Fund managers Artemis and F&C talk about how to make the second phase of outsourcing work. Nicholas Pratt reports
“Experience is the name everyone gives to their mistakes,” says Mr Dumby in the Oscar Wilde play Lady Windermere’s Fan. The majority of Wilde’s plays deal with the banality of social convention. However, most literary critics may agree that Mr Dumby’s pronouncement was a clear reference to the outsourcing arrangements of the investment management industry between 1999 and 2005. Wilde was, after all, very much ahead of his time.
The first wave of operational outsourcing deals featured several high-profile failures where back-office lift-outs were scrapped after mere months at great financial cost to the asset managers and even greater reputational cost to the providers. The concept behind these deals was simple: asset servicing firms would invest millions in developing a large, scalable, standardised platform that could safely and efficiently operate an asset manager’s back and middle-office operations, thus freeing up manager’s bandwidth to focus on more critical functions such as stock picking and portfolio construction. However, the technology behind the platforms was not quite standardised enough and the pricing models were in many cases unrealistic, leaving the asset servicing firms too much to do for too little money.
But outsourcing is back on the agenda due to the continual cost pressures facing managers and, in some cases, greatly improved offerings from the providers. In recent weeks there has been the announcement of some large scale deals (see box) involving asset managers that aborted their earlier attempts at outsourcing and now feel confident enough to try again. Also asset managers are changing their current arrangements with multiple providers to move everything onto a single newly finished platform.
The arguments for outsourcing are the same as before only now there is the benefit of experience, say the providers, particularly for those firms that are embarking on their second outsourcing deals. “If you compare and contrast the latest deals to earlier ones, some of us have a proven track record now so there is more confidence among investment managers,” says Daron Pearce, who heads up outsourcing in Europe and Asia Pacific for BNY Mellon. “Previous deals were a leap of faith and not all of them were rewarded.”
This confidence is shown by the fact that outsourcing mandates are now going from one provider to another. For example, JP Morgan Worldwide Securities Services has recently announced two separate outsourcing deals, with JP Morgan Asset Management and Artemis respectively, involving the migration of the clients’ operations from their previous outsourcing providers to its own platform.
“A big concern in any second-generation outsourcing deal is the relationship between old and new outsourcing providers but it was very professional and co-operative throughout,” says James Wright, head of JP Morgan’s investment outsourcing business.
This view is supported by Mark Murray, chief operating officer at Artemis, who says that the ability to transfer from one provider to another is important for managers that may otherwise be reticent to outsource to a third party if they think they will be stuck on a platform that is not being constantly developed.
Artemis is one of the few investment managers that has had a philosophy to outsource back office operations from its foundation in 1997, says Murray. And despite the growing popularity of outsourcing, he says that the momentum behind it has been slower than he envisaged. He ascribes this inertia to the cultural change needed at firms that would then be relying on a third party for processes they currently perform in-house, and on the fact that the providers do not all have offerings of comparable quality.
“The providers all talk of having a strategic platform but there are different degrees of reality,” says Murray.
Clients are also recognising the importance of standardisation and are more willing to be serviced via a standard platform rather than demanding bespoke processes, says Wright. “There is always a degree of customisation but standardisation is an important element,” he says. “The irony is that with the second-generation deals where there has perhaps been too much customisation or over-engineering in past projects, now they want the arrangement to be as standardised as possible.”
The other big change in second-generation outsourcing deals is a more practical attitude to pricing, says Wright. “We still see a lot of crazy pricing in the market but we are not prepared to get into bidding wars because it is not a healthy long-term position. We are not demanding the client take every service on the platform, but every deal has to be profitable.”
It is a similar case for other providers. “Pricing is much more realistic these days compared with several years ago,” says Rob Wright, global head of product and client segments at RBC Dexia. “We’ve never bought business, we didn’t think we needed to, but the industry has moved away from that approach. I’d like to think there’s a better pricing dynamic.”
Nevertheless, Murray says that there are still outsourcing providers out there with rate cards that suggest they are willing to sacrifice profit for business, something which the Artemis team was very wary of in its selection process. “I keep thinking that there will be consolidation among the providers, although it hasn’t happened yet. It is a very capital intensive business and I don’t think all of them will remain committed. So we wanted to pick a provider that we think will be a long-term winner.”
Institutional asset manager F&C Investments has recently announced an outsourcing deal where State Street will provide investment operations outsourcing for £106bn (€113.5bn) of assets. The services include back and middle-office functions including custody, settlement, fund accounting, trustee, performance and risk reporting, securities lending and transfer agency and will serve multiple domiciles. The mandate will also involve the movement of 102 employees from F&C’s London and Edinburgh offices to State Street.
As well as outsourcing the institutional middle office, the deal with State Street also results in bringing all fund administration to one provider. Currently, F&C and its subsidiary Thames River Capital use six different administrators across five jurisdictions.
F&C had previously been running its own middle office for institutional and segregated mandates, something which produced no economies, says Jeremy Charles, group operations director at F&C Investments.
“A system upgrade was required every time a new mandate was won and dealing with multiple administrators, tax jurisdictions and custodians meant that some 90% of the firm’s IT budget was spent on these back and middle-office system changes. There will be cost
savings as a result of the deal, largely from right-sizing the IT and facilities support needed for in-house administration and savings in premises costs, which have been estimated at £12m per annum, but that was not the main focus, says Charles.
“The outsourcing deal is about reducing operational risk and noise for that middle office. By using a single outsourcing provider we will have one administrator and one interface – and hence will be able to spend our IT budget on competitive differentiators in the front office.”
Back in 2005, F&C had embarked on an operations outsourcing deal with Mellon where 50 staff were to be transferred to the bank. But failure to agree contractual terms or be convinced that the Mellon platform was up to standard led to F&C bringing its operations back in-house at a cost of millions.
So what has changed in the intervening past six years? “The providers have gradually got their act together,” says Charles. “They are now more aware of how to handle risk management, performance measurement and complex OTC [over the counter] instruments. The platforms are all more or less standardised and they are much more flexible.”
This view is supported by Jeff Conway, executive vice president and global head of State Street’s Investment Manager Services, who says that the platforms are much more standardised, able to serve multiple domiciles and offer a range of services all in an enterprise-wide context. “The investment has been high in terms of developing a platform able to serve the full range of investment managers,” he says. “We invest continually. The core is there but we are building new components all the time, particularly for more sophisticated data solutions needed for end-client reporting and risk analytics.”
However, this is not to say that all outsourcing providers have fully standardised platforms of a similar quality. In the tender process, F&C reviewed seven providers’ platforms and, says Charles, it was relatively easy to whittle that down to two options. And management consultant Investit recently held a forum with ten asset managers which had outsourced their operations to review the level of service they were receiving and how effectively providers were able to meet the business needs of managers.
The view of managers was that outsourcing is still a very static service that is able to cope with the predictability of day-to-day operations but struggles when more dynamic and less predictable qualities are called for. “Most managers were relatively happy with the general service they were receiving but once you went beyond that, to the ability to manage change and diversity or to support innovation, there was far less satisfaction,” says James Hockley, business director and principal consultant at Investit.
Some of this might be explained by the fact that outsourcing projects have traditionally been overseen by chief operations officers and other business stakeholders have been less involved. “Operations people tend to talk to other operations people,” says Hockley. “So they are able to manage their providers well but are not as communicative with their business stakeholders. Too many of them are simply ensuring that their key performance indicators [KPIs] go green. They have to think beyond that. The engagement with their providers has to go beyond the daily operations. And it has to be a total relationship.”
This is recognised by Charles, at F&C, who says that better management of governance has ensured that the outsourcing relationship involves more than the operations teams on both sides. “There are a mass of touch points, whether it is the IT teams, the collateral departments, the OTC pricing guys or the administration unit. We have to monitor all this feedback and institutionalise it so that it can be managed on an ongoing basis and the relationship can improve as a result.”
Hockley suggests that the outsourcing model is maturing but is perhaps currently in its teenage years. This would appear to be an apt summation. There is still a tendency for the providers to talk up their platforms more than they should and give the impression that there is a long list of clients when the reality is that few, if any, can boast of a client roster in double figures. But at least asset managers are realising just how much effort has to go into managing these adolescent outsourcing relationships and once those difficult teenage years are negotiated, they might finally start paying them back.
©2011 funds europe