Strategic Insight: In today s trading environment, broker dealers of. Outsourcing & Analytics for more effi cient FX brokerage operations >>> PROVIDER

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1 Strategic Insight: Outsourcing & Analytics for more effi cient FX brokerage operations Heather McLean explores why FX brokers should consider outsourcing many of their back office functions and in what ways outsourced analytical procedures can be applied to a brokers risk, compliance and trading activities to facilitate more efficient business operations. In today s trading environment, broker dealers of all kinds have equipped their front offices with advanced technology to facilitate more efficient trade execution. However, few firms have upgraded their middle and back office technology, says Sam Mele, founder and managing director at Firm58. He claims many brokers are still relying on spreadsheets and legacy systems that cannot easily scale, are prone to error, and ultimately consume the gains acquired from front office advances. Outsourcing middle and back office functions provides brokers with the ability to quickly and cost effectively protect revenues in addition to providing greater business intelligence. Electronic trading today is far more complex since the introduction of electronic communication networks (ECNs), with trades often broken up into many parts across multiple venues, continues Mele. Manually calculating rates, rebates, and other fees is time consuming and cumbersome. If done in a vacuum, this processing work is siloed from other key metrics, such as the profitability of a particular client, venue or trader. To compete in today s global market, FX brokers should consider outsourcing many of the horizontal functions associated with fees, commissions, and payouts to free up time to work on proprietary strategies and other competitive differentiators. Mele continues that this renewed focus on operations is not unique to FX brokers. According to a recent report from the TABB Group, any firm that does not have a robust, globally integrated set of controls over execution costs, commission management, and compensation is at risk of losing clients and seeing deterioration in the return on its buy side relationships. The research continues, that any firm that still conducts such client analysis manually, or on ad hoc basis, cannot compete against those who are turning client analytics into a science (Reinventing the Relationship: Institutional Brokerage Profitability, by Adam Sussman and Cheyenne Morgan, The TABB Group, September 2010). Play catch up Erika Cohen, business intelligence specialist at Boston Technologies, says brokerages are looking for ways to catch up. She states: The FX market space has evolved into complex online trading systems with traders becoming more savvy and educated on ways to increase profitability, whether it be with advanced trading strategies or educational tools and programmes to guide them. With these increased trading abilities, brokerages are looking for ways to increase efficiency and reduce their risk exposure. The optimal solution is to purchase a fully built, functioning vehicle that comes equipped with a full range of accessories and functions, continues Cohen. Just like a car, a comprehensive business operation has many moving parts that need to work and react cooperatively. FX brokers should consider outsourcing their back office operations for many of the same reasons they outsource their technology of their trading systems and platforms: cost of development; maintenance; experience; skill; and sharing the cost with other users. Sam Mele To compete in today s global market, FX brokers should consider outsourcing many of the horizontal functions associated with fees, commissions, and payouts to free up time to work on proprietary strategies and other competitive differentiators. Cohen adds that by outsourcing back office functions, efficiencies achieved include: administering day to day operations; reconciliation of data; organisation of data from multiple platforms; and risk management solutions. Alexander Ryvin, CIO at Finatek, remarks: Running an efficient back office is, ultimately, all about effective information management. How an FX broker stores, retrieves, collates, disseminates, analyses and controls the data is an absolute key to whether it is operationally efficient or not. If this is not an FX broker s core competency, then most likely the broker is willing to benefit from the capability of a partner in this sector to deal with these matters instead of investing its own time and efforts, observed Ryvin. Small and medium sized FX brokers, compared to the big ones, have clearly defined core competencies, Ryvin continues. Thus for these companies it often makes sense to outsource their non-core areas to the reputable provider specialising in that area, and to 138 january 2011 e-forex january 2011 e-forex 139

2 that allows a client-facing brokerage to focus on its strengths, which are traditionally sales and marketing. Why outsource? Cohen states that exponential growth can be obtained by focusing on what one knows best. Outsourcing back office operations to a company that understands the technological complexity of the market, is experienced with managing large volumes of data, can create a dynamic system, and assists the brokerage to apply strategic and analytical performance tools, will increase the confidence that the brokerage is skillful and not just lucky, and will prove to be more profitable and longer standing than its competitors. Erika Cohen Applying outsourced analytical procedures, such as viewing trends, categorising client trading activity on a trade by trade basis, and being able to create forecasts from existing data, will facilitate a more efficient business operation. redeploy resources to focus on sales and customer service in order to maintain and grow their business. Basically, we believe a broker should outsource those processes that do not give it differentiation in the market, but concentrate on the services related to growth in its FX trading business and services that a broker must provide due to regulatory requirements. While Stephen Leahy, president of Capital Market Access Partners, a distribution partner for onezero Financial s technology and services, states: The pros of outsourcing much of the traditional broker activities, from risk management, to account opening processing, to technology support, have finally begun to outweigh the cons of outsourcing. Forex brokers face increasing regulation in multiple jurisdictions, and a generalist technology support company cannot be expected to keep up with the continuing change, adds Leahy. But the firms dedicated solely to FX can reliably handle much of the specialised technology and operational support By outsourcing, brokerages can benefit from already existing procedures, says Cohen. A brokerage can apply existing procedures developed for other customers to manage risk, compliance and trading activities or procedures developed by the outsourcing company. Applying outsourced analytical procedures, such as viewing trends, categorising client trading activity on a trade by trade basis, and being able to create forecasts from existing data, will facilitate a more efficient business operation. Mele adds: For any broker dealer, access to detailed trade data provides a level of granular information that can assist both internal and external compliance requirements. Whether it s on demand access to the trades or configurable reports that indicate trade exceptions, firms that choose an experienced solution provider to manage post trade data can improve workflow, position themselves to respond quickly, and gain strategic insight across the business. Today, many broker dealers lose time and valuable resources to the manual process of searching through paper tickets, he continues. With a SaaS solution such as those provided by Firm58 and others, these same companies can meet their internal compliance needs while lowering processing costs. While Ryvin points out: Another significant advantage of outsourcing is that it is based on an oper ational expense model, rather than a capital expense one. As financial institutions continue to focus on cost, outsourcing provides a very pre dictable cost basis. Strategic insight On how the strategic insight provided by a new generation of analysis tools can help FX brokerages 140 january 2011 e-forex

3 to optimise their revenue streams, improve cost management and deliver long term profitability, Mele comments that many firms look at hosted solutions to achieve time savings, but he says they fail to understand that the new generation of outsourced solutions can be utilised strategically, to gauge the true value of client relationships via the management of fees, commissions, and payouts. He explains: Relying on trade volumes and average prices to calculate client profitability is a recipe for failure. Most brokers have no means of determining profitability and measuring costs precisely using existing in-house methods and systems. For example, understanding profitability at the trade, client, venue, and group level can influence where to direct order flow. The transparency that comes from an aggregated view of trade data allows sales teams to fill and execute orders faster. Also, the ability to support cost-plus billing and other specialised pricing schemes can help a broker enter new markets and take on new market making and HFT clients. While Cohen adds: It can often be quite complicated to determine how much revenue a brokerage is making when one considers the variables associated with this, such as rebates to IBs, rollover, accounts with various markups, and accounting for customers whose business is generated purely on a volume or commission structure, as opposed to the spread. A better knowledge of where revenue is generated from and what areas are most profitable will optimise revenue streams, In addition she says, A better knowledge of costs and where the costs are being generated, and why, will improve cost management. By creating stability within the revenue models and cost structure, you will help deliver long term profitability. With the use of these new generations of analytical tools, one can now have better control over their revenue and cost models to strategically increase profit margins. In addition, brokerages can detect patterns which allow them to take advantage and focus company growth in the right direction. Competitive advantages As to what ways adopting an outsourcing model coupled with business analytical solutions may provide competitive advantages for FX brokers, Ryvin says that advances in technology have aided the decision to choose between the two outsourcing options: buy-in packages; or the SaaS model. Alexander Ryvin we believe a broker should outsource those processes that do not give it differentiation in the market, but concentrate on the services related to growth in its FX trading business and services that a broker must provide due to regulatory requirements. When the most established FX brokers built their trading platforms inhouse, there were very few packaged solutions available, and the SaaS model in FX did not then exist, explains Ryvin. This lack of choice, combined with standard practices at financial institutions, made building inhouse the most appropriate choice. Today, there is a much wider choice in terms of technology solutions and providers, including packaged solutions with optional customizations, and the completely outsourced SaaS model that enables financial institutions to subscribe to a trading solution without purchasing it. Ryvin notes: Where a perceived competitive advantage exists, big firms will continue to develop solutions inhouse, and the largest FX brokers generally remain committed to the inhouse build concept. They see some areas such as pricing, algorithmic trading and risk management as real differentiators and have focused their research and development capacities into these fields, because they believe that these components are not offered or well served by existing solutions. 142 january 2011 e-forex

4 Medium sized brokers are more likely to buy in packages and customise any additional aspects they require, while smaller FX players are generally looking to adopt the SaaS model, he adds. The move towards an outsourced model is being led by smaller FX brokers and new entrants into the FX markets, continues Ryvin. He says they are willing to sign up for a service and take a pay as you go approach to technology. By outsourcing, these companies can come to the market more quickly than those that build inhouse or those that buy in a package with customisations. Technology has changed sufficiently for firms to consider outsourcing and it usually involves a two-step approach. Firms will start out with a SaaS approach where the software provider manages the solution and runs it. This is a well established approach and has been very successful, says Ryvin. The next step is managed services, where company runs the software inhouse, but a software provider manages it. This option The pros of outsourcing much of the traditional broker activities, from risk management, to account opening processing, to technology support, have finally begun to outweigh the cons of outsourcing. is becoming more popular, because the financial institution can step in quickly and take over at any time it feels like it. This has given FX brokers much more comfort about the level of control they have over processes and services. The build versus buy versus outsourcing model will always be different for every financial institution, adds Ryvin. He states: Cost can drive these decisions, but not always. Sometimes a financial institution finds it difficult to hire and retain qualified IT staff, and in other cases it may want to come to market in the shortest time period possible. By utilising any of the outsourcing options, companies can be up and running in almost no time to offer efx trading services to their clients. Stephen Leahy Handling Risk Leahy remarks: Risk and trading are the two aspects of FX brokerage that most easily give way to outsourced specialist firms. Trading platforms are notoriously tough to implement, maintain and integrate from a technology side. Specialist outsourcing firms have developed their business by focusing on handling these roles. Rather than hire a staff of specialists to maintain a trading platform, FX brokers can outsource their technology needs and pay for just the amount they need. 144 january 2011 e-forex

5 As for risk management, he comments, Capital Markets Access Partners was created on the premise that for the owners of an FX brokerage, their return on investment is higher by passing through most of their risk, rather than handling it entirely in-house. While the returns to an FX brokerage may be higher by handling all risk internally, in the long run there will be significant swings in P&L over any period of time. An FX brokerage using this internal risk model must have more capital on hand to handle the risk, and may have to operate for months at a time without positive revenues when all risk is handled in-house, additionally, a fulltime 24/6 staff of qualified dealers is expensive to operate. So the higher potential reward of handling all risk internally is offset by the volatility of the returns. He says a better business model for FX brokers is to pass risk over to firms who specialise in risk management and to generate transactional revenues with each client order executed. While the top line revenues may not match the potential for internally-managed risk, there is less expense, less capital needed, and revenues are directly tied to expenses in a pass-through model, Leahy notes. He says: For the FX brokerage owner, the return on investment is higher with a pass through model. Leahy states: Our experience in the industry is that FX brokerage firms are best at sales and marketing operations. Adding the technology and risk management functions to this core is how you add risk to a brokerage s operations. If a firm can focus on its strengths and outsource the functions where it does not have a core competency, the brokerage will grow. Concluding, Leahy remarks: It really is a decision for the owners and senior managers of a firm; keep all functions in-house and assume the financial and operational risks to achieve potentially higher rewards, or outsource where you can and focus on growing the entity from a market share perspective. AD