Outsourcing has emerged as common practice not just across the financial services industry, but all walks of business. The global outsourcing market size was valued at $245.9 billion in 2021, while a recent report from Funds Europe found that almost three quarters of fund managers expect to increase the number of outsourced services they use over the next two years.
Surveys from Private Funds CFO also found that outsourcing has accelerated greatly since 2019, and that 71 percent of private fund manager CFOs say increased outsourcing is being driven primarily by its ability to free GPs to focus on their core strengths. About half of CFOs say the costs of building or buying in-house solutions is what drives their outsourcing strategy.
One particular trend is gaining traction in the foreign exchange (FX) industry, where the growing number of third-party solutions available to fund managers are enabling firms to outsource various parts of the trade workflow – from calculating the FX position, to execution, margining and settlement.
But until recently, there has not been a way to incorporate these various steps into a singular outsourced solution. The difficulty that fund managers face in outsourcing the full FX process is compounded by the fact that they must consider any third-party as part of their own business, meaning it is vital to find a reliable and trustworthy partner.
However, a new breed of fintechs with a laser-focus on fund managers’ pain points – such as the pursuit of best execution, operational inefficiencies and collateralized hedging – has emerged as a means to bridge these gaps. In doing so, financial technology is proving that outsourcing can be done cost-effectively, efficiently and, most importantly, with full control and strong governance.
A key consideration for mid-sized asset managers?
The advantages of outsourced execution are perhaps most important for mid-sized fund managers.
The numerous parties involved combined with the opaque nature of the execution process often create huge administrative burdens for these firms, eating up time and resources. Likewise, the time-consuming and costly nature of onboarding new liquidity providers can outweigh the benefits that these partnerships bring, as supported by Private Funds CFO’s Leaders Survey.
And just as the Leaders Survey showed, outsourcing frees up resources for more effective use elsewhere, enabling firms to dedicate more time to core business matters. The end-product is also more likely to be of higher quality, leading to improved execution, saving money in the long run.
A growing demand
FX is the world’s largest and most liquid market, but it is also one of the most complex. The long list of potential counterparties, advisers and electronic trading platforms in FX execution means that it can be difficult to choose the right partner.
Implementing a robust FX framework that enables best execution can involve numerous operational hurdles. Setting up and onboarding new FX counterparties, centralizing price discovery and navigating the post-execution phase often have their own complications and can be a headache for the finance function.
For these reasons, businesses are moving toward external solutions that can assist with these functions. Despite macroeconomic headwinds, private capital dry powder is rising and as firms build for scale, they need to future proof their finance function. If they don’t, inefficient processes will create a drag on resources at a time when fund managers should be focused on value-generation activities.
Many are turning to outsourced execution to benefit from the know-how of external experts and improve efficiency with limited resources. According to HSBC and Acuris, 44 percent of CFOs in larger companies have outsourced some of their day-to-day functions to increase automation and digitization.
There is a growing recognition that outsourcing does not necessarily mean a loss of control, less transparency or reduced quality of FX activities. Instead, it can save firms time and resources and, when using the right partner, can actually improve governance, transparency and execution quality.
Research from Russell Investments, for example, found that for an average $1 billion fund, savings of $330,000 per annum would be achievable from the adoption of an agency approach where FX trading is outsourced to a third-party specialist. In some cases, funds could have saved much more.
Notably, the study from Russell Investments explicitly suggested an ‘agency’ model – whereby a third-party specialist is appointed to manage FX trades as a means of achieving best execution. The benefits of this third-party are due to its ability to ‘shop around’ for the best deal for each set of FX trades to ensure that prices achieved are attractive as possible.
What to look for in a service provider
It is undoubtedly a big step to leave the world of ‘in-house execution,’ meaning there are several criteria that we believe forward-thinking businesses should look for in an external agency.
In our opinion, full transparency at each stage of the execution process, real-time reporting, independent transaction cost analysis (TCA) and complete visibility of execution costs are all vital. Furthermore, the ability to demonstrate each of these in a clear and understandable manner should also be a key consideration.
Having a third-party agency that can meet these criteria can enable asset managers to remain competitive and reduce operational risks and internal burdens whilst retaining the same tight control, governance and transparency as before.
We believe it is more important than ever for firms to find alternative and innovative ways of saving time, money and resources. Outsourced execution through a trustworthy partner can play a central role in this transition, enabling businesses to take a more strategic approach to their FX execution, while retaining full control and strong governance.
Eric Huttman is CEO at independent FX-as-a-service provider MillTechFX in London.