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Cost to Trade: Hey, Banks, Itís Time to Face the Music

Why is calculating the cost to trade so difficult for banks? The answer is as complex as the calculations themselves.

Increased capital requirements, continued regulatory pressure, and competition from new market entrants are sounding a bugle call for banks to truly understand their cost to trade.

As of late, major business decisions for banks are based on cost to trade calculations, so banks need to get it right. However, stitching together the complex components needed to construct a complete view of trade costs remains a considerable challenge for most banks. Net-net, banks need to make some difficult decisions as to which products, and even which customers, are returning to the bottom line, and which need to be removed from portfolios.

Calculating the cost to trade: Enough to make the head spin
Why is calculating the cost to trade so difficult for banks? The answer is as complex as the calculations themselves. The first hurdle for trading entities starts with intricate capital charges for products, based on whether they are exchange or bilaterally traded. Middle- and back-office costs account for most of the cost to trade, with breakdowns being roughly 15% for middle, 50% for back, and 35% for IT, which can add up to more than $500 million for large trading service providers. Transaction costs can range from as little as $.10 for cash equities to $3,000 for custom derivatives. Add to this the intricate brokerage, clearing, and exchange fees, and you've got a lot of moving parts to consider. The variables for costs are vast, which makes cost capture highly unpredictable.

Knowing the cost to trade can add up to big money, real soon
Informed trade costs can arm banks with the ammunition they need to renegotiate service provider fees, which in some cases can save banks more than $100 million. Key operational functions of trade reporting are critical for banks, but many of these activities are duplicative across banks. Reported savings of between 15% and 20% from outsourcing key IT functions are making big banks sit up and take notice. To turn a profit, remain compliant, and satisfy customer demands, banks must have a tight handle on complex trade costs to conduct business in the New Normal.

Knowledge is power. Now what?
Once banks understand their cost to trade and have sound reporting processes in place, they can begin to influence and reduce costs. Trading strategies to reduce capital charges will be integral and will require front-office, real-time trade cost calculations. Outsourcing large-scale IT programs and utilizing emerging financial services utilities can create substantial savings for banks. The use of shared services utilities in areas such as onboarding, KYC, and settlements can lead to solutions that impact the way business process services are delivered and can change how the financial services industry manages core business functions in the future.

David Oxenstierna is currently a Partner in the Capital Markets group at Capco, a global business and technology consultancy dedicated solely to financial services. He has 15 years of experience in capital markets operations across asset classes and markets including the US, ... View Full Bio
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IvySchmerken
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IvySchmerken,
User Rank: Author
10/23/2014 | 4:56:37 PM
Re: opaque
I totally agree with you. Transaction reports shouldn't be so complex, but they've become this way because of the fragmentation and order routing of small orders to so many dark pools and exchanges. Deciphering these transaction reports could be a full time job for the buy side. Some brokers are helping their clients interpret the data. Some may want to hire an expensive consultant to do the work for them, because it's an independent firm verifying the trading costs.
NJ_trader
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NJ_trader,
User Rank: Moderator
10/23/2014 | 4:46:55 PM
Re: opaque
Why should we be required to hire consultants to figure out the complex reports? brokers should make the reporting easier to understand. it's ridiculous that sophisticated financial experts need to hire consultants to read transaction cost reports because the brokers make the reporting so complex. of course, brokers have a vested interest in keeping the reporting complex. if no one understands the reporting, they can't hold the brokers accountable. 
IvySchmerken
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IvySchmerken,
User Rank: Author
10/23/2014 | 4:38:56 PM
Re: opaque
Yet, the buy side is responsible for understanding the cost of trade since these costs come out of the investor client's assets.  Because it's become so complex, I think many buy side will hire research consulants to figure it out for them.
NJ_trader
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NJ_trader,
User Rank: Moderator
10/23/2014 | 4:26:13 PM
opaque
finding the true trading cost for most trades is extremely difficult in today's fragmented markets and the way brokers provide the trade information to the buy side is hard to decipher. It is getting better, but following the trail of an order as it bounces around the many trading venues will make your head spin!
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