The risk and reward of contracting out
26 June 2013
The outsourcing of non-core investment manager functions to third-party service providers is increasingly compelling. AST spoke to representatives of BNP Paribas Securities Services about where the bank is picking up business
Image: Shutterstock
Say an asset manager outsources its key operations to a large bank. What happens to the asset manager if that bank goes bust? This was the question posed by the UK’s Financial Services Authority (replaced in April with the Financial Conduct Authority and the Prudential Regulation Authority), in a letter to domestic fund managers last year.
“Our initial discussions and research have identified that the asset management industry outsources a growing number of activities, and that the small number of outsource providers are usually part of complex international banking groups,” wrote Clive Adamson, director of supervision at the FSA at the time.
At a group level, these organisations will have balance sheet exposure to activities other than the provision of outsourcing activities, he said—adding that the FSA’s concern is that if an outsource provider were to face financial distress or severe operational disruption, UK asset managers would not be able to perform critical and important regulated activities, and cause detriment to customers.
Despite this rather alarming hypothetical situation, banks are increasingly keen on snatching up some business from asset managers looking to concentrate on their core activities.
Both Northern Trust and State Street have extolled the benefits of outsourcing certain activity to a large bank (as they would), and BNP Paribas Securities Services is aiming to garner some extra business with the launch of its fully outsourced dealing desks in May, on top of offering outsourcing to banks and brokers for the sell side.
The French bank has two models for outsourcing: a buy-side model, whereby dealing services are offered to asset managers, and a sell-side model, which offers outsourcing to banks and brokers.
In a recent event held by the bank, a discussion took place around the growing trend of asset managers and brokers turning to custodians to benefit from advanced technology and specialist expertise via an outsourced model. The conversation also revolved around the growing demand of companies wishing to outsource further provisions such as the middle office, clearing and settlement, and associated functions.
BNP Paribas Securities Services pointed to Oriel Securities, ABN AMRO’s Neuflize OBC, and Arden Partners, as just some of its clients that experience benefits such as cost control, economies of scale, and transactional services catering for high and low volumes.
Outsourcing dealing
The routing of orders to a third party for execution is one of the two major outsourcing services offered by the bank. Carl James will oversee the business as managing director of the BNP Paribas dealing services arm in the UK, in a service that aims to recruit smaller buy-side firms that typically have difficulty in developing in-house capability.
As well as helping asset managers to keep apace with technology and new trading rules, James explained that other benefits that a large bank such as BNP Paribas could offer included operation in new regions, trading in live markets, and investing in new instruments. He also noted that even a small dealing team can cost from $1 to 2 million a year—a significant outlay for a smaller firm.
BNP Paribas Securities Services can now execute orders directly from portfolio managers of buy-side firms, removing the need for infrastructure or traders, through the dealing services solution.
James said that there were several pertinent reasons as to why the bank has rolled out its solution this year. Increasing market complexity and fragmentation was one, along with increasing pressure to demonstrate best execution from regulators. Post-MiFID II (the EU’s Markets in Financial Instruments Directive), asset managers are finding that the trading arena is far more aggressive than previously, with James mentioning that some pension funds with a dealing desk don’t want to enter into capital markets.
Increased costs of staff, systems and market data, and the drive to separate execution and research within credit support annexes, all mean that the decision to outsource is becoming increasingly valid, he added.
The key clients for the service are pension schemes, multi-boutiques and conventional multi-asset firms with up to $75 billion of AUM. Firms with sophisticated technology and quality traders were not necessarily on the list, James commented that in the case of a recent client, there was no OMS or dealer, but a ‘false dealer’ that acted more as a postman in sending orders onto the broker.
Bank and broker outsourcing solutions
Julien Kasparian, the head of sales for financial intermediaries at the bank, pointed to the spate of headlines over the last two years that suggest that the back office has been pushed to the front of the cost-cutting queue, as part of a larger trend of outsourcing in the sector.
“The equity market is massively shrinking at the moment,” said Kasparian, alluding to research by Morgan Stanley that found European markets accounted for 14.5 percent of global equities by value traded in 2012—less than half of what it was in 2006, when Europe accounted for 30 percent of global value.
In 2012, European markets traded shares worth 11.8 trillion, marking its lowest level since 2003, when the region traded $10.3 trillion.
Using these figures, Kasparian concluded that MiFID has had a severe impact on equity market competition, and that firms need to focus on revenue generation and increasing market share, rather than any tertiary functions.
It appears as though the trend towards outsourcing is becoming topical, as firms scrabble to reduce costs following (or in the run up to) the European Market Infrastructure Regulation, the US Dodd-Frank Act, the EU Financial Transaction Tax, and a whole other host of regulatory change—though systemic risk continues to be the elephant in the room.
But what if the banks can promise due care and diligence from the chief executives, robust service level agreements, and good exit strategies? The future may be rosy for placing your non-core businesses into the more-than-willing hands of a big institution.
“Our initial discussions and research have identified that the asset management industry outsources a growing number of activities, and that the small number of outsource providers are usually part of complex international banking groups,” wrote Clive Adamson, director of supervision at the FSA at the time.
At a group level, these organisations will have balance sheet exposure to activities other than the provision of outsourcing activities, he said—adding that the FSA’s concern is that if an outsource provider were to face financial distress or severe operational disruption, UK asset managers would not be able to perform critical and important regulated activities, and cause detriment to customers.
Despite this rather alarming hypothetical situation, banks are increasingly keen on snatching up some business from asset managers looking to concentrate on their core activities.
Both Northern Trust and State Street have extolled the benefits of outsourcing certain activity to a large bank (as they would), and BNP Paribas Securities Services is aiming to garner some extra business with the launch of its fully outsourced dealing desks in May, on top of offering outsourcing to banks and brokers for the sell side.
The French bank has two models for outsourcing: a buy-side model, whereby dealing services are offered to asset managers, and a sell-side model, which offers outsourcing to banks and brokers.
In a recent event held by the bank, a discussion took place around the growing trend of asset managers and brokers turning to custodians to benefit from advanced technology and specialist expertise via an outsourced model. The conversation also revolved around the growing demand of companies wishing to outsource further provisions such as the middle office, clearing and settlement, and associated functions.
BNP Paribas Securities Services pointed to Oriel Securities, ABN AMRO’s Neuflize OBC, and Arden Partners, as just some of its clients that experience benefits such as cost control, economies of scale, and transactional services catering for high and low volumes.
Outsourcing dealing
The routing of orders to a third party for execution is one of the two major outsourcing services offered by the bank. Carl James will oversee the business as managing director of the BNP Paribas dealing services arm in the UK, in a service that aims to recruit smaller buy-side firms that typically have difficulty in developing in-house capability.
As well as helping asset managers to keep apace with technology and new trading rules, James explained that other benefits that a large bank such as BNP Paribas could offer included operation in new regions, trading in live markets, and investing in new instruments. He also noted that even a small dealing team can cost from $1 to 2 million a year—a significant outlay for a smaller firm.
BNP Paribas Securities Services can now execute orders directly from portfolio managers of buy-side firms, removing the need for infrastructure or traders, through the dealing services solution.
James said that there were several pertinent reasons as to why the bank has rolled out its solution this year. Increasing market complexity and fragmentation was one, along with increasing pressure to demonstrate best execution from regulators. Post-MiFID II (the EU’s Markets in Financial Instruments Directive), asset managers are finding that the trading arena is far more aggressive than previously, with James mentioning that some pension funds with a dealing desk don’t want to enter into capital markets.
Increased costs of staff, systems and market data, and the drive to separate execution and research within credit support annexes, all mean that the decision to outsource is becoming increasingly valid, he added.
The key clients for the service are pension schemes, multi-boutiques and conventional multi-asset firms with up to $75 billion of AUM. Firms with sophisticated technology and quality traders were not necessarily on the list, James commented that in the case of a recent client, there was no OMS or dealer, but a ‘false dealer’ that acted more as a postman in sending orders onto the broker.
Bank and broker outsourcing solutions
Julien Kasparian, the head of sales for financial intermediaries at the bank, pointed to the spate of headlines over the last two years that suggest that the back office has been pushed to the front of the cost-cutting queue, as part of a larger trend of outsourcing in the sector.
“The equity market is massively shrinking at the moment,” said Kasparian, alluding to research by Morgan Stanley that found European markets accounted for 14.5 percent of global equities by value traded in 2012—less than half of what it was in 2006, when Europe accounted for 30 percent of global value.
In 2012, European markets traded shares worth 11.8 trillion, marking its lowest level since 2003, when the region traded $10.3 trillion.
Using these figures, Kasparian concluded that MiFID has had a severe impact on equity market competition, and that firms need to focus on revenue generation and increasing market share, rather than any tertiary functions.
It appears as though the trend towards outsourcing is becoming topical, as firms scrabble to reduce costs following (or in the run up to) the European Market Infrastructure Regulation, the US Dodd-Frank Act, the EU Financial Transaction Tax, and a whole other host of regulatory change—though systemic risk continues to be the elephant in the room.
But what if the banks can promise due care and diligence from the chief executives, robust service level agreements, and good exit strategies? The future may be rosy for placing your non-core businesses into the more-than-willing hands of a big institution.
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