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At a time when cost efficiency has become the new world order and regulations are strangling firms, outsourcing almost everything from custody and collateral to data management and derivatives clearing is becoming the norm.

by Joe Parsons

The future of any business in the securities markets is being heavily influenced by cost considerations and the only way to stay competitive is to be efficient. At a time when firms are also being further constrained by regulation, outsourcing vendors are becoming all the rage.
Traditionally, outsourcing has largely referred to the typical back- and middle-office functions an investment manager doesn’t want to do and therefore shipping it to a custodian or vendor. Over the years, it has provided the business model for those securities services providers.
But now regulation is biting hard. Many once profitable business units for banks are now being seen as costly, requiring firms to revaluate many front-and back-end processes.
This includes fund administration, collateral management, cash management, FX, derivatives clearing, reporting, data management and reconciliation.
Suddenly outsourcing is no longer limited. The possibilities are endless.
Perhaps the biggest shift in outsourcing - as a result of the Basel III capital requirements - has been the significant increase in requests from clearing banks for technology solutions.
Speaking at the FIA IDX 2016 conference in London Ray Kahn, Barclays former head of agency derivatives services, said that technology and utility-type solutions are in incredible demand.
“We are all lining up to say ‘do you have something that will make our operations more efficient?’ The reality is that the industry is seeking efficiencies that will allow it to operate at an equilibrium, and we will look for anybody that can provide this,” said Kahn.
This regulatory pressure has formed the bedrock of the FIS Derivatives Utility, which has taken on the post-trade cleared derivatives operations of Barclays and Credit Suisse.
Banks are seeing the workload in their day-to-day operations increase as more products become accepted for central clearing, and this is where FIS see its opportunity.
“From a regulatory perspective, every firm that is clearing has to deal with Dodd Frank and EMIR. Even for the buy-side, these are projects that require changes to operating processes, changes to onboarding, and changes to technology,” says John Avery, director for client and industry engagement, Derivatives Utility, FIS.
“Our solution is focused on about 80% of what a clearing firm needs to do in the middle-and back-office on a day-to-day basis and on a change management basis. With our derivatives utility, we replace what that firm has to do today.”
While it does not remove the responsibility of compliance, it allows firms to use the expertise of the outsourced service provide and simplify these processes.
Avery adds that its derivatives utility is based on a shared resource architecture, with a mutualised, multi-tenant operating model. “The outsourced utility offering is interesting because it not only focuses on the transactional aspect of what a business requires for clearing, but also a significant value proposition through a shared resource approach.”

The impact of regulation has been profound, with many banks and buy-side firms being forced to review what is core and what isn’t to their overall business.
For certain back- and middle-offices which have traditionally operated on legacy systems, the costs of maintaining and managing the IT infrastructure is becoming too much.
“Gradually banks and buy-side firms are having debates about what are core and non-core services,” says Peter Farley, senior marketing strategist, Misys.
“There is a lot of IT costs tied up in back-office operations, and a lot of it needs to be streamlined and made more efficient. Banks will have to be able to redeploy funds to places where you can make a competitive difference in the pre-trade and risk space, and to meet the regulatory demands.”
By finding new cost-effective ways of managing back-office infrastructure, banks are attempting to differentiate what is proprietary and where they are adding core value to their customers.
Certain elements of post-trade space have largely become accepted among most banks as a commoditised function. This has allowed outsourcing providers, particularly technology vendors, to come up with a business model and take on these non-core commoditised functions as part of an overall shared resource.
“People are happy to outsource to those companies [tech vendors] because they have better balance sheets, and they are geared up more for process efficiency and optimisation,” says Rob Scott, head of market services, Commerzbank.
Scott also says that banks are increasingly looking into how FinTech can accelerate cost and process efficiencies, as well as simplifying their core business models.
“When you shift towards outsourcing and inclusion of FinTech it’s important that you retire your old infrastructure in order to drive the quantum IT change needed which typically is now decades old,” he adds.
However, outsourcing commoditised functions to a shared resource has also proved a tough sell for banks which have traditionally remained sceptical to collaborating.
Some post-trade utilities have attempted to overcome this, but to a large extent, have sadly failed. This is largely because banks want to be anonymous and ring-fence their services. Despite this, clients are pushing for enhanced visibility within a shared resource.
“What institutions are pushing for in the pre-trade area is access to platforms that will give them visibility to multi-bank bid-offer spreads across asset classes at the same time,” adds Misys’ Farley. “They will have platforms where they can deal directly with individual financial institutions because the investment banks have put them into place.
“Those investment banks don’t want to share that visibility with the other banks, but the institutions are demanding for it.”

Regulation is also resulting in outsourcing solutions evolving to include a whole manner of back-office functions.
Outsourcing not only involves custody services but is including new functions such as reporting, accounting, corporate actions, data management and collateral management.
This evolution will most likely continue, as firms will have to look across the spectrum of different regulations and review the different processes they can outsource, well in advance of the rules being implemented.
However, Scott also highlights that banks could look for more componentised outsourced solutions that will meet specific demands.
“There will be componentised offerings, which we have seen in the securities services, listed and cleared derivatives space,” he adds. “There will be pockets of solutions that will address specific needs, some of which will have many users and others not that many, but they all achieve the transformation of cost and efficiency.”
Last year Deutsche Bank launched is “Asset Servicing Only” componentised solution, in which banks, broker-dealers and asset managers can outsource their tax reclamations, corporate action processing and custody of assets to its global securities services business.
Graham Ray, global head of product management, investor services, Deutsche Bank, says firms are looking at the relevance and importance of the components they outsource.
“Outsourcing is no longer people-driven and organisational-driven – there is a greater demand to not only look at a business but looking underneath at its products and processes and componentising it. The recognition that one-size doesn’t fit all in outsourcing of services and the identification that some of the changes in the regulatory and infrastructure space are providing new ways to look at business.” says Ray.
“What we have launched is the ability to not just look at businesses as a whole but rather with a component-based architecture, and outsourcing solutions that are relevant for market participants.”
This idea of componentised outsourcing solutions are increasingly appealing to self-clearing firms as greater focus is shifted to the true cost of their trades, efficiencies in the back-office, and the liquidity they need to utilise their operations.
With liquidity being such a precious, yet also scarce resource, some outsource providers are looking to charge for liquidity.
“Banks are progressively beginning to charge for intraday liquidity, charging firms who use their balance to facilitate settlement,” says Jeff Harvey Wells, head of sales, global broker dealer services, Societe Generale Securities Services (SGSS).

With many buy-side firms now forced to carry out a whole range of new processes they traditionally have never had to do, there is - to an extent - an increased reliance on outsource providers.
Take hedge funds for example, outsourcing is part of their DNA with a large part of their back-office being shipped to hedge fund administrators.
“Hedge funds understand managing money, while allowing someone else to take care of their middle-and back-office. They look to take advantage of shared resources that bring competency and technology solutions that they may lack, among providers to make economic decisions,” says Shankar Iyer, founder and CEO, Viteos.
“In the US there was a time where many hedge funds attempted to build internal processes and charge fees based on what they spend. Now they have been challenged to manage costs and fees, and are under pressure to find efficiencies. Large hedge fund that traditionally did everything themselves are outsourcing accounting, reporting, and reconciliation among other functions.”
Outsourcing clearing and collateral management is no different for buy-side firms. According to Mark Downing, head of relationship management, institutional investors at BNP Paribas Securities Services, outsourcing solutions for listed derivatives clearing has become standardised for asset managers. Yet for OTC derivatives clearing, outsourcing is evolving.
“The market is newer and the actors are progressively improving the offering and standardising the reporting thanks to some initiatives like CCS (clearing connectivity standards),” says Downing.
“Even though clearing standards are improving, asset managers are increasingly looking to outsource reconciliation, processing and collateral management of derivatives.”
Even for some of the larger asset managers that are weighing up to perform their own clearing operations through direct membership of central counterparties (CCPs), outsourcing other functions could still be an option.
According to a recent white paper by derivatives consultancy Contango, those self-clearing firms may not be set up or have the credit or collateral available to them to become direct members. The paper argues this would lead to a new type of market participant – a non-bank credit and collateral counterparty.
“These new companies will offer access to credit and collateral transformation services that will enable the clients considering self-clearing to take the decision as to how they want to undertake the clearing of their trades,” the white paper said.
The paper highlights that a credit and collateral counterparty could be combined with a utility operations provider to deliver value and access to markets.

“We cannot see the demand for much more in-house operational risk, so the benefit of outsourcing all of these functions albeit for a fee – not only challenges the status quo, but brings a new dimension of participants and service offerings to the cleared derivatives industry,” the paper added.
There is also a large effort from the buy-side to look more into their middle-office and at analytics to support their front-office functions. According to Joshua Satten, director of business consulting at Sapient Global Markets, this could mean certain buy-side firms outsourcing to systems such as BlackRock’s Aladdin or to Charles River.
While many have had a strong tradition of outsourcing all of their back-office to global custodians, cost-pressures are encouraging them to review who they partner with.
“They [buy-side] are realising they are spending a lot on outsourcing components whereby they always retain the ultimate responsibility from a regulatory perspective, and are asking ‘does it make more sense to take some of these functions back in-house and negate the use of intermediaries?’,” says Commerzbank’s Scott.
In addition, there are now more hirings within buy-side firms for cloud technology specialists, quants, new heads of cash/collateral management and other non-traditional specialists.
With stricter rules over the collateralisation of non-cleared derivatives, having internal oversight of the collateral management process may become of strict importance to buy-siders.
“The buy-side are looking more towards an all-inclusive liquidity and cash/collateral management function out of a need to better manage their cash exposure and related risk,” says Satten.
“They want forecasting abilities and analysis; asset managers need to look ahead five to 10 days into the theoretical future and see what the cash impact could be on their portfolios based on different investments, market fluctuations, and FX movements. They are also looking to glean information from this collected data to better negotiate deals with their brokers.”
This debate around managing functions in-house or choosing to outsource will continue to be at the centre of business decisions as regulations bite. Whether cost consciousness will be the prevailing influence over in-housing/outsourcing for both banks and buy-side firms, time will tell.
What is certain is that outsourcing models are rapidly evolving. Firms have to understand that while they can outsource, overall responsibility and control still lies with them. As regulation and cost efficiencies continue to dominate the landscape, winners and losers may begin to arise in the outsourcing debate.