AST explores the move into middle office outsourced services with Denis Orrock, the CEO of GBST Capital Markets
Are custodians geared up with sufficient IT infrastructure to offer these services in single and multi-market mode, or do custodians or sub-custodians need to look at embracing technology change in order to service their customers in the post-trade space?
As providers of custody and sub-custody services look to increase revenues, they either look to win new clients off their peers or to develop and deliver new services or extend existing ones. An area that is gaining significant attention and indeed traction from a number of global custodians is provision of middle-office services, to their broker dealer clients. Now, although many have well architected custody systems, they lack the necessary workflow and transaction management functionality to move further up the post-trade life-cycle in provision of such middle-office services. It must be remembered that the custodian or service provider is now offering to take on more of the broker’s operations than simply clearing and settling that broker’s trades.
To deliver this middle office service, the provider looks to:
Operate the brokers existing back-office platform, assuming it has a sufficiently proficient middle-office functionality;
Invest heavily in developing its own middle-office solution; or
Look to migrate clients onto third-party centralised multi-entity, multi-market middle-office platform.
In order to reduce total costs of middle-office services, the middle-office functions need to be highly automated and exception management kept to an absolute minimum. The timeliness of exceptions is also critical to middle-office function as brokers typically have significant SLAs (service level agreements) with their end clients with regards to the time it takes them to receive their allocation notifications. In the pursuit of middle-office service provision, custodians and sub-custodians need to ensure that their processing is more efficient than their broker clients.
The general trend we’re seeing, across Asia in particular, is one where there is acknowledgement that traditional custody systems are lacking the level of functionality that is required to support these time critical middle-office functions; as such, providers are investing in their technical infrastructure to deliver cost effective centralised multi-entity, multi-market middle-office functions on platforms that can readily complement their existing custody platforms.
We see these middle-office services gaining the attention of customers but are they looking for regional solutions, or simply single market?
Again, if we took Asia as an example, we are seeing brokers looking to achieve a variety of initiatives across various markets. It’s not necessarily one size fits all, nor does it have to be an across-the-board adoption of outsourced middle to back-office services by any one organisation. Clients can look to outsource specific markets or a group of markets. With custodians and sub custodians typically having regional exposure it only makes sense for them to offer their clients a multi-market solution and solve a broader cost centre problem for their clients.
However, that does not necessary mean throwing the baby out with the bath water either. There is certainly a general desire from some brokers to maintain their own middle to back-office infrastructure in their hub markets. In Asia, that’s generally Japan and/or Hong Kong/Singapore. That presents a tremendous opportunity for the service provider to look at those non-hub markets on a combined regional basis and putting forward an even more compelling proposition.
How are the frontier markets evolving in the post-trade environment with regards to service provision? Given green field opportunities, are they developing broader service adoption?
I would not go so far to say that the frontier markets will drive the broader adoption of outsourced middle to back office services. It’s more the consolidation of the mid-size regional markets onto a standard technology platform and service delivery that is driving the adoption of these services. However, given that the frontier markets don’t necessarily have well entrenched operational infrastructures, middle-office services in particular can be more readily delivered as an extension to a regional platform.
Are custodians and sub-custodians struggling to build economic service deliveries due to lower volumes in frontier or developing markets?
In these frontier or non-hub markets, given their relative lower volumes in comparison to the hub-markets, it actually makes economic
sense for brokers to outsource as much of the middle to back-office function and turn the fixed operational costs associated with their own back-offices into a variable cost. If we assume that the outsource service provider can spread their costs across more than one client, and indeed across multiple markets, using a single platform, then their effective cost per transaction reduces across all their clients, across all their markets. This assumes that their technology platform enables them to readily scale the business without increasing operational overhead across these multiple clients and markets. This allows even the lower volume markets to be cost effective propositions for both parties.
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