Explaining front, middle and back office is the main discussion in this article, a discussion that has been a fairly high-level overview of technological concepts in the financial services industry. Now, in order to contextualise the issue and really dig into discussing the benefits of managing and implementing technology, we will focus on what have traditionally been the three basic divisions of a financial services company and how technology plays a role in the way each of these areas functions. The terms front, middle and back office have traditionally been used to describe how assets are managed from end to end within the financial services community. Traditionally because, these days, in the age of outsourcing and ‘bestof- breed' suppliers, the front, middle and back offices may in fact all belong to different organisations.
The front office is commonly used to describe the client-facing side of a financial services firm. The relationship managers or sales people are included in this group as are typically the executive personnel and corporate finance. Also, the asset management and trading functions of an organisation are the front office. In other words, the front office is (or should be) a profit centre of an organisation. Functions of the front office will include things happening in the pre-trade environment right up to the time when the trade is executed This will also include things like pre-trade analytics and research and will generally be the point of contact for all things up to the point of pre-settlement. Technology often used in the front office environment will include things like the client-facing technology of the websites managed by the company whether corporate or client-only interfaces for trading and self-directed research. In a study published by Technology Partners International (TPI) in 2006, they estimate that 90% of US-managed assets and 95% of mutual funds use third-party service providers for custody services.
What that really means is that economies of scale do work here. For many small and mid-sized organisations, it is far more efficient to outsource the post-trade processing and corporate functions out of a firm's area of responsibility, if having it done somewhere else will reduce both cost and liability as well as provide a better, more efficient service for our clients. Of the three basic areas, the middle office is probably the most recently developed. In the beginning of modern financial services, front office functions included (much like today) trading, research and sales and administration. The back office was essentially everything else. Since the advent and implementation of technology in the financial services community, the middle office has sprung up as the place where pre-settlement activity now takes place. As the role of technology in the world of financial services has grown, the middle office has been taking an increasingly larger role in the processing of securities and the financial services firm's overall operations as well as managing the implementation of technology across the whole organisation. I mentioned above, that the middle office is involved in pre-settlement activity. But what does that mean? Pre-settlement activity includes tasks such as risk management, profit/loss calculations and netting as well as decisions regarding and implementation of IT resources in all three (front, middle and back) segments of the firm.
This is because the one in the middle of the flow, hence called the middle office, is the department with the best overall view of how the different systems and technologies will interact with each other and the segment that best understands the needs of the other departments. The middle office's job has really become preparing the information flow for the back office and the life cycle of the security through settlement and post-settlement processing activities. The middle office is also most often where the risk management personnel and systems are located. This is where the responsibility lies to advise the executive leadership and the front office that overly aggressive behaviour in search of profits needs to be intelligently balanced and managed. It is also where risk is managed for the post-trade settlement process. More and more, the middle office are the people who ensure that the back office has the necessary tools and mechanisms in place to deal with the increasingly complex nature of the securities being sold and processed at the speed demanded by the firm's clients and the competitive environment in which these firms are operating.
One of the primary ways to accomplish this is by allocating resources, specifically, to enable the required speed and efficiency for back-office processing. Another way in which this is done is by ensuring that the firm is in a position, based on the way that the three areas operate, to implement not only technology for efficiency but that the process is flexible and scalable enough so that if one or multiple pieces of the process can or should be outsourced, they can be with minimal disruption to the rest of the organisation. The back office is the area where settlement occurs and all post-settlement activity is managed. This is the area, traditionally, where outsourcing has been most prevalent. The back office carries out activities like settlements, clearances, record maintenance, entitlements calculations, income processing, regulatory compliance and accounting. One of the back office's ongoing struggles is the chore of keeping up with what the front office is doing.
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