The Strategic Shift to Middle-Office Outsourcing
Typically charged with an array of critical post-trade functions including position keeping, derivatives monitoring and more, increased demand for sophisticated investment strategies has made the middle office more vulnerable to fragmentation. By outsourcing these services to a specialist third party, buy side managers can relieve pressure on the middle office while also gaining access to a range of invaluable services such as custody, fund administration, oversight and safekeeping.
As in past years, outsourced demand has been fueled by factors like front-office synchronization, streamlined data processing, and, more recently, the need for advanced cybersecurity protections. With investment products growing in complexity and spanning a wider range of markets and asset classes, more than ever managers require greater transparency around asset valuation, process monitoring and other areas in order to satisfy both regulators and clients. Key to this effort is proper integration of the middle office with front- and back-office systems, using automation to create a more effective system of data gathering across multiple sources, thereby reducing the likelihood of siloed activity.
While funds with deeper pockets could conceivably acquire the tools necessary to achieve enhanced inter-operability, demands on personnel, along with the push towards fully independent accounting, reporting and risk-management protocols, makes seeking a qualified third-party an increasingly attractive option for traditional and alternative managers alike. Rather than devote copious amounts of investment capital to ensure data is effectively managed and kept secure, even Tier 1 managers are now considering handing off to a provider who is better equipped at handling these tasks.
Indeed, enhancing the middle office not only means having the right tools for the job, but also ensuring solutions are properly integrated with a firm’s existing technologies, and are flexible enough to meet the needs of a perpetually changing marketplace.
Along with current mandates such as Dodd Frank, Form PF and FATCA, the issuance of newer regulatory rules has been front-and-center among firms seeking outsourced assistance. These include the recent transition to a two-day settlement cycle under T+2 in the US, as well as the ongoing phase-in of regulations around variation and initial margining of non-cleared derivatives products (the latter impacting in particular smaller buy side firms with minimal derivatives exposures that nonetheless must get up to speed in terms of regulatory compliance). Providers can help fund managers reduce their workload through solutions that can facilitate management oversight, thereby allowing companies to know where their exposures are and whether the data they’re reporting is accurate.
CYBERSECURITY TO THE FORE
In the effort to build a faster and more efficient marketplace, the securities industry has in many ways made itself increasingly vulnerable to rogue cyber activity. While large-scale fund companies have yet to be directly impacted, the growing interconnectedness of the exchanges, clearinghouses, broker-dealers and asset managers is such that even minute breakdowns resulting from a hack attack could lead to major problems, potentially putting investors in harm’s way.
Not surprisingly, the Securities and Exchange Commission (SEC) and other oversight agencies have underscored the need for market participants—asset managers included—to seek strategies for countering these risks as a precautionary measure. Accordingly, utilizing a provider’s fully secure, streamlined systems can bring real peace of mind to management teams.
Today asset managers must be able to analyze and organize vast amounts of internal and external information in order to fully achieve control of their data. Lack of integration between front, middle and back offices, however, can hamper this effort, making breakdowns more likely. Data that requires constant recalculating due to insufficient or outdated technologies only worsens the problem, leading to potential redundancies that in turn sap funds of precious energy.
It would be one thing if the average middle office had the wherewithal to keep pace with the constantly changing investment and regulatory environment. However, today many operations still rely on yesterday’s solutions, including outdated Excel spreadsheets and other manual processes. As fund information grows in complexity, maintaining inadequate or outdated systems only increases the chances for data siloes and other transmission errors.
While a global enterprise with more jurisdictions to monitor would appear to be the best candidate for middle-office outsourcing, in reality companies of all sizes can benefit from having an expert in the field, one that allows the fund to devote fully to their core competencies. Without having years of legacy systems to unwind, for instance, boutique and other micro fund managers may be able to get up and running with an outsourced solution that much faster.
Looking ahead, managers face steadily increasing regulatory and compliance costs, not to mention a challenging distribution landscape. Thus, for firms with only limited in-house resources, the ability to access a more efficient, secure and technologically advanced middle-office architecture on an outsourced basis will continue to win converts within the fund industry, particularly as concerns around beta and cybersecurity become more front-of-mind.