by Mathew Abraham, Associate Director of Middle Office Product
Whether to build, buy or outsource is a key question faced by asset managers as they look to transform their operating models and enhance competitiveness. Since each model has distinct advantages and disadvantages, it is important for managers to choose an approach based on a thorough review of their internal functions, ensuring alignment with the firm’s business strategy and, most importantly, clients’ best interest.
Managers distinguish between front office & support functions
Today’s managers are confronted with ever-changing regulation and an increasingly complex operating environment. Events such as T+1 in North America, as well as ESG and the new Central Securities Depositories Regulation (CSDR) across Europe, are causing managers to take stock of their competencies and determine how best to stay ahead of some very significant challenges. To this end, we have recently noticed a gradual shift in the mindset of managers as they look to achieve scale and cost efficiencies through automation and new technology. When it comes to systems development, managers are increasingly distinguishing between front office and supporting functions.
Maintaining control over managers’ “secret sauce”
System enhancements around the manager’s front office functions, including asset allocation, investment research, portfolio construction and trading, generally reside in the realm of inhouse development. This enables managers to maintain a sense of control and exclusivity in relation to their “secret sauce.” The propensity for inhouse development is confirmed by RBC’s recent survey of asset and wealth managers, indicating that approximately 70% of managers plan to develop internal systems in their front office, without any third-party involvement.1
Managers are generally cautious about delegating front office functions
Despite the allure of inhouse systems, they can be a challenge to develop and operate. Competing with new technology is not easy. And the need to provide IT support, in addition to ongoing maintenance and enhancement of internal systems, is likely to add significant cost and risk to the firm—perhaps even a drag on performance.
As a result, managers are beginning to deploy third-party, cloud-based solutions that enable them to maintain control over client-facing functions, leverage the specialist capability of vendor platforms and, ultimately, control costs. With 24-hour, on-demand support, augmented by the latest technology, innovation and data capabilities, managers are free to focus on their primary responsibilities to investors—generating returns.
Increasing the focus on support functions
What about the other functions that support managers’ core activities? While not as glamorous as the front office, supporting functions are the backbone of asset management firms. The post-trade operations—also known as the “middle office”—are effectively the glue that holds the business together and keeps it running smoothly. As its name implies, the middle office, including trade management, corporate actions management, collateral management and the Investment Book of Record (IBOR), serves as a bridge that connects the front office to the back office, including custody and fund accounting.
T+1 is bringing middle office functions to centre stage
While the middle office has not always received the same attention as the higher-profile front office, the upcoming transition to a shorter settlement timeframe is bringing these support function to centre stage. T+1 will require automated systems and robust operating models to process trades in an orderly and timely fashion. Otherwise, the post-execution trading cycle will come to a grinding halt.
There is also increasing demand from the front office for clean, meaningful and timely data from the middle office. Delays in receiving data relating to trade status, corporate actions and portfolio performance impede the manager’s ability to make timely and informed investment decisions.
Linking the middle office to external providers
As managers look to increase scalability, manage costs, access real-time data and benefit from new technology within the middle office, it’s not surprising that they are looking to move away from complicated in-house systems to more efficient vendor-based solutions and outsourced services. This is likely why RBC’s survey also indicated that nearly 80% of managers plan to rely on external partners to minimize reliance on manual intervention and implement the IBOR, which feeds the front office with real-time data from the middle office.2
The cost of vendor solutions can be substantial—and the risk remains with managers
Although vendor-based platforms have the potential to increase overall efficiency, the cost of implementing an “off-the-shelf” solution can be substantial. There is also the requirement for ongoing IT support and specialist resources, as well as periodic upgrades to reflect market and regulatory change. And on top of these challenges, the risk element remains with the manager, who continues to require specialist resources to “do the work.”
As a result, when it comes to the middle office and its functionality, more and more managers are looking to an outsourced, modular solution. Under this arrangement, the manager gets to choose which of the modules to take on (and when), including a variable cost model that is directly linked to usage. The manager can leverage the advanced technology and specialist skill set of the outsource provider, while still maintaining oversight through near real-time dashboards. The outsource solution also facilitates redeployment of internal resources to other key functions.
Outsourcing transfers heavy lifting to the service provider
In effect, outsourcing transfers the cumbersome process and heavy lifting associated with the operations function to the service provider, while the manager continues to own the process.
Searching for the elusive “one size fits all”
The perfect single model is probably an elusive dream as managers evaluate various build, buy and outsource options to transform their operations.
Client-facing functions are likely to remain within the domain of inhouse systems. However, if a business function is not directly generating revenue and the overall cost-to-benefit is high, managers need to reassess the “build” option and consider outsourcing to a specialist service provider, partnering with a vendor or engaging in a combination of both. This will free them to focus on generating alpha for clients.