With outsourcing of non-core functions becoming a key concept in a wide range of industries over the past few years, it was widely predicted that fund managers, under pressure to deliver good investment returns for their clients, would begin to outsource everything not central to the management of portfolios. Growing complexities in back and middle office systems linked to an increase in cross-border trading has helped push this concept.
"The whole STP discussion means that whether you’re a custodian, manager, or broker dealer you need to put in the resources to understand the issues and meet the requirements," says K.K. Tse, State Street's chief executive for investor services Asia. "Certainly for fund managers Y2k was a major challenge and now with T+1 for US settlement scheduled for 2004, and with Omgeo and GSTP there is another big challenge on the horizon. Many managers are wondering why they are expending resources to even try to understand it when they can find a provider to take care of it for them."
Outsourcing this area of the business, which is becoming increasingly complex, is something that has been talked about for several years but most of the deals so far have been done with the largest custodians and investment managers. Moving a large piece of the back office or middle office to the custodian bank's operations, where it is typically set up as a separate unit, is a big change to make but one that the likes of PIMCO, Scottish Widows and Merrill Lynch - organisations with over 100 billion in assets – have embraced. By outsourcing to their custodian State Street they don’t have to spend resources dealing with the complex evolution of industry and vendor-led matching engines and issues relating to settlement speed.
"The custodian banks have to do all of this anyway so there is a logical relationship between manager and custodian developing whereby the custodian takes on the back office and or middle office role from the investment managers."
But Tse says that the idea has not really taken off in Asia yet, for reasons of scale and also reluctance to change business structure.
"I believe fund managers think they can still manage their back office cost effectively within their own organization and they probably don’t want to fire anyone in the process," he says. "They may also have concerns about keeping certain proprietary information within the organization. These are the two main reasons it hasn't taken off in Asia yet. However I think the investment management community might come to realise the benefits of outsourcing over the next 5-10 years."
Investment managers have actually been outsourcing certain aspects of their business for a long, long time in appointing custodians, administrators and using vendors for computer hardware and software systems. But the outsourcing of entire back and middle-office operations is a bigger step to take – even if it is the logical extension of wanting to focus on the core responsibility of managing funds.
Intellectually speaking most fund managers don’t have a problem with outsourcing in this way, but in reality there are concerns about whether it can be done smoothly without interfering with day to day operations, and also the numbers – how much do they have to pay?
Some people, even at large investment managers, are waiting to see the impact of the large transactions that have already been done, and how the projected benefits of outsourcing actually play out.
"The Asian managers, even the local units of big global fund managers, don't really see the benefit of outsourcing yet. They are medium sized (in a global context) with around $5-10 billion under management. They probably already have in-house people that manage their back offices quite OK. It's really the smaller or newly established manager who are keener to outsource in this area."
But the problem at the moment, says Tse, is that the smaller managers don’t have the volumes or size of funds under management to make them attractive customers of the large custodians' outsourcing services.
