Northern Trust to Add Options and Derivatives Outsourced Trading Capabilities

Northern Trust plans to add outsourcing capabilities for European listed options and derivatives by the fourth quarter of this year. 

Plans for the rollout are currently underway, according to Gary Paulin, global head of integrated trading solutions in Northern Trust’s institutional brokerage business. 

“Our strategy is that we need to be able to be everything and everywhere. So we needed to address how we can facilitate at least the requirement for a number of our firms, and to outsource the dealing function for some of the derivative instruments. And so that led us to looking into what we could and couldn’t do,” he tells WatersTechnology.

The service will first be offered through the receive and transmit order (RTO) model. Northern Trust is considering trading the instruments under its own name at a later stage. 

“What we’ll do in the first instance is offer an RTO model. So we’ll be able to do [European listed options and derivatives], but we will receive and transmit those orders as opposed to trading them in our own name,” he says.

Paulin says the firm is weighing the costs and benefits of facilitating trading under its name, and the things it will need to consider, such as clearing mechanisms, and other issues like balance sheet risk, and so on.  

“For now, it’s simply to be able to facilitate our clients’ order instructions so they can keep a centralized book and outsource the dealer function,” he says. 

On behalf of clients, Northern Trust will deal with the clearinghouses and prime brokers with which clients have existing agreements.

“The trading and settlement will occur between those two entities. We sit in the middle and just pass the order through,” he says. 

However, outsourcing the dealing function is not suitable for all funds. One example is a macro hedge fund, Paulin says, as the dealer provides insights and value to the fund’s investment decision process. “So, it’s only for those clients that are perhaps in a predominantly plain vanilla equity or fixed income, but they might have some overlay strategies, or they might from time to time have a large re-balancing that they need to put on a future just to hedge it momentarily,” he says.

It will make more sense at firms where the dealing function is more peripheral rather than a core focus. “Because it’s peripheral, hiring a specialist dealer or a dealer just to focus on that one activity, for many it might seem a little bit of overkill. So if they’re already considering outsourcing their equity dealing function, then it would make sense to outsource the derivatives component as well. So it frees up some resources from that end, and maybe from a system’s capacity,” he says.  

Northern Trust will soon add a subject-matter expert (SME) to lead this initiative. This person recently accepted the offer and will start in August or September. Paulin says the SME will be in charge of firstly implementing the process and ensuring it works. Northern Trust already has a project team putting the process together. Once the SME joins, the process will go through an internal risk review.

“The person will help define the workflows, the processes around that and ensure that we’ve mitigated all risks, and everyone knows their roles and what needs to be done. And then we will start looking at the client side. We already have two or three clients that would like this functionality added on to their current book of business,” he adds. 

In terms of geographical expansion, Pete Cherecwich, president of asset servicing at Northern Trust, who spoke on the Waters Wavelength podcast, said the firm will continue ramping up its presence in the Asia-Pacific region. 

In the past two years, he said Northern Trust has added brokerage, treasury, securities lending, and transition management capabilities in Australia. It is considering opening up another trading desk in the region. 

Paulin says Northern Trust already has a trading desk in Sydney, Australia, but the aim is to have a dual trading desk running in real time in the region. 

The firm already has people on the ground in Singapore, so this could be a sensible place to locate the new trading desk, he says. 

“The only thing we need to do between now and then is settle on which entity we will set up and where, be it a Singapore-based entity or Australian entity. And we’re just getting counsel to advise on what they believe is the best approach forward. But we’re pretty close to settling on that. Once that’s settled then, we will look to roll that out,” he says.

Once set up, the new desk will replicate the instrument coverage that its Sydney trading desk has.

Before the coronavirus pandemic, the plan was to have the trading desk set up and running in the fourth quarter of this year. Now it is more likely to happen in the first quarter of 2021.