Transition management: spotlight on transparency and reporting

The transition management industry has seen significant shrinkage in recent years, with a number of service providers exiting the business. In some cases, such exits have come about through mergers, while in other cases, a decision may have been taken that transition management has been deemed ancillary to a service provider’s core business. Consequently, the need now exists for many clients to review their transition management panels.

The transition management industry has seen significant shrinkage in recent years, with a number of service providers exiting the business. In some cases, such exits have come about through mergers, while in other cases, a decision may have been taken that transition management has been deemed ancillary to a service provider’s core business. Consequently, the need now exists for many clients to review their transition management panels.

Recent months have also seen increased interest in transition management on the part of regulators. In particular, regulators are keen to ensure that exacting standards of transparency are met when providers conduct a transition management project for their clients.

Against this backdrop, Northern Trust remains fully committed to its transition management business, and to providing our clients with the highest levels of transparency when conducting assignments. In our opinion, the following are some of the foremost areas that should be considered and evaluated when appointing a transition manager.

Fees

The transition manager should disclose details of all remuneration received as a result of the assignment. The client should always demand that their transition manager fully quantifies any remuneration they will earn, in its entirety. If a transition manager appears to be offering a very low commission rate, the possibility exists that additional revenue may be earned elsewhere. For instance, using an affiliate in the course of executing a transition may allow a firm to make extra revenue that is not disclosed to the client.

If the transition manager also acts as the trading broker on their assignment, the client should request confirmation that the transition management fee is the only form of compensation for that business and all of its affiliates.

Clients should also pay close attention to the execution of foreign exchange and hedge transactions and in particular, work with their provider to understand how these transactions will be executed. All fees and execution methodology should be explicitly stated.

When trading with third party brokers the client should always ask if the transition manager or any of its affiliates receive compensation from third parties.

The transition manager’s business model

Clients should understand exactly who is undertaking their assignment—a transition manager can operate from a variety of different business models. A provider may offer a ‘zero commission, no fee’ transition—and then trade with an affiliate entity at a higher rate than a third party broker. Clients should enjoy total transparency around any additional fees paid to the transition manager or its affiliates, including riskless principal trading and internal cross-trades.

Information and reporting throughout the assignment

Clients should be able to clarify with the transition manager all reporting to be received throughout the assignment. Northern Trust’s view is that the following should be considered among the most important areas when choosing a provider:

• Pre-trade: the transition manager should provide a pre-trade report and timeline working on a consultative basis with their client, planning the strategy and timing of the transition.


• Intra-events: an end of day report should be provided at the end of each trading day, together with both actual and projected costs. Intra-event (and intra-day) information should be provided upon request and close coordination and communication between clients and their selected transition manager should take place.


• Post-trade: after completion the transition manager should be expected to report on the restructure. A detailed post-trade analysis should be provided, ensuring that the client fully understands the costs and process undertaken.


• Internal crossing: this refers to instances when transition managers use their access to index funds or other transition client flow to offset buys and sells. The transition manager may be undertaking several assignments at any one time and, in the course of implementing one transition, may decide to delay trading an asset to match with another client that wants to buy it.


• This may create misaligned interest for the transition manager and may result in one or both of the clients receiving a less than optimal trade execution. Such uncompetitive pricing on ‘crossed trades’ can affect performance and the cost of a transition.


• External crossing: this term refers to instances where trading desks execute their orders with alternative venues are defined as ‘external crosses’. These come in a multitude of types. Some will allow only buy-side firms to participate, whereas some may provide rebates to high frequency traders to provide liquidity. It is, therefore, important to know their characteristics, benefits and weaknesses.


• The use of external crosses is a good way to source liquidity and reduce costs, but should only be used as part of the transition strategy, to ensure no market leakage or impact takes place.


• Oversight and governance: oversight and governance expectations for the complete scope of the transition should be made clear at the outset.


• Brokerage allocation: the transition manager should clarify whether it makes use of one or more executing dealers, and be clear about the rationale behind this decision. Ask the question: is your transition manager or any of its affiliates receiving compensation from third parties?


• T-charter: it is important to know if the transition manager uses T-Charter reporting. The T-Charter is the voluntary code of conduct for transition managers and helps clients to understand the transition process and capture the effects on portfolio performance from all transition activity. Adherence to the T-Charter can be seen as a commitment to meeting certain standards of quality and client care throughout an assignment.


• Operational set-up: clients should ask how the transition manager is set up operationally. For example, does the provider have an existing relationship with your custodian? How are their trades reported to the custodian? And is this done electronically via SWIFT, or manually? Manual trades can be a source of operational risk on settlement of trades. In some cases, the processing of manual trades may result in unexpected costs charged by a custodian.