Component Outsourcing - If BMW can do it can our industry
Outsourcing is now a mainstream activity. Custody has been run by third parties for decades and the acid test of a mature outsourced service is the ease with which the operation can be transferred to a new supplier. Transfers of investment books between custodians are efficient and the expectation of success means this process rarely hits the operational risk register. Can the same be said where the middle and back offices of the Investment Manager are outsourced? How many of the big outsourcing deals between Investment Managers and Global Banks have been unwound or transferred to a new vendor?
There are inherent inefficiencies in investment operations outsourcing. The provider is trying to find a one size fits all enterprise model that is extremely difficult to implement. This difficulty is caused by many things including; the range of customer requirements, the explosion of complex security types, creaking operating models and architecture the core of which were founded in the last century. The market place is dominated by solutions that are a mixture of technology layers, disparate systems and manual workarounds. Should it be this difficult? What is stopping the service maturing and the switching of supplier becoming an option?
The Autumn 2009 edition of the ISC Chronicle explored the need for the Investment Manager to establish effective ‘isolation’ from the outsource provider. The flows of data to and from the Investment Manager must pass through effective ‘isolation layers.’ These layers should be present on both sides. The Investment Manager must have its data appropriately structured and maintained before passing it to the service provider through as few ‘pipes’ as possible. The service provider should recognise this data and control and then enhance it. The data should then be passed back to the Investment Manager’s isolation layer efficiently, allowing the Investment Manager to consume it to meet requirements. The common example of this process is the Investment Manager sending executed trades to the service provider and receiving back close of business transactional and positional feeds.
If these layers of isolation are in place and service providers are efficiently performing the process between the layers, then the switching of suppliers may be a conversation that management teams at Investment Managers could contemplate.
Full outsourcing is difficult and compromise is required. The sense that the Investment Manager cannot ask the questions, “where is my trade?” and “what does it look like?” adds to the fear. The Investment Manager has a duty to prepare properly for outsourcing by creating isolation layers and the service provider should try to allay this fear (aka risk). Could the service provider create a ‘middle office dashboard’ that gives the oversight team at the Investment Manager more comfort? Technologies exist to overlay the investment operation process to provide an ongoing view to answer the two questions above - a web-based portal that provides the oversight team with a red, amber, green representation of essential activities. Have all my trades been received? Have all my trades been matched? Are any of my trades failing? What is the status of reconciliation v custody records? How many holdings have stale or missing prices? Is data ready for client reporting? The set of questions is large, matching the number of moving parts in the investment management process. The data requirements are sometimes complex, but this read-only view of client data will reduce the fear and enable assessment of the provider against the Service Level Agreement. In fact the service provider should see this as a selling point, in that claimed service levels can be proved.
But what of those not outsourced? There are a rump of large insurers not outsourced and together with some tier 1 and 2 managers. ISC attended the latest industry conference, TSAM Europe, held this month in London. The outsourcing stream concluded that component outsourcing is more prevalent than full outsourcing. Investment Managers are more interested in outsourcing part of their operation.
I watched one of those ‘How do they do build that?’ programs on TV. The 30 minute program visited the new BMW factory in the USA. This factory builds the off-road ‘X’ range of vehicles and very few clients and dealers fear executing a trade for a new BMW. There is a certainty about the timescale, outcome and quality. But the piece that caught my eye was that BMW actually component outsource. Their phrase was “just in time outsourcing.” The best example is the build and delivery of the car seats. Although having hundreds of different possible combinations of specification, BMW outsource to a third party. On receipt of an order, BMW advise an independent company of the required specification. This company have hours to build the seats and deliver the seats the 12 miles to the BMW factory. The seats have to arrive on the production line 90 minutes before they are required. There is an expectation that this smaller scale component outsourcing meets the standards of quality and timeliness required by BMW. As it is only one component, it is easier to specify and deliver to a prescribed service level. This example chimes well with the trend in component outsourcing exhibited by Investment Managers.
Investment Managers are more comfortable discussing the outsourcing of components like collateral management and NAVs. To match this demand, new service providers are coming to market offering to run functional components like transaction management. The infrastructure and resource costs are mitigated and the Investment Manager’s quality expectations are more easily met. Does this foretell the end of the large, full outsourcing contract in favour of a set of niche providers?
It is 30 months since our last article on outsourcing and the answer may be evident sooner, but we will provide an update on this trend by Autumn 2014.