Last Thursday, BNP Paribas held its fund management industry conference. The trend towards front, middle and back office outsourcings was discussed, as well as the impact of big data and Brexit on the industry.
There is a trend towards investment managers looking at outsourced solutions. We often see the bundling of middle and back office functions – for example, middle office bundled with back office functions such as fund administration, accounting and transfer agency. The conference took this further and considered whether there is a new dawn for dealing desks as investment managers are increasingly outsourcing dealing services as part of a bundled arrangement.
What is driving the trend?
The key drivers for outsourcing by investment managers are:
- Cost: There are numerous costs associated with performing services in-house, including staffing costs, market data costs and other indirect costs. By outsourcing functions, an investment manager can benefit from the economies of scale driven by the multi-client platform of a professional services provider. The fee/cost provisions in an outsourcing agreement need to be fully-scoped and comprehensive to avoid any hidden costs or inappropriate day rates.
- Capability and scale: It is the business of professional service providers to be at the forefront of innovation and technological changes, for the benefit of all of their clients. By outsourcing, an investment manager can benefit from these technological advances on a large scale which drives onward efficiencies and time savings to the benefit of the investment managers and their clients. It can also improve execution outcomes. We expect investment managers to seek to include appropriate contractual obligations in their outsourcing agreements to ensure that providers deliver and drive service improvements to the manager and to ensure they implement them for the benefit of the manager.
- Operational risk: In the event of an issue or error that causes an investment manager (or its clients) a loss, it can seek to recover that loss from the service provider. This is not an option if the services are provided in-house. In order to recover its loss, the investment manager must include sufficiently robust liability provisions and we suggest including a list of deemed direct losses in the outsourcing agreement to ensure key losses are recoverable.
- Global operating model: Investment managers who want to expand the scope of their operations or provide coverage on a 24 hour basis can outsource, for example the dealing function, to service providers in certain regions. A provider’s global operating model can also mean that the investment manager benefits from established relationships (with, for example, front office providers) which in turn leads to the other benefits mentioned here. Mike Ritchie, Global Head of Aladdin Implementation at BlackRock Solutions, spoke about the strengths of BlackRock’s global operating model in the context of Aladdin implementation. It is important to ensure that an outsourcing agreement includes detailed implementation provisions including key milestone dates and any specific dependencies on the manager.
- Regulation: Regulators are increasingly focused on outsourced arrangements and the levels of oversight and engagement that an investment manager has over its service provider. Increased scrutiny from regulators means that regulatory change is a key consideration. By outsourcing, professional service providers can help spot upcoming regulatory changes and can implement those changes for the benefit of all of their clients. The key point for investment managers is to ensure that they have oversight and scrutiny over their service provider, whether through detailed governance or change control arrangements, KPIs or service credit mechanisms. Investment managers also need to ensure they have robust regulatory change provisions in their outsourcing agreements.
- Regulatory support: Professional service providers can offer regulatory support. This could be in the form of, for example, trade and transaction reporting. In an increasing world of regulation across multiple jurisdictions, this can be of significant benefit to investment managers. These regulatory support services will need to be built into the service descriptions and SLAs.
How does Brexit impact the industry?
David McCarthy, Manager, Brexit and International Policy at the Investment Association, spoke in detail about the impact of Brexit on the investment management industry.
Whilst Brexit remains an uncertainty for everyone, it is interesting to note that there are exciting opportunities for the investment management industry post-Brexit. The UK provides 37% of AuM in Europe, and is second only to the US as a global hub. The ambition in the UK is to double total AuM over the next 10 years, largely in emerging markets in Asia and Latin America.
The UK, therefore, is well-placed to capitalise on global trends, such as:
- worldwide assets are predicted to continue to rise to approximately $100trn by 2020 (a compound growth rate of nearly 6% per year);
- demand for assets are likely to strengthen as banks continue to deleverage and alternative sources of finance are sought. This is combined with a growing preference of governments in developed countries to use the private markets to fund investment to fill the infrastructure gap; and
- the growth of financial technology solutions and intensifying global competition will require investment managers to be more innovative and adaptable in order to attract future investors, especially on sustainability.
All of these trends indicate how important outsourcing will be going forward. Investment managers are likely to look to professional service providers to help meet demand and to keep at the forefront of innovation, technology and service improvements in order to keep up with global competition post-Brexit.