As financial services firms continue to create, sell, service and manage increasingly complex financial instruments, for example derivatives, the back office is often playing ‘catch up' once these instruments have been issued and sold. This is because, they are the ones responsible for managing the asset and subsequently processing any corporate action having to do with that security. In the next few lines, we will examine in more detail how these three areas of a financial services firm work together to satisfy the needs of their customers and how they continue to work towards a fully Straight Through Processing (STP) environment for the processing of corporate actions for securities. The landscape in the United States changed in the late 1990s. Earlier, investment legislation, dating back to the wake of the stock market crash in 1929, distinguished banks from investment banks and insurance companies with regard to who could do what.
Almost 65 years of established law ended in 1998 shortly after Citicorp and Travelers merged creating Citigroup. This was the beginning of a convergence model in the US market that has had wide-ranging implications. One such impact has been the adoption and common use of the term ‘financial services' to describe the US (and latterly global) banking and investment industries. Some will argue that this was a necessary evolution given the global nature of the banking and investment industries today and that the United States had to adjust their laws in order to remain competitive in the modern era. The historic distinction of banks versus investment companies was due to the Glass-Steagall Act, passed in 1933 during the Great Depression. Officially named the Banking Act of 1933, the legislation introduced the separation of banks according to their business type (commercial or investment banking). In 1999, the Gramm-Leach-Bliley Act was enacted, which repealed the Glass-Steagall Act of 1933. One impact of this repeal is that certain advisory activities of the banks are now regulated by the Investment Act of 1940. It also enabled investment and insurance firms like Travelers (which owned the investment firm Salomon Smith Barney) to combine their operations with traditional commercial and retail banks like that of Citicorp. This merger was just the beginning.
While there are other examples of firms from either side of the industry combining, the merger of Citicorp and Travelers was the first and remains one of the high-profile mergers. The trend continued with other banks either merging with, or building their own investment and trading businesses, and traditional investment firms either combining with, or starting their own banks. This activity has ushered in an era of combined, one-stop shops for ‘financial services'. This began, in the United States, a dichotomic trend in which there was on the one side a creation of financial supermarkets and on the other side, particularly for the smaller firms, a growth in the trend of outsourcing the back office. The trend of convergence which began with the Citicorp Travelers merger, while spurring tremendous development in the financial services industry has also served to create many challenges for the financial services industry. By removing the limitations of banks, insurance companies, investment banks, private banks, custody banks, commercial banks and brokers on their operations, the landscape has become more complex. At SWIFT's annual SIBOS conference in Boston in 2007, Michael Clark, then Executive Vice President-CEO of Global Security Services of JP Morgan Chase, said that the term custodians or global custodians doesn't really describe the function of what they do anymore and suggested that a more accurate designation would be to call them, ‘global asset servicers'. Mr Clark was on the panel at the Securities plenary session and during the discussion suggested that there are many ‘elements of change' which are driving the direction of the way the front, middle and back offices interact with each other. These elements include global investment and trade, new product development and the increasing complexity of investment instruments.
Mr Clark described the need for real-time pricing and processing, and competitive pricing by the asset servicers necessitates the need for scale to provide a comprehensive, compliant and efficient middle and back office. He was joined on the panel by Jay Hooley, Vice Chairman and Head of Global Securities servicing at State Street who cited an article from the Economist entitled, ‘Is the middle office, the new back office', the premise of which was to discuss how the traditionally back-office functions of settlement and clearing, as well as the processing of post-trade corporate actions like proxy voting and claims processing, were the areas most likely to be outsourced. Now that is being mirrored in the middle office environment of risk management, pre-settlement activity like netting and IT implementation as these functions are more and more being handled by outside technology and other service providers. The difference from the current landscape is that, the spending Mr Hooley advocates on ‘client-facing technology' will also serve to assist the middle and back office in processing.
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