Best of breed

The pressure on banks to increase choice while decreasing cost is enormous. Further to this, the definition of scale has changed dramatically, making global competition more costly.

While cost reduction continues to be the main benefit gained from buying a service rather than building it from scratch, it has driven banks to take a look at their core competencies and recognise that ownership of trading platforms is not necessarily one of them.

Focus on FX

Nowhere has this become more evident than in the global market for foreign exchange where the outsourcing model has evolved from simply using the payment capabilities of a larger bank to having them provide the actual foreign exchange trading capability and clearing of the transactions. FX has been at the forefront of technology spending in recent years as banks look to create faster pricing engines and e-trading platforms.

The Royal Bank of Scotland began providing its outsourcing services to other banks at the end of 1999. Tom Roche, managing director and global head of e-commerce and agency treasury services, at RBS, says: “At that time, a number of financial institutions were going through a review of personnel, trading style and technology investment, of which some concluded that it was more efficient to take advantage of the purchasing power and investment of a larger bank.”

RBS offers banks the ability to utilise its agency treasury services to execute transactions on their behalf, alongside the confirmation, matching and reporting capabilities of its back office. But according to Mr Roche, the recent surge in interest has come from the growing appetite of smaller banks to access RBS’s liquidity via e-commerce platforms. “In the last few months we have seen increased interest in e-FX outsourcing. Banks of a certain size are beginning to question the level of investment required and their ability to continuously invest in their own electronic platforms for spot FX and forwards,” he says.

Time means money

For many small to medium-sized banks in the FX market it is difficult to build the business case for the kind of investment and resource commitment that real-time trading and sophisticated client demands require. If a bank is too slow in updating its price, money is lost. Less technologically advanced banks face increasing risk, particularly as volatility has increased alongside the volumes.

Mr Roche says that technology is leading this drive to outsource. “The barriers to entry in terms of technology are increasing. It is not just a significant one-off investment that is required, rather a continuous re-investment. The platforms have to be continuously upgraded. The supply and demand is such that the platforms are becoming a lot more sophisticated and more volume-orientated so the stresses and strains it is putting on core operating systems can be quite intense.”

Shared infrastructure

It was the same pressures that led UBS to launch its “Bank for banks” initiative in 2001, offering everything from a single component to the use of UBS’s entire infrastructure. Markus Straessle, head of market development for financial institutions at UBS, based in Stamford, Connecticut, says: “We have structured our services from front to back office services, from pre- to post-trade, which can be bundled up or broken down to sub-components. We offer our bank customers the same infrastructure that we use for our own purposes.”

While some banks have come in for specific services, such as continuous linked settlement third-party membership, more extensive agreements include cash management and currency services, along with securities trading and some parts of UBS’s global asset management capability, as part of a single solution.

Asset management

Asset management also lends itself well to outsourcing. Formed a year ago from the investment management team within RBS’s private banking subsidiary, Coutts, RBS Asset Management is now advising on a growing amount of external assets. The bank’s wholly owned subsidiary offers two outsourcing services to financial institutions of either providing access to third-party investment managers as an adviser, or providing the actual internal investment vehicles – funds of funds.

Andrew Hutton, managing director of RBS Asset Management, believes that outsourcing investment management has evolved from the need for performance and diversification. “The increasing appetite for alternative investment and hedge funds has driven the need to seek external expertise to manage investments. Clients are demanding greater performance,” he says. “No single organisation can be outstanding in all asset classes, and therefore the single relationship with an investment manager is sub-optimal.”

Hedge fund investments

RBS Asset Management might deal with the smaller private banks which want to be able to offer their clients hedge fund investments but lack the scale to have a specialist team. Then there are larger institutions such as insurance companies and public funds looking to outsource the management of part of their portfolios. Outsourcing management of part of the fund can give the institutions access to investments they would find hard to get at themselves.

For Mr Hutton, the case for outsourcing investment management is a compelling one, made possible by a more open architecture in the investment management industry. “Diversification, which is leading investment managers to outsource, brings better client returns and less volatility,” he says.

Trade finance

ABN AMRO has been providing white-labelling and outsourcing for trade finance and FX for a number of years. Groupe Caisse d’Epargne (GCE), has recently signed up to the bank’s outsourced and white-labelled trade services under which GCE will make use of ABN’s trade services technology and global network.

ABN’s trade portal MaxTrad will be white-labelled with a full French translation, enabling GCE to retain its own brand and client franchise, whilst offering its customers online access to a broad and expanding range of trade finance products and services.

Last year, ABN signed similar agreements for the provision of trade services with Barclays and Allied Irish Bank, which are now fully operational.

New division

ABN says that the renewed drive towards outsourcing has led to the creation of a division devoted to strategic outsourcing. Alliance Solutions was created in July 2004 following a comprehensive market study of banks around the world.

Colin Klipin, who heads up ABN’s Alliance Solutions business, says: “We have created what we believe is a unique business model that has very few of the traditional characteristics of outsourcing and is driven, primarily, by an understanding of the value chain. ABN’s Alliance Solutions group is a different model. It is not an extension of, or dependent on, a specific product area.”

ABN says it now has a number of clients entering the first phase of a solution around the securities processing, clearing and settlement as well as the provision of a rates capability. Further down the line ABN will provide smaller banks with a white-labelling capability to offer their customers more sophisticated products like derivatives.

Structured finance

Structured finance, or the unbundling and bundling of financial instruments to create new products that better meet the needs of customers, is a cornerstone of banking. This same unbundling and bundling is going on operationally in banks as some offer their core services to others to bundle up in their own services. But is the core business of these banks still banking or is it outsourcing?

“What’s the difference?” asks ABN’s Mr Klipin. “The historical model where you manufacture everything you distribute and you distribute everything you manufacture is rapidly changing. We believe there is a segment of our business where we will become a best of breed aggregator and in some cases we will wholesale and in some cases we will be a full-service distributor. The ability to understand what it takes to satisfy your customer’s customer is a key driver to being successful.”