AST: How has the financial crisis affected the asset servicing industry?
Geoff Harries: One of the major developments we have seen as a result of the financial crisis is tighter control on exposure management - be that to clients, or counterparties - and there’s a greater focus generally on understanding requirements for recent directives and regulations at a global and regional level.
As part of the response to regulations focussed at improving investor confidence there is now a broader a more holistic approach to derivatives operations impacting institutions, intermediaries for specific instruments. Historically, this has been seen as a silo within an organisation, but there have been moves on both the operational and regulatory sides to move to vanilla swaps, a retrenchment in terms of risk profiles. So there’s been a move to streamline operations, by folding the derivatives part of the business into the main organisation and looking at what operations are actually skilled-up to support.
DST is positioned as the place to aggregate all that information from both an investment accounting and asset servicing perspective. We can consolidate down at the accounting level whilst there may be specialist systems managing the trading and confirmation flow. For example, there are issues with corporate actions on underlying securities and post trade activities such as payment schedule cashflows and resets that have to be managed. The key has been in people understanding what the exposures are and how exposed the positions can be and ensuring that the operation is streamlined to process the post trade events.
So counterparty risk is high on the agenda. If counterparties start to default, it’s vital to know what the implications are. The catalyst for the increased information is the demand from fund industry clients who want to know what their exposure is - do they need to make a provision, what would happen in the event of a default and what is their ultimate exposure?
When Lehmans collapsed, it took some insurance companies months to know what their exposure was. Now, clients want to know the next day. And they want to know that there is good governance around the process of ensuring transparency of activities.
AST: What are clients demanding of their asset servicers?
Harries: Asset managers have the principle liability and exposure, and are accountable for fund performance. Asset servicers have a slightly different responsibility, both in the middle and back office need the ability to identify and report out exposures, while the asset manager retains the responsibility for changing strategy and monitoring the market, whilst the asset servicer may provide this as a value added service, the asset manager needs to be comfortable that outsouring this process has adequate controls around it.
Clients are looking to the asset servicing industry to provide increased transparency, as the cost of operations to do this on a single client basis is often prohibitive, and the options are not to trade, or find a cost effective way to process the increased operational responsibilities, asset servicers offer that economy of scale, if they can source and retain the required knowledge from a scarce market resource pool.
We have clients with multiple installations of HiPortfolio across the world. Some clients are sat across regional centres, so to get a consolidated view of their exposure its necessary to pull it together from those hubs.
AST: What are the key challenges that asset servicers are facing?
Harries: You have to put it in context - the response to the crisis may be topical but it’s not the only challenge being faced. Asset servicers face severe challenges in meeting the requirements of both regulators and their clients, there are real cost pressures. We are supporting them to meet those challenges through better usage and optimisation, creating more efficiency in their business processes. These asset servicers are really getting squeezed - SLAs are so much tighter, which means the only way to maintain profits is to be more cost effective.
We worked with a lot of clients in looking at what success means in terms of the mandates they can win and how they better service their existing clients. The business reference is to be the best in class, and often that creates a work programme to get higher up the table in the benchmarking space for key service offerings such as Unit Pricing
AST: What is best in class?
Harries: It’s about the quality of service provision. If you outsource a business function and have to put in a lot of time and money implementing controls to catch service quality, the benefits of outsourcing are eroded. You waste time, maybe you have to mirror processes, and you end up spending the money you were expecting to save. Timeliness is key; having the information presented late will disadvantage the fund manager who has outsourced. And it’s important for the fund manager to have visibility of anything that has changed.
Given that the objective has been to outsource the middle and back office so the fund manager can concentrate on fund management, if the outsourcee still has to carry the burden of back and middle office functions, then that agreement has not succeeded.
Much of this is about business process efficiency and technical innovation to ensure scalability - asset servicers need to invest in their technology and infrastructure. The cost of the investment is spread across a number of clients, which should lead to service innovation and operational efficiency.
AST: How efficient is the asset servicing industry?
Harries: Historically the quickest way to transition was to have the asset management business lifted out and dropped in to the asset servicing world without a change in technology - this means there wasn’t time to develop a strategic platform and economies of scale are harder to achieve. The opportunity to implement best practise is lost, harmonised processes across clients are not achieved and the asset servicer effectively gets caught in a business as usual trap servicing the client with a dedicated team trained in specific client oriented operating procedures.
We see our clients executing programmes of optimisation of their system in areas such as corporate actions and derivatives processing aswell as continuous improvement in the area of Unit Pricing. It’s not a revolution in any of these businesses, more a programme of constant operational improvement.
AST: Does this mean it’s easier for a smaller firm to bring in new, leading edge, technology to compete with the big providers?
Harries: The biggest and best firms are out there defending their positions through investment in their core systems and goals to develop strategic platforms. If they don’t, they’ll probably still be ok with their existing clients, but they’ll find it increasingly difficult to bring in new clients effectively. They are constantly updating their technology to stay ahead. It’s an intensely competitive market, in any selection process there will be a fairly predictable shortlist and getting the new business in is very tough.
AST: How are providers looking at their technology? Do they prefer to have their own in-house systems or are they keener to go to specialist firms?
Harries: Outsourcing continues to be a trend for the asset management community, both of operational functional and infrastructure. We’re also seeing a number of clients in the asset management community choosing a halfway house. Their technology is hosted in a managed application service whilst they retain running their own middle and back office ,but they don’t want to be responsible for the infrastructure.
There are firms who want to keep their operations close to their brand and don’t have the philosophy or culture to outsource. And depending on the type of operation you have, it may not be the type that lends itself to outsourcing.
So in terms of offering a hedge fund process or derivatives process, that’s something they’re likely to be developing in house. Five years ago, asset services companies weren’t specialising in hedge fund administration. But now the lines between hedge fund management and investment fund management are blurring, so if you are looking to outsource you will find there is more ability to take it on.
AST: Who is driving this development? Is it fund managers wanting to outsource more, or is it the asset servicers themselves who want to be able to offer more products?
Harries: It’s a bit of both. People have SLAs they have to complete. So if you add more business capability to your platform, you have to ensure you can still meet your contractual requirements.
You will also get pressure from your clients - if they want to launch new products, you have to be able to respond. And regulations will have to be responded to as well - if they have implications for the fund industry, they will have implications for the asset servicing side. So the asset servicer will need to amend its provision to support its clients. And of course the final driver is the need of every asset servicer to be as efficient as possible.
AST: Why is there a lack of efficiency in some areas?
Harries: Some if it is historical in terms of mergers and acquisitions in the investment management world - the asset servicing provision may not get streamlined so you end up with a bit of a jigsaw, with one bit of work done by company A, another done by company B.
Then product lines are often segmented, so you may have mutual funds and OEICS run separately from life and pensions funds, possibly with derivatives going to a boutique provider. It’s common to find segmentation on a geographical basis as well, so you have this complex arrangement in terms of location and asset class. And this makes it much more difficult to restructure the asset servicing position.
The way many firms operate tends to be the practical way, rather than the most efficient way - not everyone has the luxury of being able to restructure to become the most effective.
AST: What do you see taking place in the future?
Harries: We see a lot of component outsourcing; firms don’t want to lift out everything but prefer to move over specific services, segmenting middle office functionalities or derivatives servicing for example.
I think we will get used to people who are able to support multiple outsourcing relationships, so the fund manager is not reliant on one single asset servicer. This will happen over the next three to five years, but it will be dependent on the asset manager being able to put the jigsaw together and manage the information from multiple providers. Technology innovation will drive that, as will competition from the asset servicing providers to win parts of mandates rather than the complete book of business.
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