Boundary Conditions

01 December 2006Features

The back-office handles the grunt work of processing in the financial services industry, but where does it begin and end? You have to know that before you can decide what can be handed off to a third party processor.

Barclays, ING, Deutsche Bank and ABN Amro, amongst others, have been making headlines over the past year with back-office outsourcing deals. Streamlining the business or cutting costs is one reason cited, but the cost of a person in India or any of the now-traditional outsourcing locations compared to one in most of Europe is no longer the only consideration — many are pushing out to improve quality and get a faster time to market. Often with banks which have decades of legacy technology, it is easier to look at outsourcing parts of the process or IT than it is to think about completely re-engineering the back-office which supports a myriad of other processes.

Simon Briskman, a partner in City of London law firm Field Fisher Waterhouse, believes that outsourcing has become an essential tool in the management box and that it is a tool that is here to stay. “I don’t see how you can manage a large enterprise of any sort without considering outsourcing — particularly back-office outsourcing. It is pretty obvious that you can achieve cost savings, economies of scale and often even better business processes and better technology from an external vendor. Add to that the offshoring component which is giving people the chance to do cost arbitrage at the moment and reduce costs even more heavily if they can manage these deals well.”

Boundaries

The back-office seems to be the best place to start outsourcing because it is deep within the financial institution’s belly without much — if any, some would argue — customer-facing activity, which has become a taboo area for most banks in terms of outsourcing. But as with a lot of things, the back-office means different things to different people and the boundaries are continually shifting.

“All the downstream activity is increasingly viewed as administration and, therefore, not core to a fund managers business, which is why we are seeing increasing numbers of fund managers over the past four or five years look to outsource those and the other associated functions,” says Simon Pilkington, vice president of investment operations outsourcing services at State Street, a provider of financial services to institutional clients, who views the back-office as anything post-execution.

Guillaume Weeger, vice president of business development at Calypso, a firm which provides a cross-asset, front-to-back platform for capital markets, agrees but adds that he sees the back-office in charge much earlier. “We see the time and the reaction of the back-office being much more interactive with the front office because the tools are much better and they have an almost instant warning if the limit is broken or if there is a problem with static data. We see the benefits in more interaction rather than change of responsibilities.”

Jeremy Bryson, director of global financial services at consulting and outsourcing firm Atos Origin, argues that payments should also be considered part of the back office. “I think that with a lot of activity going on in the payments arena at the moment both globally and what is going to happen with the Single Euro Payments Area, the back-office should also include payments. The reason for that is it is becoming a commodity process, a pile ’em high, stack ’em cheap service that is done for the bank or white-labelled clients. That is how you treat the associated settlements around investment banking trades or retail banking accounts. It is all about straight through processing, commoditising it, automating as much as possible, streaming that through account management and trading settlement into the payments arena.”

But wherever you draw the line, most agree that the outsourcing decision comes down to the idea of fundamentally getting rid of everything that is not core competency. Many projects have focussed on a direct “lift and shift” approach where the processes are taken offshore and recreated, while the technology, and possibly the applications management, is left inside the financial service organisation. This protects the intellectual property rights of the institution, but limits the outsourcer in the amount of changes it can make. The financial institution is effectively projecting forwards what it has done in the past.

Nigel Roxburgh, research director at the National Outsourcing Association, says that this can lead organisations into a type of cul-de-sac. “[The outsourcer] can change scanning technologies or help desk technologies, but in terms of the core applications which the end user wants him to use, the end user still retains control of those and, therefore, if there is a historical clunkiness in that application, that will never get fixed in this arrangement.”

Roxburgh says that lifting and shifting offshore is a sure way of “knocking 40% off your costs” but that firms are looking further that just a one-off savings. “By using a third party to re-engineer things, you will be able to bring in better practices. You actually save money not just in the bodies of people that are offshored, but you actually save money by recovering money that the business wouldn’t have found that it lost.”

Tim Brazier, head of capital markets at Catalyst, a UK-based consultancy focusing on complex change programmes, including outsourcing, restrcturing and large IT initiatives, recommends that firms should streamline or manage the process to be more efficient, whether it is IT or the operation itself, before handing it over to another. “If there are efficiency gains to be made, you should make them yourself, not give them up to the outsourcer. In general it is best practise, and it is easier to outsource something that has got a good process around it and good control as opposed to something that doesn’t.”

Jonathan Charley, vice president of banking at outsourcing giant EDS, believes that there are two schools of thought: “One is from a number of financial services organisations that feel they need to own intellectual property for they see their IT as a competitive edge. And the other school of thought says that IT specialist organisations are far more likely to invest in that technology, and are far more likely to apply it effectively because it is the primary driver for their business, so it makes sense to outsource that to someone whose business is IT and can deliver a competitive advantage.”

As an outsourcer, State Street has a clear policy that in transactions where it has lifted out and taken on the technology, it looks to move the client off its legacy technology as soon as possible. “It is dangerous to say that our technology is necessarily better — we like to think it is better — because better is subjective, but we certainly have to deliver what our clients are looking for,” says Pilkington. State Street has developed a single integrated platform for investment operations, fund accounting, global custody and transfer agency.

Calypso’s Weeger believes that the technology to outsource the back-office is in place, and there are already instances of entities like funds or smaller banks inside a group that are outsourcing their back-office internally to another entity of the same group or externally like a fund to a prime broker, but between banks there is more of a confidentiality issue, or a perception of such an issue, that prevents a bank from completely outsourcing its back-office to another. He thinks that the banks are not really in the situation where they are ready to accept it because of this issue.

Yet JPMorgan was ready to take the plunge with hedge funds earlier this year. In February, JPMorgan Worldwide Securities Services, a global provider of fund services, acquired the middle and back-office operations of Paloma, a privately-owned investment fund management group, in order to build a complete suite of outsourced services for hedge fund operations and administration. The group is now known as JPMorgan Hedge Fund Services and includes JPMorgan’s own hedge fund admin business JP Morgan Tranaut.

Bank to fund

“This acquisition allows us to immediately offer our hedge fund clients a high quality option — built on top of a hedge fund-specific platform — for outsourcing their daily operations,” Liz Nolan, global head of alternative investment services for JPMorgan WSS, said at the time.

Within three months, JPMorgan had signed its first agreement with London-based Henderson Global Investors. Under the multi-year contract, JPMorgan Hedge Fund Services will provide daily middle and back-office services for Henderson’s hedge fund operations. Henderson employees have been transferred to JPMorgan as part of the deal.

This is an interesting development — where a financial institution is buying the back-office outsourcing capability of a fund manager.

Overall, the trend to outsourcing is continuing and expanding in scope — though maybe at a slower pace than some would like.

Weeger says: “I would agree with the statement that banks should have [outsourcing] on their roadmap. We know that the market is very raw, so if someone pulls the trigger, everyone will follow otherwise the first one will have a competitive advantage. Today all the big players are looking at each other preparing themselves to get it on the roadmap.”

Roxburgh believes that regulations, such as MiFID, will make more institutions ready to go down the outsourcing route. “You are trying to create a level playing field across Europe that will force organisations to re-think [their strategy]. For those that want to start playing across Europe generally, they may look to third parties to supply them with the scalability. Because of the scale, some are not going to be able to do it and will have to find a niche market because foreign competition is going to be piling into their home market. They may look to a third party to come up with ways to create a niche that is defensible based on their expertise.”