Legacy Systems Challenge Asset Managers
As Clients Push for High-Return Strategies

Originally published November 14, 2005

NEW YORK — The key to solving asset management firms’ trading needs of tomorrow appears to lie in getting those needs solved outside the firm by removing in-house systems surrounding but not including the trading itself, and turning more often to outside solutions.

“We see some movement toward application service providers [ASPs] in the trading technology but certainly not the trading function per se,” says Gavin Little-Gill, Research Area Director, Investment Management and Retail Brokerage & Investing, at TowerGroup. “Certainly, [firms are] using systems that are doing more for them around the trading function itself, like FIX networks and others.”

A study naming the top 10 business drivers, strategic responses and technology priorities for 2006 by TowerGroup puts legacy-system replacement at the top of the list. Other industry observers and participants see outsourcing increasing as firms consider it their preferred response to the technology demands of new trading needs. “We’re now seeing legacy applications that really haven’t been touched for seven or eight years, extended beyond their shelf life,” says Little-Gill, author of the study. “At the same time, there is a lot happening on the vendor front with them replacing their own architectures and upgrading, as well as the merger and acquisition activity.”

Little-Gill cites recent deals, such as the acquisition of FMC, Inc. by SS&C and ITG Inc.’s acquisition of Macgregor, the order management system provider, along with product changes like Advent Software’s launch of APX, an integrated asset menagement solution, and Thomson Financial’s plans to upgrade its Portia system. These advances compound the issue for investment firms that haven’t changed their legacy systems, he explains. “If they need to convert, with Portia, Advent or [SunGard’s] InvestOne being changed, they have to get out a request for proposal and look at an entirely new application,” says Little-Gill.

The replacement of legacy systems by firms varies widely, according to Jonathan Cohn, Senior Managing Consultant at Mercer Oliver Wyman. “It seems to go on a seesaw between companies taking the plunge to spend $20 million to replace one, and the other extreme where a firm will never spend that, and will just keep using the legacy system,” he says. “We see clients maintain the core business rules and logic embedded in these systems, which typically is very difficult and expensive to rewrite. But we see them wrapping them in more industry standards for compliance.”

The asset managers are more frequently turning to “work-arounds” or “skunkworks,” as Little-Gill calls them, to fulfill their technology needs. “They’re not replacing a portfolio accounting system as a skunkworks,” he says. “[Skunkworks are used to] get certain things done, whether building connectivity back to a trading application, building post-trade functionality or an access database for client reporting. Rather than stopping to put together a business proposal and a budget, and getting sponsors and sign-off on it — which takes weeks or months — a lot happens under the radar. People say that is not worth it, so let’s do the right thing and get it done. The capital investment is relatively minor.

“There are times when it’s easier to ask forgiveness than permission,” he adds. “That’s what this falls under. Everything that ends up in a project plan just slows the process.”

Similarly, a one-to-many outsourced solution can be a more efficient way to process trading functions, explains Joseph Anastasio, Partner and Executive Vice President at Capco. “Outsourcing everything you can, whether you’re a traditional asset manager or have a hedge fund mix, to take advantage of the big-scale players’ leverage — realizing that no one can be as cost effective as a firm that is a major concentrator — will be far cheaper than doing it for yourself. It’s not just about people, but also about maintaining fewer systems, and being able to take advantage of [a new system] being a one-to-many solution, where many people are paying for it, but it’s not being repeated over and over again.”

The operations support requirements of asset management firms, too, are transforming. The drivers are performance pressures and a need to show their clients that they are generating creative ideas to deliver return on assets, utilizing multiple instruments and advanced strategies. This transformation makes these firms more like hedge funds, according to Anastasio.

“Asset management firms’ support requirements [as a consequence of that transformation] are vastly different from the traditional custodian asset-servicing model,” he says. “In this new world, managing liquidity, the status of investments, optimization of the portfolio and the hedging strategies all have similar characteristics and behavior to traditional hedge funds. The question is whether the custodians that provide one-on-one asset management services are prepared to do that.

“There have been transactions that would have been unheard of five years ago, where major firms with hundreds of thousands of transactions a day have given up exchange operations and gone to a third party to handle execution and order flow,” adds Anastasio. “There are no boundaries anymore on where economic sense drives change. As long as they can preserve the client intimacy and value proposition, who does the commodity stuff is not that important.”

Some asset managers may simply rely on sell-side firms for technology, according to Robert Gasser, Chief Executive Officer, NYFIX Millennium LLC. “Buy-side order management systems (OMS) are not heavy-duty in their bandwidth and trade-order blotters,” he says. “For an institution that sends out one stock at a time that is then sent out to the counterparties who send back executions, this is probably bunched so they get one average price and one large trade. In the future, they’re more likely to trade baskets with multiple real-time executions coming back from electronic direct market access providers. This taxes system capacity for a lot of well-known OMSs.”

If asset management firms absolutely have to do things in-house, they turn to algorithmic trading or direct market access solutions, according to Cohn of Mercer Oliver Wyman. Algorithmic trading is accessed through OMS tools, as well, and about 60 to 70 percent of firms get that capability in this way, according to Cohn, although only about 5 percent are the traditional, larger firms.

Decreasing average trade size is driving the increased use of algorithmic trading, Cohn notes. “This complicates the middle and back office functions, and the allocation function,” he says. “They get better every year at being more efficient. The systems they spec out to handle certain order flow, even though the trading sizes have decreased and the volume is up, build in these needs.”

Asset management firms are also finding that mobility is a trading need, meaning that traders need to be able to access liquidity pools remotely, without being right in their offices or at their desks, according to Michael Speranza, Vice President of Product Management at IPC Information Systems LLC, a financial communications solutions provider. “More and more what drives efficiency is the ability for any employee to access their liquidity pools from wherever that person is in the world,” he says. “We cater to that with IP [Internet protocol] and enterprise solutions, that allow global decisions to support functionalities, so the solutions interoperate and firms can get rid of the old legacy equipment, and support this type of mobility no matter what situation arises. The firms are looking for cost efficiencies wherever they can get them. So the costs start to go down to support things like moves, adds and changes; the costs go down to support mobility and flexibility goes up.”

Risk management has emerged recently as another major trading need, according to Daniel Abitbol, Business Development Director at Sophis, a provider of portfolio and risk management solutions. “There’s big pressure from both investors and regulators to get very clear figures on the global risk, to make a financial play safer,” says Abitbol.

With 90 percent of orders going to the market electronically, Abitbol estimates, data collection becomes another greatly important need. “The accuracy of the data affects everything,” he says. “Without correct data, it’s like buying a Ferrari, but not having the good petrol; it will go nowhere. What you put in the engine is by far the most important. When we were trading equity and bonds, data collection was very simple — you just opened [the newspaper stock tables], you had the name of the stock, the dividend, date of payment of the dividend and the rest. It was simple to find. Now we want historical volatility for the yield curve on different markets, dividends for cash and the ability to select from different sources, sometimes for the same product."

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