Regulation has been a driving force behind outsourcing of post-trade processes including OTC derivatives processing but asset managers are also looking for support with new product launches. Lynn Strongin Dodds assesses the different routes being taken and the growing role data plays in outsourcing strategies.
Outsourcing is far from a new concept but the unrelenting tide of legislation coupled with changing investment habits has altered the game plan. Cost savings are no longer the main reason but access to a broader range of skills and infrastructure are also prerequisites. The buy side not only needs help steering through the complicated maze of financial regulatory rules but also support in developing new diversified product ranges across geographies to hone their competitive edge.
In fact, financial regulation has become less of a concern, according to a recent survey – Opportunities for Optimism conducted by State Street. It found that the top priority for the majority of the 400 asset managers across 23 countries surveyed was to develop new offerings and new capabilities in alternatives and multi-asset solutions to cater to a greater demand for bespoke as well as passive products. It is also being driven by the need to fend off non-traditional entrants encroaching on their territory.
These new products including those with derivatives overlays have added another layer of complexity to the investment and risk-management processes which are already handling more onerous reporting requirements.
“Regulation is not going away and it is ever present but over the past few years, there have been service providers such as State Street, lawyers, accountants and consultants who have supported the buy side and helped them structurally deal with the impact,” says Andy Wilson, Head of Asset Manager Solutions UK at State Street. “Today there is a greater focus on staying closer to the needs of the end clients and that has changed some of the drivers of outsourcing. For example, asset managers are looking to use the data more to their strategic advantage and are using services such as risk analytics to better examine their portfolios for shocks or redemptions.”
“Today there is a greater focus on staying closer to the needs of the end clients and that has changed some of the drivers of outsourcing. For example, asset managers are looking to use the data more to their strategic advantage and are using services such as risk analytics to better examine their portfolios for shocks or redemptions.” – Andy Wilson, State Street
Daron Pearce, CEO of Global Financial Institutions within BNY Mellon Asset Servicing echoes these sentiments. He notes that conversations today revolve around business efficiency, growth, investment performance and distribution. For example, take big data which is part of the regulatory compliance story but can also be employed to store large volumes of historical market data to feed trading, predictive models and forecasts. In addition it can conduct analytics on complex securities, using reference data, market and transaction analysis from multiple sources.
“Big data is such a hot topic at the moment and not just because of regulatory compliance,” he says. “Fund managers can use the data within their investment as well as client portfolios to generate new insights. This is easier to do if they have a well-structured investment book of record (IBOR).”
IBOR is key because it keeps track of the entire lifecycle of the transaction, and operates as a centralised data management framework meeting front- to back-office information needs. Amassing all the information from the legacy and disparate systems has not been an easy task. This is particularly true in derivatives processing. Having a single source of truth across the organisation as well as state of the art technology systems can help asset managers boost return rates and deliver the transparency and accuracy that regulations and investors demand. In addition, these systems should offer integrated workflows in managing cash, margins, deliverables and collateral, accurate reporting and the ability to quickly introduce new products to market.
Against this backdrop, it is not surprising that choosing a provider has become much more nuanced. Gone are the days of the lift out model where a supplier acquires and operates the asset manager’s existing IT platform, staff and processes. Component based model – where only some of the firm’s existing IT platform and staff are taken on by the supplier – is still popular but many are looking to form deeper bonds with a smaller number of third party providers.
“What we are seeing is rationalisation to fewer providers and deepening relationships as well as broadening engagement,” says Pearce. “In the past, the largest fund managers may have used seven to eight firms for outsourcing but now they are down to three to four. However I can’t see it going down to one because of the need to manage counterparty risk and the need for competition.”
“In the past, the largest fund managers may have used seven to eight firms for outsourcing but now they are down to three to four. However I can’t see it going down to one because of the need to manage counterparty risk and the need for competition.” Daron Pearce, BNY Mellon Asset Servicing.
Mathieu Maurier, Global Head of Sales and Global Relationship Management at Societe Generale Securities Services, agrees, adding, “The larger asset managers are reducing the number of providers because they want to become more efficient in the middle and back office. They had been using multitude of players in a number of jurisdictions and systems. However, they can’t outsource everything and there is a thin line between what they can externalise and what they need to keep in-house as a regulated organisation.”
For example, all oversight and fiduciary functions performed by compliance, risk and technology executives will remain within the four walls of an organisation. In addition, although there is talk of outsourcing front office activities, the buy side is unlikely to hive off their core functions of investment decision making and managing risk because they can be key differentiators.
However, once chosen, providers cannot rest on their laurels. “If you look at the custodial banks, they are all in the midst of various transformations and looking at how they can improve their business offerings from the back to the front and broaden offered solutions across their client base,” says Joshua Satten, director of business consulting at Sapient. “They have upped their game in technology with better functionality as well as hiring people with the right skills while making targeted forays into innovative technologies.”
Fund managers have also turned up the pressure with regular reviews to ensure their third party providers are keeping pace with product and regulatory developments. One major area of focus is whether these firms have the acumen to match the critical data management piece with the larger functions of performance measurement, compliance and reporting requirements. In the derivative space, there is greater attention paid to collateral management, portfolio reconciliation, ability to calculate margin calls, processing and reporting.
“We are seeing a move away from plain vanilla products and services to collateral management and calculations for complex products,” says Maurier. “We are also seeing an increase in demand for I-DEAL which enables investment managers to better monitor execution of an order to ensure that best execution is being provided by the broker dealer.”
Launched last October I-DEAL covers order placement, routing and execution, and facilitates regulatory reporting and some middle-office services. It is also designed to integrate with SGSS’s custody services, depository control, fund administration and asset servicing offerings.
While larger fund management houses are leading the charge, their smaller brethren are also moving up the value added chain. “Those smaller and medium sized managers are facing the same challenges but may not have the access to the human or real capital to keep up with the regulation and distribution of new products, according to Dan Houlihan, Executive Vice President and Americas Head of Global Fund Services, Northern Trust. “They are looking more for the full back and middle office package versus a component based offering.”
“Advice has also become an increasingly important part of the offering,” Houlihan adds. “We have a dedicated global team of people who understand the rules and can interpret them in layman’s terms for our clients.”
