Investment Operations Outsourcing - Outsourced and Isolated
Over the last decade the out-sourcing of investment management functions has matured from the provision of custody services and net asset value (NAV) calculations, to complete lift-outs of back offices and transitions to full competency enterprise platforms. However, across many of the arrangements between Investment Manager and outsource administrator has operational excellence been maintained and does the optimum operating model exist? It is probable that two optimum models exist, one at the Investment Manager and one at the administrator, but are these models harmonious? The key component in achieving harmony and a reduction in operational cost is having a strong, well-defined and flexible isolation layer between the two models.
The Isolation Layer
The isolation layer is the layer of technology or process that exists between the two parties in the outsourced arrangement, capturing and controlling the flow of data and information between the parties. Isolation should occur at two points between the Investment Manager and administrator; the first controlling the flow of data from the Investment Manager to the administrator, and the second controlling data flowing in the opposite direction. An example of ‘outbound’ isolation could be the point in the lifecycle of a transaction where outsourcing occurs, typically this at the point of trade execution. The delivery of data back to the Investment Manager for inclusion in formal client reports is one of a number of flows that should cross the ‘inbound’ isolation mechanism.
These two points of isolation are important as they determine how the parties to the outsource agreement; connect, exchange data, manage the service level agreement, ensure operational efficiency and lower operational risk. Business critical data flows across the isolation layers and it is important that they are robust and effective, collecting or presenting business critical data in a complete, accurate and timely manner.
Establishing the isolation layers is one part of the jigsaw that delivers operational excellence. The second part is to understand and document fully these isolation layers. They do not have to be a single application, but could be comprised of multiple applications or processes servicing the touchpoints across the isolation layers. These touchpoints are typically flows of data (i.e. transactions, positions, reference or market data) supported by a technical or manual process and each touch-point requires a detailed, up-to-date specification.
When the isolation layers exist and the touchpoints that link two potentially diverse operating models and business cultures are fully understood and documented, what extra benefit can be derived?
Benefits for the Service Provider
Linking two operating models efficiently should lower the operational cost of outsourcing. More automation, applied appropriately should lower the cost of administering each transaction, and provide the ‘where is my trade, what is its status’ transparency to the Investment Manager.
The providers of outsourced investment management functions are able to isolate their clients (the Investment Managers) from change. The administrator may need to rationalise lifted-out platforms to a single enterprise platform, or implement new applications within the enterprise service. Ensuring that data is presented to the isolation layer consistently from lifted-out architectures to enterprise platforms may isolate the client from this change. Depending on complexity and how business critical the functions involved are, the client may only need to regression test the change. In the worst case the detail specification of the touch-points across the isolation layers will determine the size and impact of the change and direct the appropriate level of testing. The existence of isolation layers gives the administrator the ability to receive and present data consistently, efficiently, and accurately. This ability helps enable administrators to deliver true multi–client platforms and differing levels of service from standard through to bespoke. Providers of outsourced services want to demonstrate an improved ability to handle complex asset types, fund structures and regulatory change. Additionally these providers want to deepen relationships by offering a broader service, demonstrating an ability to service more middle office functions and provide an extended range of post-accounting functions such as; collateral management, performance measurement and client reporting, either as bundled or unbundled services. Efficient isolation layers will also enable administrators to complete more transitions of new clients per year onto their enterprise models improving revenues and profits at the margin.
Benefits for the Investment Manager
One of the primary benefits that should exist in each outsourced arrangement is that the operation outsourced has benefited from lower operational risk at a lower operational cost with improved quality of data. Good isolation layers will ensure that all three of these attributes exist for the Investment Manager.
The isolation layers ensure that transactions and data delivered by the Investment Manager are received correctly and errors can be managed on an exceptions basis. Similarly, data received supports functions like client reporting, performance measurement and updates to front office systems with the most appropriate degree of granularity.
Sending and receiving data between two harmonised operating models ensures the Investment Manager can have the confidence to entrench core competencies and broaden the differentiators of its brand that are important in winning and retaining clients. These differentiators may be enhanced client service evident in content-rich, bespoke client reports, or the ability to transact complex derivative instruments required by specific investment products. As well as reducing operational risk and supporting a wider service offering, the existence of isolation layers provides the Investment Manager with the ability to achieve operational economies when delivering or reacting to change. Change introduced by the administrator can be more efficiently tested and implemented as the impact can be precisely determined by review of the affected touch-points. This allows change-control resources to be applied at the appropriate time and in the right quantities.
Outsourcing may have split a high-quality operation into two parts, buts the benefits of applying good layers of isolation between the two parts are evident. If applied correctly isolation layers provide; operational efficiency, risk reduction, an enhanced brand and allows a service offering to broaden, whilst allowing marginal revenue and profit gains for both parties in the outsourced agreement.