The next phase of Investment Management outsourcing

Posted on : 27-02-2012 | By : richard.gale | In : Finance

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Many Investment Management (IM) firms have outsourced significant business functions: settlement, collateral management, accounting departments have been ‘lifted out’ of a significant number of IM companies and are being run as a service by a smaller number of specialised financial services organisations.

We think the next phase for outsourcing are the middle and some of the front office functions as focus for IM firms is on ability to out-perform, reduce time to market for new products and to reduce costs. Regulation is a key driver for this as the complexities of dealing with constant regulatory change is increasing costs and constraints on  IM firms ability to move into new, more profitable, markets. For example OTC derivatives are much more widely utilised in investment firms than, say, 5 years ago and there is an avalanche of regulation in-flight (Dodd-Frank, MiFIR & Solvency II to name a few)  to enforce reporting and risk management. This results in operational activities such as collateral management becoming much more complex than transacting with conventional securities.

Last month we discussed the future of middle office outsourcing with Maha Khan Phillips in January’s edition of Best Execution magazine and we want to expand on those thoughts here.

Another trend we see is how the Investment Banking industry is starting to look at outsourcing the non-value-add functions to reduce costs and help streamline their business areas. They are being impacted in a similar way to IM firms at the turn of the century in terms of reduction in income and focus on cost reduction.

 Outsourcing history and developments

The first phase of outsourcing often was a simple ‘lift-out’ where the back office was separated as a whole – people, systems, and processes  with a line drawn across the organisation splitting the remaining front/middle office from the outsourced back office. This was driven by a number of factors but cost reduction and the drive to better returns was core.

As an approach the lift-out worked and enabled the IM organisation to focus on its core business of investing money.  Over time as the industry matures, the limitations of this approach are becoming clear. The ability to be responsive to new business requirements can be reduced:  flexibility in the operating model to react to new changes such as business focus, new asset classes and volume variations are often slowed by split between organisations. The outsourcers will have a number of clients with differing requirements and a limited ability to change which can impact speed of delivery.

These factors have led to some operational challenges and frictions between the client and supplier the result of which has led to a reassessment of the services and relationship. The client has a number of choices available and, as the earlier contracts mature, firms are identifying this period as an opportunity to review the current state vs. alternative strategies. The choices are broadly:

  1. Insource. To undo the lift-out and bring services back in-house. Some organisations have done this with varying degrees of success but the underlying rationale for outsourcing and the business case underpinning this needs to be closely examined.
  2. Migrate to new outsourcer. This is potentially one of the more complex solutions but also a possibility to re-engineer the business. Often there are complex interactions between the client/supplier that exist because of the way the outsource was constructed historically. This ‘web’ of interfaces, processes and procedures will need to be cleaned and logically split to migrate. Also the level of complexity from moving from one (client) organisation to an outsource supplier goes to a new level when migrating suppliers.
  3. Stay with existing and work together to improve service, relationship and capabilities.
  4. A combination of the above not excluding outsourcing more functions of the client firm.

Assuming the client strategically does not which to insource the functions then one of the most important activities is to grow the client/supplier relationship into an aligned partnership. This is the time when parties need to work together to construct a roadmap to move to a more efficient, cost effective and flexible model to deliver optimised services and capacity to grow.

This trend is gathering pace as firms look to ‘smarter’ outsourcing which bundles up groups of functions and let someone else look after the day to day management whilst enjoying a consistent service and pricing. Significant middle office functions are in-scope and included in those are what are traditionally seen as front office capabilities such as deal execution and compliance monitoring.

Interestingly the Buy-side has led the way on outsourcing. Investment banks have previously been too busy ‘running’ to keep up – growing new business areas and have been wary of outsourcing as a brake on their flexibility and ability to expand. The focus has been on IT infrastructure, testing & development and creating ‘captives’ in lower cost areas for operations. Now cost and regulatory pressures are proving a heavy burden then banks are now spending more time and energy looking into outsourcing their non-propriety functions. We think this is one of the trend areas for the next few years.

Business IT Alignment and the 3 ‘R’s – Rationalisation, Regulation and Ring-Fencing

Posted on : 24-06-2011 | By : john.vincent | In : Innovation

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Delivering IT within Financial Services organisations doesn’t get any easier. Just as technology services look to simplify and commoditise through maturity and new innovation, along comes a whole bunch of hurdles to overcome driven by economic, social and political circumstance. For many years we have talked about the alignment of Business and IT but never before has it so been important to step up the engagement to a seamless, symbiotic relationship.

Organisational objectives such as Cost, Risk, Quality and Agility and the associated measurements thereof are scattered liberally in the SMART’s of support functions throughout the industry. And yet, couple that with what is often a disconnected business strategy and a culture of short-term meritocracy and it doesn’t take too much intellectual wisdom to realise that something needs to change. Sound familiar ?

So let’s look at some of the current challenges facing business and technology leadership.

1) Rationalisation – by definition “The process of reorganizing and overhauling a company’s operations, policies, and anything else needed to make the company more efficient”. Within FS we’ve been undertaking this for a number of years. Indeed, objectives have been set top down throughout the technology organisation with a year on year increase in weighting. Headcount has been reduced, delivery organisations merged, Capex spend limited, contracts renegotiated, services moved to “best shore” locations etc… However, this only goes so far before a new approach is required and of course, you can’t “shrink yourself to success”.

2) Regulation – as we meet with different organisations one thing is very clear – the increase in regulation and their impact on business and underlying technology services is a constant challenge for organisations. We’ve already been through numerous regulatory and compliance implementations in the past and it isn’t slowing down. We will need to understand the implications of Basel III, Dodd-Frank and FACTA ( Foreign Account Tax Compliance Act ), to name but a few. All of these are being introduced for good reasons and it is vital that the business and technology organisations are closely aligned to determine what are the key implications for systems and processes.

3) Ring-Fencing – it is a matter of opinion as to whether the Independent Banking Commission went far enough with its interim report around future requirements to segregate the business activities of investment and retail banking. What is clear is that again business and technology organisations need to jointly determine the impact now that it seems almost certain they will be endorsed later this year. In order to facilitate ‘retail ring fencing’ there will need to be significant operational and systems changes that would need to be undertaken by each individual bank. As the Commission sets out, there are some functions that should not be ring fenced (related to investment bank) and those that should (relating to retail banking) – the challenge is that there are many shared services across universal banks that service both these areas and would need to be separated if retail banking activities are to be ring fenced. The greater the costs and complexity of ring fencing operations, the longer such changes will take and the more potential for disruption to everyday banking services.

Many organisations will have advanced thinking on the 3 ‘R’s but it is worth taking time to consider certain aspects.

In terms of Operating Model, we feel that the following dimensions require special attention:

Business Alignment : is the model in terms of governance and process connected throughout the organisation to the business consumers of services ? Often we have committees for Run The Bank and Change The Bank investments, but do changes in business activities in terms of scope or volume have a predictability in terms of the associated changes ? Understandably there is a large amount of sunk or fixed cost but it is important that the actual “existence” of all technology assets is understood and coupled to business value.

Service Agility : how efficiently can services be reconfigured as a result of an external change in circumstance ? The focus around costs has led many Financial Services technology organisations to realign operational services from a vertical to horizontal model for internal synergies. Clearly some services are common and therefore this rationalisation move makes sense. However, there is also a risk of making any future Ring-Fencing requirements more complicated and costly. Considering the Business Alignment imperative in conjunction with Service Agility should be the cornerstones of future operating models.

Strategy and Architecture : all organisations have a strategic roadmap for technology and services. However, there are two important questions to ask. Firstly, how mature are we in terms of Enterprise Architecture and the governance thereof ? Often, EA is a pseudonym for Infrastructure or Application Architecture. True Enterprise Architecture considers all aspects of an organisations business activities and can drive innovation, reduce risk and deliver efficiencies if placed in close proximity to the strategic business model.

Secondly, how far out does the strategy look ? In a recent conversation a senior banking leader discussed the need for FS organisations to look much further ahead, akin to the way that Shell does it’s Scenario Planning. Is it feasible to look 5, 10, 25 years in advance ? Conventional wisdom says not in terms of technology… but by considering all environmental, political and economic influences and overlaying the technology aspects then the different paths can be drafted in terms of “Signals and Sign-Posts” for the future operating model.

Risk Management : Disaster Recovery and Business Continuity Planning are well embedded and typically mature with FS. The journey to Service Recovery is understood. However, similar to the Scenario Planning, an increased awareness and vision is required throughout the organisation in terms of the myriad of external impacts to the world we live in and subsequent organisational response. We don’t have to list the surprises of the past 5 years…can we predict what’s next ?

Sourcing : where are services sourced from, whether internal or external, is driven by a number of factors including culture, compliance, cost and innovation. As we think about a more long term and holistic operating model, not just about technology or operational services, how does the way we deliver services mirror the 3 ‘R’ influencers ? Shared Service models or Joint Ventures may be key providing they have the correct construct in terms of commercial, flexibility and partitioning of delivery. Technology advances can help in this, with cloud computing well on its journey along the “Gartner Hype Curve”. The ability to source services in a more on-demand / scalable way provide choices for application provisioning for business consumers, notwithstanding the well known attention areas.

In summary, perhaps it’s time to step back and think about the future. The 3 ‘R’s are, of course, only the basic foundations.