Fund managers try to provide their institutional clients with best execution, but are falling short of the mark in one key area- back office settlement fees.

Thanks to a technology company and broker-dealer called ESP Technologies, they don’t have to.

Here’s a glimpse of the status quo: Fund managers invest in plenty of high-fangled algorithmic, direct market access and other expensive front-office technologies to ensure trades are sent to the right venue quickly and inexpensively. Or, they send it to a broker-dealer who’ll do the same.

While such a strategy may result in lower implicit costs, it does generate more trades and ticket charges. That means that if a large block trade is broken up into multiple smaller trades placed with different brokers, algorithms, or dark pools — there will be more tickets – which means more individual trades for the custodian banks of the fund manager to settle.

While the fund manager doesn’t pay the custodian bank for each trade settled, the ultimate end investor, such as an pension plan does. Some custodial banks break out the charge per transaction while others incorporate the fee into overall custody charges. On average, that fee can come to anywhere from $5 per trade settled to as much as $15 per trade, two custody bank operations executives told Securities Technology Monitor. Mutual funds typically have omnibus accounts with their custodian banks so they don’t pay ticket charges.


So each time a manager for a pension plan or other institutional fund executes a block order for say 5,000 shares of IBM it could easily end up costing the pension plan or mutual fund anywhere from $25 to $75 in settlement fees if the trade were broken up for execution into five pieces at five different trading venues.

Those settlement fees can add up to hundreds if not thousands of dollars each month for each institutional customer and those fees deducted from the value of the assets in turn can eat into the overall performance of the fund manager from the customer's perspective. That translates into a very unhappy pension plan or mutual fund client.

ESP Technologies says it has found a way to help fund managers reduce settlement fees for their end institutional clients. The firm, launched in 1999, has developed the technology to consolidate multiple trade tickets into a single ticket and custodial delivery per account, no matter how many different execution venues are used by the fund manager. So instead of the pension plan or mutual fund paying for five tickets to settle its fund manager’s purchase of say 5,000 shares of IBM it is paying for only one.

“The goal is to combine best execution on the front end with best settlement practices and processing on the back-end,” says Scott Kurland, director of product development for ESP, which acts as an introducing broker-dealer for trades that its Clearvoyance platform aggregates. “Money managers should include clearance and settlement costs as an important factor in their best execution analysis, ir order to accurately perform Total Cost Analysis.”

A $5 billion investment manager with 30% of its orders fragmented and 600 daily allocations generating a ticket charge of $15 each could save $675,000, or 1.35 basis points, a year, by ESP’s estimates. That is if the investment manager uses ESP for all of 600 allocations. It doesn’t have to.

The fund manager is free to use ESP for only a part of its trade allocations, depending on which execution venues and which accounts are most impacted by custodial ticket fees and order fragmentation.

"With ESP's Clearvoyance platform, fund managers have the ability to enable or disable ticket aggregation for specific accounts, brokers, and market centers in order to maximize the benefits and cost reduction where it counts the most." says Kurland.

Here is how ESP’s Clearvoyance platform works: The buy-side trader routes an order through an order management system or execution management system, or phones it in to a broker or series of brokers just as it does today. Each broker then executes its portion of the order- it can execute the order as a block trade or can cut it down into multiple trades in multiple venues.

Once each broker placement has been completed and executed the fund manager will allocate the trade – aka divide it up—among all the institutional accounts that are due to participate in the fund manager's investment decision. This process typically results in the fund manager's order management system (OMS) generating multiple allocations to the same set of institutional accounts, in the same stock.

Once all of the broker trades have been allocated in the OMS, the fund manager will then typically send each broker the specific allocation instructions either via fax, the FIX message protocol file or through a platform operated by Omgeo called Oasys.

This is where ESP’s Clearvoyance system comes in. After being installed between the fund manager’s OMS and its allocation system, Clearvoyance intercepts the allocation instructions that come out of the OMS, aggregates the allocations for accounts, brokers, and market centers that have been enabled by the fund manager, and then appropriately instructs each broker to deliver the eligible shares to ESP and its designated clearing firm and also instructs ESP where to have its clearing firm deliver the aggregated allocations, using the fund manager's existing allocation methods and systems.

Clearvoyance does not interfere with the fund manager's existing trading or OMS allocation processes. In other words, it operates as a complete post-trade process, and is seamless to the trader.

In addition to saving institutional funds money from a reduced number of tickets, broker dealers also benefit from lower settlement costs as well. That is because broker-dealers can reduce the number of allocations they must pay their clearing firm or internal clearing division to deliver and settle to the fund manager’s institutional customer accounts.

“In most instances it is cheaper for a broker-dealer to flip one block trade to ESP’s clearing partner than it is to send out dozens of delivery-versus payment allocations to various custodian banks,” says Kurland, who declined to disclose the names of ESP’s clearing partners.

Fewer settlement instructions also mean fewer potential failed transactions, cancellations and corrections and new account set-up costs. Such efficiencies to the broker-dealer, says Keith Jamaitis, chief operating officer at ESP, justify the executing broker-dealer paying ESP a “nominal” clearing fee for handling the allocations and client deliveries.

ESP is typically paid this clearing fee out of commission sharing agreements it has in place with its participating broker-dealers. The fund manager’s commission rate typically does not change. It's just that some fund managers may elect to pay ESP’s clearing fee out of commission sharing agreements.

Jamaitis declined to specify ESP’s clearing fee saying it varies from broker to broker. It typically declines with share volume, number of allocations, and the average allocation size ESP handles for each fund manager and broker dealer, he says.

So far, about thirty U.S. fund managers have signed up to use ESP with about forty participating broker-dealers. Most of the allocations ESP processes each month are in U.S. equities where trade fragmentation among fund managers is the greatest, followed by U.K. and Euronext. Among the thirty fund managers are Nuveen and RS Investments.

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