ASP providers are now offering to manage all technology from the front office all the way through the processes managed by the middle office and manage the data flow in such a way that the back office is getting a uniform and complete (standardised) set of files from which to manage their processes. These systems do not yet manage all processes in the back office because some of the tasks sitting in the back office environment are not yet automatable. However, there is movement towards a comprehensive solution here too. Another trend which ASP providers are moving towards is signing with partners who are themselves ‘best-of-breed' outsourcing providers for complex corporate actions. This model then allows for the back office to offload complex manual tasks to a specialist who will manage the process more efficiently from both a cost and risk perspective. All the while, the user remains involved and in control of the process as they are the users of the ASP system. The major advantage of this model is that users are free to focus on their business and only have to deal with a single interface for all their services.
For smaller institutions, and others who have real weakness in the back office segment of their operations, they might consider a Business Services Provider (BSP) with which to begin a relationship. This way, rather than the ASP model the institution completely outsources their investment and trust operations and implements the BSP's solutions as a whole. These banks rely on the provider's investment processing technology and entrust them with the actual management and processing of client transactions - often called the ‘back-office' operations. By relying on the provider's expertise, these banks and trust institutions can reduce risk and achieve operational efficiencies, thereby improving the quality of services. This will also generally lead to a reasonable reduction in head count of back-office personnel, because most of their jobs will have been outsourced to the BSP. Labour costs being what they are, this again goes back to the issue of reducing cost. So, the benefits are operational efficiency, reduction of risk, reduced labour cost and a presumably scalable environment in which the user of the BSP is free to go out to innovate and generate new business with confidence that the solutions to deliver are in place. It is important not to underestimate the value of reducing risk within the process. As security types become ever more complex, trading volume increases and total value within the markets continues to rise, the importance of risk management rises too.
One mistake in processing, settlement, classification of security, a break in the processing, miscalculation of entitlement, missing an election for mandatory and optional events and failing to file entitlement claims (i.e., tax and class actions) can be extremely costly. The benefit for an institution that isn't able or doesn't want to manage these processes themselves is that they can outsource them. Then, you have to pick the right provider. The same principles apply to picking a provider as they do to picking a system. Scalable and comprehensive are the keys to a successful relationship with a BSP; and also some flexibility in pricing, logically based on the volume and relative complexity of the work involved. Most firms should opt for variable pricing as it will give incentive for the BSP to provide better service knowing that since they are managing your technology and providing a majority of the back office support, the better you (their client) perform the more business there will be. For smaller firms and arguably some mid-size firms, the BSP model is catching on. Given the operational efficiencies to be found in the back office from volumes, it is much more efficient for a small firm to send that portion of the work out.
When it comes to larger firms, there seems to be a bit more reluctance towards this comprehensive, BSP-type solution. This is particularly true of the bulge-bracket firms. The members of the Association of Global Custodians, the top ten investment banks largely, are not interested in outsourcing their processing, in part, because they already take advantage of operational efficiencies given the size of their own operation. However, this one benefit of being big and doing it yourself is often used to justify the traditional inclination towards building rather than buying. The view is that,‘I know my business better than anyone else, so I can build the best system'. Although intimate knowledge of one's business is certainly important when implementing IT to improve efficiencies within it, often an outside eye which may take the customer's, a counter party's and even a regulator's view is likely to provide insights that prove to be just as valuable to the system being built as the business owner's. The most dangerous thing a large firm with a ‘not built here' complex can do is to fail to consult with outside sources of knowledge. This is not to say that one of the institutions that belong to the groups listed above is not capable of building its own systems; it is just caution that never should they be so arrogant in their development process that they fail to consult with others who have the ability to provide advice and insight. For these types of firms, which in part have grown through acquisition, the issue isn't limited to reaching outside for a better view of the process; it is also that they are literally stuck with multiple legacy systems. Major custodians and investment banks often are running on one platform for New York, a different one for London, sometimes a different system still for individual branches and even multiple platforms in the same physical location due to a merger at some point in the past. The sad thing about this is that very often, the merger didn't take place last week, last month or even last year.
In several examples I can think of, which will remain nameless to protect the innocent, the mergers which gave rise to multiple platforms within an institution occurred over a decade ago. Does this mean that in the last 10 or so years a solution hasn't been devised to flatten the back-office process, that most if not all organisations would greatly benefit from the reduction in cost and economies of scale from using one standard system across an organisation?The answer, of course is,Yes! The issue at hand is finding or building and implementing a system which will support an ever-growing range of securities with comprehensive reference data, unique and illiquid transaction types, regulated and industrystandard accounting calculations and process automation which streamlines the management of complex instruments, and this should be the goal for any and especially a large global alternative investment manager. Probably the most important issue when building or selecting such a system is: Is it scalable?
If the answer is ‘no,' keep looking. Because if you don't, you will find yourself at some point in the not too distant future, looking at another solution to either replace or to patch the system you have. In this context, scalable also means able to take an input from a legacy system so that the processing, at least going forward, can be migrated from legacy to a comprehensive enterprise-wide solution. The difference here, given the continued change in the financial world, are the types of financial products now available for trade which must subsequently be settled and serviced. Many of these are rather esoteric further complicating the process. For example, prior to the advent of fully scalable multi-currency platforms, accounting for different currencies within the same portfolio was a complex chore requiring a patchwork of systems and manual data transfer, which slowed the process and increased the risk of error. Global hedge funds operate in many currencies and their strategies also involve a wide variety of equity, fixed-income instruments, derivatives and Special Investment Vehicles (SIVs). These firms invest in a myriad of currencies and instruments, often through multiple brokers. As such, they require an accounting system with the ability to manage the complexities of global hedge funds 24/7.
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