Strength and Stability are Key Considerations for Outsourcing Trading Partners

In the dynamic landscape of asset management, outsourcing has emerged as a strategic solution to enhance operational efficiency and focus on core competencies. A recent Coalition Greenwich survey conducted in 2023 sheds light on the evolving preferences of asset managers when selecting partners for outsourcing. The survey revealed that an organization’s strength and stability is the top consideration, reflecting the industry's growing awareness of the potential long-term risks associated with outsourcing the front office.

In the survey, which canvassed 151 global asset managers, 42% of respondents emphasized the importance of the organizational strength and stability of their chosen outsourcing partners. This top-ranking consideration underscores the apprehensions that have been fueled by sporadic incidents of major financial institutions collapsing due to overleveraging and unchecked risk-taking. Notable names like Lehman Brothers, Knight Capital, and Credit Suisse serve as stark reminders of the tumultuous nature of financial markets.

Traditionally, cost considerations have driven the decision-making process in outsourcing. However, the survey reveals a shift in mindset, with only 27% of respondents identifying price and value as their primary concern. This changing sentiment reflects a maturing industry that recognizes the potential repercussions of prioritizing cost savings over stability, especially in the context of outsourced trading.

When evaluating the strength and stability of potential outsourcing partners, asset managers should focus on four critical areas of investigation: financial strength, risk management, long-term viability, and business continuity.

Financial Strength: Defending Against Vulnerabilities

The financial health of an outsourced trading provider should be the initial focus, considering the susceptibility of trading firms to sudden market shifts. Instances such as the collapse of Knight Capital serve as stark reminders of how a single adverse trade can lead to devastating consequences. Areas to assess include the firm's capital reserves and the presence of errors and omissions insurance, which act as safeguards against unexpected downturns. Any outsourced provider that fails to provide adequate answers should likely be removed from consideration.

Some questions asset managers can ask when assessing the financial strength of a potential outsourcing partner include:

• What is the firm's current capital, and how has it evolved over the past few years?
• Does the firm have any financial reserves? If so, how much?
• Do you trade principally or hold positions in firm accounts? If so, how do you manage your financial exposure and risk?
• Does the firm carry errors and omissions insurance, and what is the coverage amount and deductible?
• In the event of a significant market downturn, how does the firm ensure its financial stability?

Robust Risk Management: Safeguarding Against Uncertainties

A demonstrated history of effective risk management is a strong indicator of an outsourcing partner's stability. Evaluating how the firm navigated past financial crises, the strength of their compliance department, and any recent regulatory actions can provide valuable insights into their risk mitigation capabilities.

Some questions asset managers can ask when assessing the risk management structure of a potential outsourcing partner include:

• Can you provide insights into the firm's risk management strategies and practices?
• How did the firm navigate through previous financial crises or market disruptions?
• What measures are in place to prevent and mitigate operational and trading-related risks?
• How does the firm ensure compliance with regulatory requirements and industry standards?
• Are there any recent regulatory actions, fines, or sanctions against the firm? If so, how were they addressed?

Long-Term Viability: Ensuring Continued Success

Understanding the sustainability of the outsourcing partner's business model is crucial. Exploring aspects such as ownership structure, business longevity, employee tenure, growth strategy, and client retention can offer a comprehensive view of the partner's prospects. Questions like whether the firm is for sale and the tenure of their existing client relationships can reveal their commitment to long-term success.

Some questions asset managers can ask when assessing the long-term viability of a potential outsourcing partner include:

• What is the ownership structure of the firm, and are there any recent changes in ownership or leadership?
• How long has the firm been in operation, and what is its track record of stability and growth?
• What is the average tenure of key employees, including senior management and traders?
• Are there any plans to sell the firm or merge with other entities in the near future?
• Can you provide insights into the firm's growth strategy and vision for the next few years?
• How long have other clients been utilizing the firm's services, and can you provide references for long-standing clients?

Business Continuity: Thriving Amidst Uncertainty

Unforeseen events can have far-reaching consequences, and therefore operational resiliency must be considered when selecting an outsourced trading form. A comprehensive plan to ensure that essential trading functions can be carried out in the face of disruptions should be made available and reviewed as part of due diligence. This should include a review of recent disaster recovery and business resiliency testing. Data and cybersecurity are other critical and often overlooked components of resiliency. And location diversification should also be evaluated, namely where the outsourced trading firm’s primary and backup sites are relative to one another and your own offices.

Some questions asset managers can ask when assessing the business continuity preparedness of a potential outsourcing partner include:

• What steps has the firm taken to ensure seamless business operations, even in times of disruption?
• How does the firm handle unexpected technical failures or system outages that might impact trading operations?
• Do you have back-up locations separate from your primary place of business?
• Can you provide details about the firm's disaster recovery and business continuity plans?
• How often does the firm test its disaster recovery and business continuity procedures?
• What are the results of recent tests?
• How does the firm maintain client confidentiality and data security, especially in the digital age?

In the realm of outsourced trading, stability is more than a desirable trait, it is a critical necessity. The disruptive potential of a destabilized partner can have cascading effects on asset managers, resulting in operational disruptions and potential financial losses. Particularly when entrusted with trade execution, the outsourced partner must demonstrate unwavering stability to ensure seamless and successful operations.

The paradigm shift in asset managers' priorities towards organizational strength and stability underscores the evolving dynamics of the industry. While cost considerations remain relevant, the potential consequences of an unstable partner have prompted asset managers to redefine their evaluation criteria. By focusing on financial strength, risk management prowess, and the long-term viability and continuity of outsourcing partners, asset managers can make informed decisions that safeguard their operations and bolster their overall success in an ever-changing financial landscape.