Financial Services Operations: Is the Middle-Office the New Back-Office?

Transcription

1 November 2006 Financial Services Operations: Is the Middle-Office the New Back-Office? By John Eagleson and Roger Sparks Partners and Practice Co-Leaders Global Financial Services Advisory Services, TPI CONTENTS 2. Introduction 3. Similar Drivers But Differing Impacts 5. A Forward-Looking Opportunity 6. Conclusion

2 introduction With traditional back-office functions becoming commoditized and reaching outsourcing maturity, leading asset management service providers, such as State Street, Bank of New York, JPMorganChase, Northern Trust, Sungard, and Bisys are shifting their focus to developing and expanding middle-office platforms and service offerings. 100% 80% 60% Figure 1 Outsourcing Maturity Rates For asset managers, the chances are high that a solid portion of your back-office is currently outsourced. Third-party service providers provide custody services to an estimated 90 percent of U.S.-managed assets and 95 percent of U.S. mutual funds. Trailing custody in outsourced adoption rates are fund accounting (60 percent), transfer agency (50 percent), and fund administration (35 percent) 1. 40% 20% Custody: Total Managed Assets Custody: Mutual Funds Fund Accounting U.S. Back-Office Transfer Agency Total Managed Assets Mutual Funds U.S. Middle-Office In contrast to this phenomenon, industry analysts estimate that 95 percent of the U.S. trade processing functions that comprise the middle-office are not Figure 2 Middle versus Back-Office Middle-Office Trade Matching Trade Settlement Reconciliation Post-Trade Compliance Reporting and Data Investment Accounting Performance Analytics Data Warehousing Estimated Cost: 3.5 basis points Back-Office Custody Fund Accounting Fund Administration Transfer Agency Estimated Cost: 11.8 basis points currently outsourced. European money managers, while more apt to outsource the middle-office, still represent an estimated 85 percent of these activities. This is vastly different from what has happened and continues to happen with the back-office. So what s the difference with the middle-office? Is outsourcing the middle-office going to grow, or are there inherent limitations? Are there greater risks for asset managers in outsourcing middle-office functions versus back-office functions? Are the service provider offerings robust or even developed adequately? In this article, we will examine whether the middleoffice is the new back-office. Copyright 2006 All Rights Reserved

3 Similar Drivers But Differing Impacts In general, back-office outsourcing is propelled by a set of business drivers that are common to many asset managers: Table 1 - Drivers of Back-Office Outsourcing Economics Technology Business Focus Convert fixed costs into variable costs Increase the predictability of costs Shift development costs for scalability Forego system enhancement costs required to keep pace with regulatory requirements and product changes Move IT assets and employees off the books Increase fund performance by reducing costs Reduce or eliminate technology and legacy system dependencies Enhance regulatory and compliance reporting Implement an integrated global back-office capability Automate labor intensive activities, reducing error rates and failed trades Ensure access to backup facilities and technology for business continuity Increase time to focus on core investment business, including: Product innovation (depth and breadth) Performance Distribution channel Sales and marketing Client segmentation Market expansion Conceptually, some of these drivers could apply to the middle-office as well. But do they resonate as strongly? For most asset managers, back-office functions (custody, fund accounting, fund administration, transfer agency) represent a significant drain on economic and technology resources, as well as business focus. Costs are relatively high and not variable. Technology requirements are commoditized but resource-intensive. And backoffice functions normally are not core competencies or competitive differentiators. In the middle-office, these economic, technology, and business outsourcing drivers are still relevant, but their impact is muted for a variety of reasons: Processes do not leverage the same type of large-scale transaction processing that the back-office uses; therefore, costs and benefits of automation are unclear Flexibility (e.g., separate trade processing modules) is needed for scalability and product development Technology investments, while substantial, are smaller than the large-scale mainframe transfer agent, fund accounting, or custody back-office platforms Need for significant customization may limit potential cost savings Concerns over control, ownership, and conflicts of interest could develop between an asset manager and its service provider Compliance and regulatory situation is not clear; T+1, USA PATRIOT Act, privacy issues and BCP requirements will continue to evolve causing many firms to defer decisions Copyright 2006 All Rights Reserved

4 What does all this mean for middle-office outsourcing? First, outsourcing transactions are nevertheless taking place (see Table 2). In part, this is because in recent deals asset managers are bundling middle-office with back-office outsourcing. In these cases, asset managers are seeing that, despite a few differences, middleoffice outsourcing, like back-office outsourcing, can present some tangible opportunities. Second, middle-office outsourcing is not following the adoption path of back-office outsourcing, neither in terms of scope nor rapidity of outsourcing transactions, and will not do so in the future. The limitations on middle-office outsourcing, while not insurmountable, compel an asset manager more than ever to consider its sourcing plans within the context of its broader strategy. With the right framework, such deliberations can result in the optimal sourcing plan, tailored to your company. Table 2 - Recent Bundled Deals Asset Manager Service Provider In-Scope Back-Office Functions Allianz Dresdner State Street Custody Asset Management Fund accounting AXA Investment State Street Fund administration Managers Fund accounting In-Scope Middle-Office Functions Securities pricing Account performance calculations Record retention Reporting Daily position reconciliation Performance measurement Investment operations support Julius Baer Investment Northern Trust Fund accounting Full trade support Management Client reporting Performance measurement services Cash management (including FX) Portfolio Mana- JPMorganChase Fund accounting, Trade matching and gers Limited (Morley Fund Management, Australia) fund administration, custody instructions Daily holding and transaction data Daily valuations and cash flow reporting Month-end tax accounting and reporting Copyright 2006 All Rights Reserved

5 A Forward-Looking Opportunity What are our company s business objectives? Do we need to reduce costs? Do we need to re-focus on our core competencies? Do we need to transform or improve the function? Would outsourcing certain middle-office functions help us achieve our goals? What are those functions? Are there other options besides outsourcing? What would the impact of outsourcing be on our organization? How would our clients, employees, investors, competition, fund boards, and other relevant stakeholders react? What about our technology? What quantifiable value would we expect to realize from undertaking such a transaction? How do our appetite for risk, our need for value through sourcing, and our timing requirements (speed to transaction) corelate to inform our decision? Which service providers are in play? Of course, these questions do not have simple answers; they require time, input from internal stakeholders and external experts, and most importantly, a structured process for analysis, facilitation, and financial modeling. TPI s approach considers the following key dimensions: Functional Maturity: analysis of back or middle-office component process maturity Organizational Readiness: analysis of client environmental maturity, including competition, investors, fund charters, people, technology, and geographic aspects Transactional Alignment: evaluation of an optimal deal structure, including aspects of risk, value and speed to results that match distinct client objectives Lessons Learned To keep a potential transaction moving, determine early on which fund boards may need to vote on a third-party provider and which simply need to be informed for awareness. Consider the touch points between a potential middle-office provider and existing back-office providers for potential problems. Negotiate rates even for asset classes that you may not deal in today so that if those are acquired they are pre-negotiated into a deal. - TPI Advisors Sourcing Outputs: the optimal service delivery mechanism, including options beyond outsourcing Provider Fit: analysis of provider options and attributes, including capabilities, rankings, investment appetite, technology alignment, migratory plans and prior experience Each of these dimensions informs a detailed roadmap of potential sourcing options, or what TPI calls an asset manager s Service Delivery Framework (SDF). The SDF does not always point to outsourcing; in fact, more than one-third of TPI s assessments do not lead to a transaction. Instead, an SDF succinctly summarizes the sourcing assessment, lays out the options, and facilitates executive decision making on potential next steps for the company. It ensures greater alignment of your sourcing strategy to your organization s overarching business goals. This is fundamental to establishing a successful service delivery relationship over the length of the contract or service arrangement. Copyright 2006 All Rights Reserved

6 Conclusion Progressive asset managers will seek to evaluate the appropriateness of outsourcing certain middle-office functions. But, though they share similar economic, technology, and business drivers, the middle-office is inherently more complex to outsource than the back-office. Asset managers must carefully align internal business priorities and transformational needs against the developing market offerings and multitude of service delivery models. TPI has a comprehensive solution that adds meaningful context and provides a framework for assessing the options and challenges presented by various middle- and back-office sourcing alternatives. Copyright 2006 All Rights Reserved

7 To discuss your asset management middle and back-office with TPI, please contact: John Eagleson Chaz Foster Partner Partner ABOUT TPI: TPI is the founder and innovator for the sourcing advisory industry, and the largest sourcing advisory firm in the world. We are expert at a broad range of business support functions and related research methodologies. Utilizing deep functional domain expertise of accomplished industry experts who possess extensive practical experience, TPI collaboratively works with organizations to help them optimize their business operations through the best combination of insourcing, offshoring, shared services and outsourcing. For additional information, visit Americas Nigel Walker Partner or nigel.walker@tpi.net EMEA Denise Colgan Marketing Manager +44 (0) or denise.colgan@tpi.net Asia Pacific Arno Franz Managing Partner +61 (0) or arno.franz@tpi.net