and therefore, for the sellside, the number of providers that they have to connect to and maintain contact with is growing. There are a lot of smaller OMS or EMS providers for the buy-side, and

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I have to deal with an ever-growing list of providers.

Following this the competition started between the internet providers rather than direct FIX connectivity, and subsequently there was pricing competition, in terms of the more connections you send my way, the better pricing I’ll give you. That was a result of the network providers having their fixed costs and realising that they can offer better pricing if I have bigger market share; I’d still make more money because my cost will not increase.

A full time job As a result, I found myself managing all these relationships, and having to have constant meetings because with each one I wanted to get the best pricing.

Basically the biggest expense that I had running a sellside operation became FIX connectivity. Because of that, I was dedicating a lot of time to it. I could meet with a FIX provider once a day, and then I could try to rework the way my connections were sent based on the next best deal I got. I found myself inundated with dealing with FIX connection providers and it became a significant distraction from my primary responsibility, so we started looking at outsourcing.

And what I realised was that for the amount of money it was going to cost me to have a FIX provider, it was almost the equivalent to hiring someone to do this

“It is far more cost effective when I am willing to consult with the experts in this specific field, and that pertains to FIX connectivity, it pertains to the OMS, and it pertains to data information flow.“ full time, and in my mind and based on studies and reviews I examined, there were potential cost savings and services that a provider can give me access to that I would never have been able to attain.

The second area is that this provided a value proposition from a regulatory point of view. I had someone that was now monitoring this on a regular basis from a risk management point of view. And it was a lot easier for me to interact with one provider that could represent me, and this one provider had access to more solutions than I did because they were in this business on a regular basis, and they were acting with the end client on a regular basis.

When I evaluate the spend on my income statement on the business that I’m responsible for, I look at it from a Tier 2 point of view. This is not necessarily a fit for a bulge bracket in my opinion because they have much larger infrastructure, a much larger spend, and also they have a much more scaled technology. However when I look at my overall technology budget it drives me to outsource a number of different services and then have the ability to take advantage of knowledge and experience in those firms’ specific fields to realise the technology, rather than trying to work with my own technology budget or internal technology staff. It is far more cost effective when I am willing to consult with the experts in this specific field, and that pertains to FIX connectivity, it pertains to the OMS, and it pertains to data information flow.

A rolling review How often we change providers and analyse the services we are outsourcing depends on the evolution of my specific firm. If my firm’s revenues grow fivefold and that allows for a larger technology spend, then at a certain point, it becomes more cost effective to bring various pieces of the tech stack in-house.

That’s when firms can maximise the technology services that outsourcers can provide versus what we can do in-house. As a firm we have to be constantly monitoring what is becoming a commoditised offering or function that I need to take advantage of. For my firm, it will benefit us to utilise outsourced providers for some time to come.

Basically, when it becomes scalable internally, it will be worth it for me to bring any given piece of technology in-house.

What I do look for constantly is alternative providers for the technology I have outsourced.

I’m always reviewing the providers we utilise and could utilise to ensure that I’m getting, first, the best price and second, the best service.

As I grow revenue in a specific product, I’m looking to make sure that I have the correct technology and capacity for the growth of that business. For example in the options world, we’re slowly adding FIX connectivity for a lot of our options clients. When we were a smaller business, it wasn’t worth it. Our options business has tripled in size over the past five years and now it’s worth it for me to pay more attention to FIX connectivity; that’s going to be part of the service that I’m going to expand and I may want to look to upgrade my OMS and look for the optimal provider based on the size of my business.

When I need a top-of-the-line offering because of the amount of business I’m doing, I’ll buy it, but I think in that 3-5 years, it’s more of a matter of constantly looking at the upgrade cycle and the service providers that I use. It’s an ongoing analysis and a constant conversation to be looking at the different providers and different offerings and different price points.

With contracts lasting anywhere from 12-24 months on an auto-renewal basis, it’s our job to be in front of it, to be on top of it. One of the things is that the bigger we get, we look for providers that offer multiple services, as then I have more pricing power; rather than using six different providers for six different things. If I can get one provider for three of those things, it’s usually more cost effective.

This is a more and more a commoditised business.

Execution is more efficient than it’s ever been.

Every 15 basis points on income statement makes a difference and I pay attention to it because it allows me to make sure that I have the money to re-invest in my business and keep growing our offerings.

EYE ON Outsourcing

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Playing with the Big Boys Mike Abbruzzese of Dominick and Dominick explores the business case for outsourcing as a small firm amongst much larger competitors.

Smaller investment managers often outsource trading technology to achieve competitive parity with larger market participants. Yet, timely upgrades to the FIX trading architecture require a flexible, segmented approach. Coordinating specialist offerings from multiple vendors can facilitate faster upgrades and client response times.

FIX connectivity is the daily point of contact with our clients. As such, it needs to be flexible and multifunctional. At Dominick and Dominick, we outsource our FIX connectivity separately from our OMS/EMS providers. Outsourcing gave us the flexibility of not being married to our OMS anymore. Previously, it had been a major project to change an OMS system because the provider housed your FIX connections, held end-of-day files as well as the connections to your brokers.

Concentrating all our FIX connections through our OMS provider also gave us too much exposure to one external provider. We had everything with one firm, so when there was a problem everything went down.

Splitting these elements out into FIX connections

and our EMS reduced our operational risk.

By putting a firm in the middle to manage our FIX connections, we run one pipe into the OMS, which then goes to each executing broker. Adding new FIX connections through the OMS provider was a lengthy process and often they did not know what networks our clients were on. After outsourcing this element, new FIX connections are turned around in two days.

Moreover, if we need to change our OMS or EMS or the technology base changes, we can adapt. Without a dedicated FIX team, this would otherwise be difficult.

Outsourcing has yielded cost savings with clients that have multiple connectivity options, as our specialist provider gave us a better option than the client’s primary provider of FIX connectivity. As a smaller shop we want to give clients, whether institutional, high net worth or family office, the seamless capabilities to compete and look the same as our peers.

Naturally, outsourcing FIX connectivity enables us to get clients online quickly, but if a client tags a trade incorrectly, which then leads to problems on the OMS, our partner helps us deal with that. For EYE ON Outsourcing

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Playing with the Big Boys

“As a smaller shop we want to give clients, whether institutional, high net worth or family office, the seamless capabilities to compete and look the same as our peers.“ example, we had a problem with our EMS where we had one institutional group and another for the rest of the firm’s business. At one point we had to revert to an old OMS and were running two OMSs simultaneously. Our partner put in another pipe and we never had to bother the client.

It is not good to be constantly on your clients’ radar. Our clients expect that once we are set, all necessary changes should be done internally.

Outsourcing gave us the ability to do that.

We switched overnight and the client did not know because it looked the same to them.

Long term relationship Just as we build rapport with clients, we appreciate long-term relationships with our vendors, where each understands the other’s business better. Our FIX provider recognises adding a connection as a small firm involves taking a risk on the cost. The decision process for adding new connections is based on client costs and potential flow. Exploring connectivity options that are cheaper, but look and work the same helps us make that decision.

Staying competitive in our segment means outsourcing FIX, reviewing our EMS and paying attention to client changes. By the same measure, when providers promise us functionality they later cannot deliver, the added workload is a competitive disadvantage. We would rather a provider says “No we can’t do that” than “Yes we can”, but find the solution does not fit the problem.

Despite best efforts and improving technology, problems do occur. We want partners with the capabilities to handle issues as and when they arise. Every product runs well in ideal conditions, but the test is how it reacts in the event of an error.

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Mike Abbruzzese, Head of Equity Trading, Dominick and Dominick

Until that happens, we assess our vulnerabilities and spread our exposure over multiple partners.

Technology and consulting We frequently review our needs for what we can do better ourselves and what should be outsourced. To keep up with technology advances, we expect our partners to stay current even as we internally review developments in functionality and features from other providers. Up-to-date partners are essential when clients we have not heard from in six months suddenly request a change. If our partner is behind and cannot meet a client’s demands, we suffer for it.

There is a long list of inexpensive, commoditised trading services and finding what differentiates these products is a lengthy process. When evaluating new solution providers related to our EMS, OMS connections, brokers or FIX functionality, we look to our partner amongst other people for recommendations.

Typically, we look at our needs and consult with vendors to itemise the areas we have to address, and then we look at costs. Together with the COO, we review each scenario and make decisions.

Sometimes it comes down to cost and whether we can build it in-house, but many times it comes down to functionality. If it makes economic sense for the business, and especially if it allows us to trade like a larger firm, then we outsource it.

Partners, not providers:

the vendor relationship as a two-way street

Pershing’s John Vrettos discusses his approach to vendor selection, relationships management and resource allocation.

Whether a firm integrates third-party service providers into its trade processing technology was commonly a question of price. This focus on commoditised products and services has evolved to now include areas of specialisation and expertise. With a greater emphasis on the broader strategic relationship, the “technology provider as consultant” has access to more of the client’s infrastructure and wallet in exchange for providing greater efficiency across the entire trade process.

On the trading side, our focus has been on technologies and services where we find a) there is more specialised knowledge and expertise, or the potential therein for greater specialized services, and b) where the technology is commoditised. We find that there is generally more competitiveness in pricing and service levels when the services are more commoditised.

The common theme we hear from prospective clients time and again is, “We are looking at where we can get specialised knowledge and get it better and cheaper than developing in-house.” As the relationship with providers has changed, the discussion is no longer solely focused on delivering solutions at the most economic price point. For example, we look to integrate third-party solutions into our technology ecosystem from firms that will invest time to understand our business and our business needs. It is not just who is the cheapest, but who provides quality service and functionality at a competitive price.

As trading has evolved at Pershing, we trade for multiple types of clients, and each business type has their own needs. Pershing has built a very sophisticated risk management control system to service its retail business, but different solutions are EYE ON Outsourcing

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Partners, not providers For example, we currently use Convergex’s Connex in our connectivity to market places and liquidity pools and to manage some client connectivity, both inbound and outbound. . We have also leveraged Connex for risk management tools, utilizing their complementary expertise to enhance the array of client solutions Pershing offers clients.

John Vrettos, Director, Business Development & Strategy Pershing LLC

needed to trade for institutional clients through highspeed DMA or algorithmic capabilities. To meet the institutional clients’ requirements for speed in trade processing and market access, as well different types of risk controls and parameters, we enhance our solutions by integrating specialised service providers.

We have a strong development culture and control focus on our core processing engines. As a clearing firm, our services, solutions and information processing is critically important. The trade processing engine is internally controlled as well as most of the core platform tools we offer our advisors. We prefer to control the advisor interface and where we can, we want to provide an optimized client experience and manage it in a way that lets us support our clients in the best possible manner.

Pershing is committed to developing and providing our clients with solutions that meet their evolving needs.

At the same time we recognize the value of integrating third-party services into our technology ecosystem to enhance the solutions we offer clients. We balance the use of internal resources and integrated solutions to offer our clients more choices and with solutions that deliver the greatest strategic impact.

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When considering a third-party solution there are a number of considerations that must be made. We look at credit risk and other regulatory requirements before bringing that into vendor discussions to ensure we address both the business and the credit risk needs. We also have to consider the inbound and outbound processing needs of the interfaces between our internal systems and the external provider.

Often, these strategic relationships lead to applications in other areas of our businesswhich enhances the solutions we bring to market and benefits both our clients as well as the vendors we work with. In the end, it all comes down to creating

“It is not just who is the cheapest, but who provides quality service and functionality at a competitive price.“ and maintaining strong relationships. Our relationships with third-party vendors have yielded mutually beneficial outcomes- whereby their solutions have helped our clients, and Pershing, in turn, has helped the vendors to improve their offerings- which they can then bring to market elsewhere. By working with our clients and providers to arrive at the best possible solutions, everyone has an opportunity to benefit.

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