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October 4, 2007

Back-Office Expenses Mount

Report Says Buyside & Clients Face Increased Clearing Charges

By Gregory Bresiger

Electronic trading has been a two-edged sword for institutional investors. Sure, they've benefited greatly from cheaper commission bills, but the accompanying multitude of transactions has caused a spike in their back-office expenses, according to a recent TABB Group report. Pension funds have found that these efficiency-increasing trading tools

produce commission savings that can get eaten up by higher clearing costs, the report says. These costs are footed by pension funds and can chip away at returns.

The root of the problem is the fragmentation of the market into multiple exchanges, ECNs, dark pools and other alternative trading venues. An active asset manager may have to deal with many brokers and venues each day. This creates multiple deal tickets, each of which adds to the costs of trading for the clients of institutional money managers.

The report, entitled, "Buyside Clearing: Driving Efficiency Through Aggregation," says asset managers have a heightened awareness of these costs, and are growing "more concerned" about them.

More Processing

The algorithmic slicing of large orders executing in multiple venues-each venue representing a ticket-has led to an explosion in the number of trades money managers and custodians process. As a fiduciary, money managers are responsible to get their clients best execution, and the best prices are scattered around a fragmented marketplace.

The report estimates that the number of custodial tickets generated by big asset management firms has increased 60 percent over the past five years, due to multi-venue trading. And that has led to total settlement and clearing costs rising by about 40 percent in the same period, the report says.

Robert Iati, a TABB Group partner and author of the report, says the average cost for trade processing five years ago for the largest asset managers has increased by about $50 million a year. Now they are spending over $170 million per year on trade processing costs alone, Iati says.

"The explosion in tickets has been a particularly odious problem for individually managed accounts," says Richard Holway, chief executive of Firefly Capital, a technology firm that offers an execution management system. Holway points out that the rise of electronic trading caught many pension funds off guard: They didn't expect the huge rise in the number of tickets their accounts began generating-and the costs. Consequently, the pension funds went to buyside management to complain about the rise in custodial ticket charges, and the issue eventually found its way into the lap of the firm's buyside trader.

One trading professional says that only recently have traders scrutinized this issue. "Frankly, the problem has been that the average trader really hasn't cared about clearing costs…it wasn't our responsibility," says the trading executive, who declined to be quoted by name. The problem resulted because the back office hasn't kept pace with the advances that trading desks have undergone.

If a solution isn't found, excessive clearing costs will eventually alienate clients, the report predicts. The report also argues that, despite the technological advances of the trading desk, for years the back office has been a neglected part of the asset management firm.