The SEC’s new rules on outsourcing make big winners out of co-sourcing service providers

The most innovative fintechs mitigate the new burdens that arise from the SEC’s proposed oversight requirements, believes Michael Trinkaus CEO, 4Pines Fund Services.

Fund managers and administrators who have embraced technology in recent years could be the big winners from the SEC’s new proposed rules for investment advisors. Co-sourcing, in particular, is poised to become a preferred approach for general partners, fund administrators, and other financial service providers seeking to comply with the proposed rules quickly and efficiently to mitigate risk.   

The new SEC proposals would impose two new requirements on investment advisers. First, they would need to conduct due diligence before outsourcing certain services and functions. Second, they would need to monitor their service providers on an ongoing basis. If enacted, the new regulations will require fund managers to maintain robust, ongoing diligence reviews and partnerships with service providers who offer future risk-adjusted solutions, such as co-sourcing. 

In co-sourcing, investment managers retain control of their data but outsource services and functions to an advisor. The advisor simply operates within their client’s technology stack. In contrast, when a firm outsources a service or function, an external advisor manages/controls the investment manager’s data and administers the client’s needs using whatever systems they use be it proprietary or otherwise. 

Everyone is outsourcing  

The SEC proposed the new rules because of the explosion of outsourcing in fund management. Sixty percent of asset managers are considering outsourcing, a Northern Trust survey found in July. Regulators want to keep general partners engaged as they increasingly offload more responsibilities to fund administrators and other service providers. 

The trend has led to efficiencies. But many fund managers are still unhappy. Service providers commit errors. They can suffer from high turnover; clients build relationships and then their advisor moves on. Many lack the latest technology. They don’t easily collaborate virtually. They can’t provide documentation and other information automatically. Fund managers deserve better. 

But when a service provider possesses all of one’s data, switching is difficult. One has to migrate that data to a new service provider who may or may not have used the same platform as the previous firm. There will likely be transition costs and snafus along the way where the service provider’s expertise will be essential.  

The SEC’s proposed new rules, however, could trigger audits of fund managers who don’t adopt new requirements and measures to hold service providers accountable. Most importantly, if, under the new rules, investment advisors vet and track their service providers’ performance and find them wanting, they have an obligation to move. Or else they likely face the risk of having neglected their fiduciary responsibilities.

Mitigate risk with co-sourcing 

The proposed SEC rules create a new dimension of risk. Service providers must address this new risk innovatively if they want to compete for the business of fund managers who are constantly asking themselves whether they should outsource, insource or co-source various services. They need to offer solutions that offer a better risk-adjusted relationship, in other words, by offering co-sourcing, the GP owns the software license, not the fund administrator, reducing exposure to risk as the SEC’s proposed regulations call for.

Co-sourcing reduces risk in other ways, too. Fund managers who co-source with service providers keep all of their data. That means they have the information necessary to conduct due diligence and compare how their service providers are doing over time – independently of the service provider. Automation technology today especially makes it easy to see what’s being done, when it’s being done, who’s doing it, and whether or not it was completed. That’s rock-solid documentation that is at the heart of compliance.

Also, if a chief risk officer looks at a service provider’s track record and decides they need to go, the transition costs to new co-sourcing, outsourcing, or insourcing relationships are negligible. The service provider’s systems are not vital to the fund manager. Another firm can replace them. What’s important is that the fund manager owns the data and therefore is in control of their destiny. 

Transparency, real-time information, and collaboration  

Top fund managers are benefitting from the transparency that comes from sharing data with, rather than relinquishing data to, service providers; the communication and closer collaboration that it makes possible; and the access to real-time information it provides.  

The SEC’s new proposed rules will also force service providers to sit upright in their chairs, of course. If fund managers can change service providers more easily and with fewer pains and service providers can quickly and seamlessly partner with financial companies, the service providers can expect to have to work harder to satisfy their clients. Their mistakes will be more costly. Their reputation will be more important. Their value proposition will be tougher. 

Tech-driven fund administrators should welcome the opportunities coming soon. 

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