Mergers and acquisitions between asset management firms are at a historical high, driven by margin compression, the ascendance of passive management, and growing regulatory compliance costs. A thorny FX management challenge facing asset management firms is the need to rationalize disparate workflows and approaches when firms acquire or merge with other asset managers. For many newly combined entities, rationalizing FX management across the entire firm can be particularly painful. Pain points arise from a number of areas: systems capabilities, business workflows, asset classes, regions, and execution venue and broker-dealer relationships. Each challenge needs to be addressed differently, but if the full benefits of the combined firm are to be realized, the solutions will require technical capabilities within the Order Management System (OMS), as well as choices on the business side. In the first of two articles, we’ll consider the challenges related to order generation.
Systems challenges usually present themselves in one of two ways: either in capability shortfalls, or in over-customization scenarios. One common situation is that neither of the trading systems used by the companies engaged in a merger satisfies all the needs of the combined entity. This could be because the instruments are modeled in the database differently, or because one of the managers has built a bespoke system that relies on technology that can’t be easily replicated in the other system. Extensive customization can also lock clients into versions that are no longer supported. Clients that find themselves in this position often come to the realization that the solution is not solely a technical one. Certainly, the OMS needs to support all of the industry standard FX instruments, market data and order generation and management requirements; but additionally, often it’s the business aspects that need addressing. That leads to the second area of concern: business workflows.
Business workflows are perhaps the most difficult problem to tackle. At some asset managers, the FX component of the trade may be “baked in” to the firm’s investment process. In these cases, rationalizing workflows for spot order generation and hedge creation can be difficult, as firms can end up in an environment where some FX orders need to be tied to specific trades, while others represent cash balancing across multiple funds. This gets trickier when regulatory aspects are considered.
“Driven by margin compression, the ascendance of passive management, and growing regulatory compliance costs, mergers and acquisitions between asset management firms are at a historical high. A key challenge for asset managers in the process of merging with or acquiring another firm is the rationalization of disparate systems, workflows and approaches to FX management. A modern order management system must be able to handle these complexities.”
Jay Hinton, Charles River Development
Similarly, if a particular firm is structured such that the role responsible for FX order generation is operations AND trading AND portfolio management, there will be inevitable conflicts. Rules-based permissions in the OMS can help with this, but if (when) problems occur with a trade, untangling who is affected can be laborious. There is no easy solution to this problem – ultimately, a firm needs a bit of Occam’s Razor to reduce the order and execution workflows to the absolute minimum required to support the investment activity, taking a thorough look at which ones are actually adding value and which are simply legacy workflows ripe for retirement or reengineering.
This directly ties into the issue of hedging: We see conflict when two firms have different approaches to hedging. In some asset management firms, hedges are placed on a trade-by-trade basis, with the forward amount based on some percentage of the spot trade, depending on the combination of fund, currency pair, strategy and discretion. In others, hedges are set across the entire fund’s exposure. The tenor of the forwards may vary, as may the frequency and approach to rolling those positions. Some managers choose to adjust rolling amounts based on the currency balances in the funds, while others split out hedging activities from cash management. Supporting all of these approaches is possible, but can be costly in maintenance and set up time, as extensive rule sets need to be built. These rule sets add to testing overhead, and when markets change or additional funds are added, systems need to be migrated or upgraded.
These challenges alone are difficult to address comprehensively. They are not, however, the only issues that need attention. In the second article, we will consider issues around order execution.
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