Magazine Issues » December-January 2012

OUTSOURCING: Cost comes to the fore

Jigsaw_puzzleNicholas Pratt reviews the major outsourcing mandates of the year and talks to some players about trends and concepts that are likely to appear in 2012.

The most noticeable factor about recent outsourcing deals in the asset management industry is the variety of both the structure of deals and the motivations of clients.

Some asset managers, such as Man Group, are first-time outsourcers and long-term exponents of in-house systems development. But they have realised there comes a time (and a size) when it could make more economic sense to employ a third-party operations providers.

Operational efficiencies and scaling-up have always been prominent in asset management outsourcing decisions, but cost is now more important than it was.

“The economics are a big factor,” says Richard Ernesti, global head of investor client and sales management at Citi. He says outsourcers are now having more discussions with chief finance officers rather than chief operations officers, which suggests that a reduction in cost is a more decisive factor than an improvement in processes.

The economic argument for outsourcing is only going to become more persuasive, says Lou Maiuri, global head of outsourcing at BNY Mellon Asset Servicing.

“There is still at least five years of headwind facing the industry and to seek alpha, firms will need to be in different asset classes and different geographies. And each time they do this, it involves changes to their infrastructure. Therefore, many managers are looking to remove the fixed-cost base that they have in operating their own services in-house. Most smart managers realise that there is no value in that. And over the past 15 years we have demonstrated that we have robust platforms.”

Meanwhile, there have been renewals or extensions of long-standing outsourcing relationships, such as the deals between BNY Mellon and Bridgewater, and between

State Street and Pimco. These are the so-called second generation deals that typically involve the inclusion of middle-office services alongside the traditional back-office functions. It is an evolution that many providers feel will eventually reach the front office.

“There are standard middle-office services such as transaction management, record-keeping, cash administration, corporate actions processing, collateral management, OTC [over-the-counter] derivatives processing and data management,” says John Campbell, who leads the outsourcing business for State Street in Europe, the Middle East and Africa.  “And there are other functions such as performance analytics, risk management, fee billing and futures clearing that could be viewed as front-office services.

“We already hold the data that supports these functions and managers are realising that it makes sense for us to run the calculations and provide the service. The aim is to see how much more seamless we can make it, so keeping agile and flexible are important.”

According to Markus Ruetimann, group chief operating officer at Schroders Investment Management, this focus on less mature outsourcing services such as derivatives support, performance attribution, tax reporting and fair valuations of assets has been one of the most significant developments of the past one to two years. “Many providers have reached maximum efficiency levels in core functions such as custody and fund accounting – a prerequisite for further rate card reductions for big outsourcing mandates, both existing and prospective,” he says.

There are a number of areas where Ruetimann would like to see outsourcing services develop further. In addition to the aforementioned services supporting derivatives and investment risk analysis, Ruetimann believes data management is key. For example, data scrubbing for asset prices, asset valuations and indices.

“Consolidated management reporting and analysis across holdings, positions, asset classes, instruments and locations is also an emerging service as providers already host many such data components.”

Another concern for managers, and one shared by Ruetimann, is the cost pressure facing outsourcing providers, something which underlines the idea that managers are not simply pursuing the lowest available price when considering outsourcing providers. “Process efficiency, quality of people, adaptability of technology, strength of balance sheet, the scale of its proprietary sub-custodian network and price remain key considerations when appointing a provider,” says Ruetimann.

‘Outsourcing with oversight’
Despite the apparent dominance of asset servicing companies that are owned by investment or trust banks, there are other outsourcing providers in the market, many of which are starting to pick up mandates, especially among the small and medium-sized managers. Merchant Capital has four Dublin-based Ucits funds worth more than $80 million (€60 million) with plans to launch a further three funds shortly. It has outsourced the majority of middle-office functions for these funds to Point Nine, a UK-based provider of middle and back-office services to fund managers. 

The two founders of Merchant’s Ucits funds, George Cadbury and Christopher Day, have a background in in-house development. In their previous role at PCE Investors, which held more than $2.5 billion in assets under management, all the systems had been built in-house.

“This had a lot of benefits but we realised that we would soon get to the point where the assets-under-management exceeded $3 billion and we would then need to make some significant upgrades to the technology or consider outsourcing,” says Cadbury.

When it came to selecting an outsourcing provider, Cadbury says there was a clear intention to look beyond the major providers. “If you outsource to one bank for middle-office services and another for back-office services, you get tied up in a lot of politics. We made a conscious decision to outsource our middle-office to a technical specialist such as Point Nine because we value their independence.”

According to Ambasuthan Jananayagam, partner at Point Nine, providers such as his that rely on web-based delivery of their services are a “genuine alternative” to the large providers’ single platforms. “Asset managers are creating more exotic funds and each fund has to pay for itself, so we are finding managers that would prefer to find a new provider for these new funds rather than pay more to the existing outsourcing provider.”

Jananayagam describes Point Nine’s service as “outsourcing with oversight” meaning that the client is able to see what is going on at all times because the services are delivered over the internet – a feature that is increasingly important for providing reporting services. “The challenge for us is to keep up with the changes,” he says.

This is the challenge for any outsourcing provider that chooses to target the reporting function for increasingly exotic funds. The reason is that providing reporting services takes the outsourcer nearer to the front office, where clients become more demanding, at least more so than the understanding inhabitants of the back office

Cadbury feels that the growth of cloud-based services will be particularly important in the provision of data-based middle-office outsourcing, even if it is too early to tell whether they offer a genuine alternative to the single platforms developed by the large bank-based outsourcing providers.

“There is a huge scope for growth in the outsourcing market and it could be very interesting to see how many of these third-party providers fare in 2012,” he says.

Talent and technology
Perhaps 2012 will also see greater use of the term co-sourcing. According to Schroder’s Ruetimann, the concept of outsourcing should eventually be replaced by evolving “co-sourcing” operating models.

“This entails the synchronisation of talent and technology between the fund manager and its external providers through a more integrated approach, vis-à-vis operational knowledge transfer, IT developments and system interfaces.”

Such a collaborative approach is particularly suitable for data management services, says BNY Mellon’s Maiuri. “Data management is a good example of co-sourcing where there are two different operational teams, from the provider and the client, able to work using the same data. This is also where private, secure clouds can play a part. This approach is not suitable for every task, such as accounting, but it is an increasingly useful way to work and one where there is a clear delineation.”

As this comment shows, cloud-based services are not the sole preserve of niche providers. After all, in many ways cloud computing is simply a new term for an old service model – the hosted or managed service, also known as the application service provider or ASP – albeit one where the emphasis on web-based technology is even stronger, thus lowering costs for both the manager and its provider and therefore helping to ease the economic pressures being felt on both sides of the outsourcing arrangement.

©2011 funds europe