Whitepaper

Middle Office Outsourcing in the Investment Management World

Version: 1.0 | Published on: 28/08/2012 | Author : Ajith Narayanan

Hexaware Technologies. All rights reserved.

www.hexaware.com

Whitepaper
Middle Office Outsourcing in the Investment Management World

Table of Contents
Introduction An over view of outsourcing What led to the idea of MO outsourcing? Key considerations Current outsourcing models A few decision makers for Asset Managers to outsource in MO A few significant challenges in client onboarding in MO outsourcing Where Hexaware can help in the MO outsourcing process E2E Conversion- Where Hexaware can help Service providers Conclusion 03 03 04 04 05 05 05 06 06 08

Hexaware Technologies. All rights reserved.

www.hexaware.com

Whitepaper
Middle Office Outsourcing in the Investment Management World

Front Office
Marketing, Researh, Portfolio Management, Trading

Middle Office
Transaction Management, Record Keeping, Data Management. PnA, Client Billing, Client Reporting, Recon, Corporate Actions

Back Office
Fund Administration, Fund Accounting, Transfer Agency, Custody, Clearing & Settlement

1 Introduction
Shifting markets, profit pressures and the ever-present demand for better returns are driving more and more investment managers to consider outsourcing their investment operations. In the last few years the middle office outsourcing has been looked at seriously by Asset Managers while evaluating their current business models and core competencies. Primarily the role of an asset manager is to maximize returns on the investments for their clients, given the extremely competitive environment in the investment world and clients increasingly looking at Asset Managers to help them in these turbulent and violent economic swings that we have been seeing in the last few years. Post the 2008 financial crisis that gripped the world, the concept of Middle office outsourcing has been gaining popularity in the Asset Management world, more because of operating compulsions and the need for the Asset Managers to be lean and focus more on their core competency of Investment Management. When used effectively, middleoffice Outsourcing can bring about additional efficiencies, savings and provide more predictable costing. Choosing the right suite of the middle office outsourcing services can help Investment Managers focus on the critical front office services while leaving the running of their costly middle office functions to the service providers. While the back office services have been outsourced to Custodians (Third Party) for the last several years, the acceptance level in the middle office services by third party is slowly gaining ground and currently it could probably be 20% of the current market size, whereas the back office outsourcing would be in the region of 90%. What this means is the potential in the middle office services that could grow in the coming years and with the major players in this space BNYM, State Street, JPMC & Citi Group increasingly spending and upgrading their platforms to offer a wide range of middle office services. It is to be noted that all the above mentioned players are large Custodians and for them to bring in the middle office services along with their current stable back office service offerings will only add a seamless integration of the services for Asset Managers.

2 An over view of outsourcing

Source 2011 WFE market highlights - http://www.world-exchanges.org The global financial markets from the early 2000s have been growing across a number of sectors in both the developed and emerging markets. As shown in the figure above the world market capitalization has grown from US $ 30 Trillion, peaking to US $ 60 Trillion in 2007 and ending 2011 at US $ 47 Trillion. Supported by technology and processing, the trading volumes have increased tremendously and in addition to the market increases

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Whitepaper
Middle Office Outsourcing in the Investment Management World
the number of global counterparties and also the use of alternative assets became mainstream as the institutional investors increased the portfolio allocations to the Hedge funds and private equities. With the current trend of Asset Managers operating on a global scale and increased product offerings, fund managers have to deal with investment strategies keeping in mind the various suite of applications from a technology perspective spread across geographies and serving specific regions, these systems had been built for specific country trading, different reporting requirements, different currencies, different asset classes. All this posed multiple challenges for asset managers. Integrations and mergers seen across the Asset Management world focused more on the consolidation of brand names and leaving the processing to multiple and disparate platforms. All this led to high costs and also inefficiencies in data delivery and performance. By the beginning of 2000, it became apparent that the success of Investment Managers would be measured not just by the assets under management but also how efficiently they streamline the operational delivery from the Front Office to the Middle and the Back Offices. This led to the Middle Office space giving the biggest scope for improvement.

3 What led to the idea of MO outsourcing?

Middle office relates to the post trade and pre settlement areas, where due to the disparate systems, the straight through processing automation was becoming a difficulty due to the multiple interfaces from brokers, custodians and other third parties, thereby leading to increased manual intervention was becoming necessary to complete the transactions. Another factor was also the increased use of exotic, less liquid asset classes by Hedge funds, Private equity where valuations were becoming difficult also escalated the need for a seamless MO space, since the Front office always depended heavily on the data coming from the middle office and the need for the accuracy of the data, which the FO relied on their investment decisions. Any errors could lead to wrong decisions, delays in reporting and thereby effecting the perception of the investors on their asset managers. This led to the Asset Managers turn to their service providers for solutions, who for long had been providing the back office related Custody, Fund accounting, Transfer agency services and knew the Investment Management world well enough to provide additional services, given that the MO space could seamlessly integrate to their existing BO service offerings. However the road to MO outsourcing was filled with enough challenges, more than what was initially thought off, due to the decisions that had to be made in the areas of consolidating systems, closure of offices, staff reduction, lack of proper scoping of the business requirements, significant delays in the complete movement taking over 3 years for each conversions and the capital and time required both by the Service providers and the Asset Managers which ultimately led to the larger asset managers to actually scale back their MO outsourcing goals. However over the decade, the large players like State Street, Citi Group, JPMC & BNYM have been significantly investing in the space, enhancing their service offerings and the knowledge gained from the initial years have now helped them to build more robust models, which under the given market circumstances will add to the increased move to outsourcing the MO operations by the Investment Managers.

4 Key considerations:
Asset Managers while considering outsourcing the MO operations, should look into the following criterias: With your transportation mission and promise in place, examine each aspect of your operation as listed below for selection of initiatives Will the service provider be a partner to them? Low fees alone should not be reason for a decision Short term savings should not be a decisive factor, but a look at the firms long term gains and needs to be factored in. How accurate will be the data provided by the service provider? How fast will the service provider be, in providing the services Will be service provider be able to service all the asset classes? Will be service provider be able to service globally? Will the front office receive all data accurately to make investment decisions? Will the service provider be able to provide customized solutions? E.g Reporting? What will be the impact of BAU during transitions/ conversions? What will be the impact of the existing teams with the Asset Manager?

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Whitepaper
Middle Office Outsourcing in the Investment Management World

5 Current outsourcing models:

Lift outs:
The Asset Managers operations teams and all other related functions are carved out, ring fenced and taken over by the service provider. This way the service provider gets the experienced staff and the asset manager immediately gets the benefit of the costs reduction both fixed and variable. Care should be taken by the service provider to ensure a seamless transition to the transferred employees change in work and location and corporation cultures and also the uncertainties that arise thereof. If application systems and technology movement is involved then service provider to make significant investments to ensure linking into their existing platforms. In terms of execution, this model is complex.

Conversions:
No movement of staff or systems to the service provider world and all services and business moved to the providers platforms. This model has gained popularity due to the decreased time to execute and in some cases conversions completing in a years time, though the provider will have invest significant upfront time and material in the areas of due diligence well ahead of the executions.

Component based:
A recent trend in MO outsourcing, where asset managers do not move their entire space, but certain areas eg- performance analytics, record keeping etc. where the asset manager thinks could add value in terms of quality and cost. This model gives the flexibility of making the outsourcing process in stages. A good model for smaller asset management players. More standardization of service offerings by the provider, thereby eliminating the need for customization as is often seen, when servicing larger asset managers.

6 A few decision makers for Asset Managers to outsource in MO

Reduction in costs associated to technology, staff and locations Dont have to build or renew licensing on systems, thereby reducing large investments in technology. Ability to expand geographically in business and not having to invest heavily upfront on technology to enter new markets. Large service providers will continuously upgrade and invest in technology to give the latest and faster service offerings. Dont have to invest regularly in the changing regulatory requirements, as the large service providers will anyways invest in them, given their large service offerings globally. 6. Can add new asset classes, without having to bother about enabling or building new technology to accommodate these new asset classes. Though the MO outsourcing opportunities certainly adds to the existing revenues these service providers, it does come with a number of challenges, which they have been addressing over the years and are now teaming with their IT vendor partners to execute the same at lesser costs by outsourcing the activities to the partners offshore locations in India. 1. 2. 3. 4. 5.

Initiative three

Initiative Four

7 A few significant challenges in client onboarding in MO outsourcing:

Extended Requirement Phase (Scope Creep) Prolonged impact analysis on core system and process Mismatches in systems cause increased manual intervention and lowered STP Prolonged Migration Timeframe Indefinite testing timeframe Negligible Standardization of reporting More time needed to get requirements to appropriate level of granularity Difficult for Ops and Tech stakeholders to understand feature/functions being described and requiring sign-off Requirements and system design need to have more detail and be written in conjunction with Tech & Ops Operating model needs to be better understood at time requirements are written A heavy reliance on module/component testing, stubbed data and manual testing Full end-2-end integrated testing only undertaken in UAT Lack of business domain knowledge results in a heavy reliance on Requirements and Business SMEs Lack of quality test data and minimal use of automations

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Whitepaper
Middle Office Outsourcing in the Investment Management World
Need for a better understanding of data lineage/ flows through architecture Need for more comprehensive test data in Tech testing phases Need for more domain knowledge within Tech and more staff with end-2-end knowledge of architecture and business Disparate locations of Technology, Operating and Product teams hampered communication, learning and knowledge sharing Too many handoffs between AD teams and a need for better ownership of key interfaces

8 Where Hexaware can help in the MO outsourcing process

Due Diligence and Analysis:
Deploy domain consultants with deep end-to-end middle and back office asset management experience for accelerated/ rapid business understanding of the customer operations with detailed business flows Use Hexaware developed application portfolio mapping tool for quick mapping of customer landscape Compare client requirements with standard service catalogue and identify gaps Deploy process mapping experts for detailed process mapping in reduced timeframes Use Hexaware developed process mapping tools / techniques / templates like Belva, Verzonen Document application and gap analysis using templates based on industry best practices Create online knowledge management for future reference

Transitions and Steady State:

Use Hexaware developed tools like DART, BIMA, BELVA for quick and efficient data migration Leverage best-in-class SDLC incorporating tenets from Hexaware Deploy domain consultants with deep end to end asset management experience for more business focused support during BUAT and CUAT testing Tap into alliances with our Partners- HP, IBM for test automation tools Use of Hexaware in-house Testing COE Leverage optimized onsite-offshore model for extended coverage Off-the-shelf service management process packs like Rapid SM (service desk, incident, problem, change management) Periodic analysis based on Lean & Six Sigma principles

9 E2E Conversion- Where Hexaware can help Service providers

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Middle Office Outsourcing in the Investment Management World

Areas where Hexaware can offer services in the MO outsourcing conversion process Requirement Analysis: Interface Mapping

Conversion Data Migration (Base-lined & Forward Period data)

Format & layout Mapping of data structure and formats Data requirements: Data enrichment / transformation and data field omission Delivery channel: Mapping of delivery channel for each data source
Transaction Data
Trades Positions Cash Balances Fund Flows (Subscriptions / Redemptions) Collaterals & Margin Expenses Corporate Actions ( Dividends, Income, Maturities, Splits. M&A etc)

Data Dictionary mapping Data set sequences & dependencies Data enrichment / transformation, data validation and reconciliation exception resolution Post Migration Data building (Rolled up Summary information)
Historical Data
Trades / Cash Transactions/Corporate Actions Positions Taxiots Investor Register Accounting Data ( Journal Entries, GL/ SL Data, Trial balances, balance Sheets) Static & Reference Data

Static & Reference Data

Securities, Currencies, Exchange, issuers, Issues, Country, Region, State, Cities etc. Counterparties / Brokers / Custodians / Banks / Portfolios / Funds / Managers Pricing Information (MTM, FX Rates, OTC Valuations)

Dynamic Data
Unsettled trades Open Cash / FX Transactions Open Corporate Actions Corporate Action entitlements (post Ex-data) OTC transactions

Internal Data Interfaces

Downstream Feed Requirements Reporting / EDW Requirements

Pre-Conversion: Configuration & Data Set-up Application Customization & Enhancements Application & System Settings Static & Reference Data Fund Set-up
Transaction Data
Brokers, Custodians & Counterparties SMF Data Cash Accounts Setup Capital Account, income Account, Margin Account Fund and Cash Account Linkages Country and Currency Setup, Tax Tables, Holiday Schedules Base rates and foreign exchange rates Custodian Deadlines, etc

Testing Data Comparison / validation Data Quality Testing Interface / Integration Functional Testing Business Process Testing

Fund Setup
Base Currency, Transaction Currency Accounting periods & Reporting Cycle Accounting parameters and rules Chart of Accounts Price source for various instrument types Taxiot selections of the fund ( Average LIFO, FIFO, Maximize/ Minimize Gain/ Loss, Specific lot) Fund groups and blotters based on requirements Fund-Custodian linkages

Parallel Run

Setting of baseline conversion data until prior period Posting of transactions Running batch cycle for accounting Validation and reconciliation with existing client system

Hexaware Technologies. All rights reserved.

www.hexaware.com

Whitepaper
Middle Office Outsourcing in the Investment Management World

10 Conclusion:
As mentioned earlier in this document, over 90% of back office operations have been outsourced to the Custodian world, with the middle office areas still at 20%, thereby suggesting of increasing business opportunities shifting to the Custody world over this decade which brings to an interesting find that technology spend by the Asset Managers will be less in the MO and BO areas in the coming years, with the Custody world taking the larger role and opportunities. Does this trend make a compelling idea/ strategy for IT providers like Hexaware to focus and partner more in the areas of IT and operations with the Custodians, than with the Asset Managers on a business and revenue growth? Yes, it makes more business sense.

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Hexaware Technologies. All rights reserved.

www.hexaware.com