Banks can outsource bond trading activities

Electronic market makers like Citadel Securities and Jane Street Group are expanding their market share in competition with rival investment banks. But to really get ahead, they need a boost, and it would be surprising if these banks could help them achieve their market share expansion goals.

HSBC is considering hiring a non-bank market maker to handle some of its bond trading. Illustrative photo

HSBC Holdings has been in discussions about outsourcing some of its bond trading to a non-bank market maker. If such a deal goes through, it would be a major win not only for the firm that wins the contract but also for the outsourcing concept, which has attracted interest from European bankers. But there is still a long way to go before the model can be proven effective, and there is also the possibility that the risk may outweigh the reward.

Advantages of trading technology

Trading stocks, bonds and currencies is increasingly done electronically, with smaller profit margins, making handling larger volumes of trades using advanced technology a surefire way to make a profit.

Banks with the largest financial markets operations, such as Goldman Sachs and JPMorgan Chase & Co, invest billions of dollars in technology each year. Less profitable banks, especially in Europe, struggle to keep up. That’s a gap that electronic market makers like billionaire Ken Griffin’s Citadel Securities are looking to fill after announcing plans to offer trading services to banks last year.

HSBC is not alone. Many banks are looking at outsourcing their trading operations, according to Christian Schmid, a senior partner at Boston Consulting Group. “ In theory, this would be best suited to smaller banks, but in practice some of the largest banks are showing a stronger interest,” said Schmid.

Bond trading is better suited for outsourcing

Bond trading is better suited to an outsourced model because much of this activity in Europe has been digitized and takes place off-exchange, requiring banks to maintain advanced technology systems.

European equity trading, by contrast, is not part of this trend because it largely takes place on exchanges or within banks’ internal platforms. In addition, electronic market makers are prohibited from paying fees for order flow, which is what drives their business in the US.

Eliminate unprofitable segments

Under the leadership of new CEO Georges Elhedery, HSBC is looking to cut costs and exit areas where it has no competitive advantage or where profits are too low. HSBC focuses more on corporate clients than financial institutions, so it makes sense that Georges Elhedery would consider reducing investment in electronic trading.

Even with reduced investment needs, however, HSBC may not be able to save much on operating costs. Banks are keen to outsource their lowest-margin transactions, such as government bond trading, while retaining higher-margin trading, such as illiquid corporate bonds. However, both operations share the same technology systems and administrative staff.

“ Banks are thinking about outsourcing the least profitable areas, like government bonds, but they haven’t done a thorough analysis of how much cost they can actually cut in the rest of their trading systems ,” said Christian Schmid, senior partner at Boston Consulting Group. “ If they do it piecemeal, they could be stuck with IT and operational costs that they can’t eliminate .”

Additionally, if banks have large hedge funds as clients, they may face another problem: Why should these funds trade through the bank when the bank itself wants to outsource the work to an electronic market maker? HSBC and other banks focused on corporate clients may be less concerned about this, but the risk remains.

Competition between banks and market makers

Nonbank market makers are still thriving. Citadel Securities’ trading revenue last year surpassed that of Barclays and Deutsche Bank, according to Bloomberg. But the biggest investment banks are fending off competition by offering more back-office services and expanding into more complex, higher-margin trades.

Large-scale outsourcing deals like the one HSBC is considering could be a game changer for fintech companies. But getting from idea to reality is a challenging process.

Bond trading is better suited to an outsourced model because much of this activity in Europe has been digitized and takes place off-exchange, requiring banks to maintain advanced technology systems.

Minh Hien

According to AFR

Source: https://congthuong.vn/ngan-hang-co-the-thue-ngoai-hoat-dong-giao-dich-trai-phieu-380285.html