A swathe of outsourcing deals has seen global custodians moving into the middle offices of investment managers – and even edging towards the front offices. However, Frances Maguire finds that the global custodians are not taking their own advice on outsourcing.
The custody market has already undergone a great deal of consolidation. Several Tier 1 banks have sold up their custody arms to one of the banks that now make up the top five largest global custodians, as custody was deemed a product offering that needed both scale and to be part of a wider business relationship to be profitable (see news story on Citigroup’s purchase of ABN Amro’s custody operation).
What began as offering custody as part of securities services to investment managers has, over the past three years, escalated to a full “lift-out” of the entire asset management back office by the largest global custodians.
Start of a trend
The trend began in the late 1990s with a few large deals such as Scottish Widows outsourcing to State Street, JPMorgan Fleming Asset Management to Bank of New York (BNY), and Schroders outsourcing to JPMorgan. Today, it is still growing, both in terms of numbers of asset managers signing up for lift-out deals and the extent of the deals.
Daron Pearce, managing director of BNY SmartSource, says that the provision of integrated outsourcing solutions is the largest growth area of the bank. The recent decision by RCM, the institutional equity arm of Allianz Dresdner Asset Management, to migrate its UK operations to the BNY outsourcing platform is an extension to an earlier agreement last year with RCM Capital Management in the US.
Mr Pearce says: “We will now provide a full-service outsourced solution to RCM’s operations in London and San Francisco. With RCM going live in less than 12 months, we expect the UK operation to be live in mid-2005.” RCM staff will join BNY SmartSource’s 550 staff in two operating centres in London and New York, and until migration is complete, RCM’s back office technology will also be lifted-out and run by BNY.
Comprehensive deal
The agreement encompasses trade support, asset servicing, position keeping, client reporting, fund accounting and custody – taking it well beyond a back office deal. “Every asset manager wants a different model. What is outsourced depends very much on what is considered core and where they can add value. Some asset managers retain trade confirmation and allocations; others keep functions at the other end of the chain in-house, such as client reporting,” says Mr Pearce.
But the move closer to the front office – in terms of processes that can be outsourced – shows no sign of abating. “Organisations are realising they don’t need ownership of the infrastructure to process the trades. There are few asset management firms that have the scale required and can continue to invest in the technology needed. Outsourcing is inevitable, if not immediate, as new standards and regulations come in,” says Mr Pearce.
Padel Lattimer, first vice-president of Mellon Financial, makes no bones about the fact that becoming an outsource service provider has enabled Mellon to move further into the middle office, increased Mellon’s assets under custody as well as boosting its securities lending and foreign exchange businesses, as the outsourcing relationship has grown. With around 30 outsourcing customers to date, Mellon is now managing $350bn of assets through outsourcing deals.
Sensible move
“Outsourcing makes a lot of sense for us,” says Mr Lattimer. “Asset servicing is a very important business component; it provides a significant percentage of our top line and our bottom line. The custody product has changed. The level of straight-through processing has grown in importance, as well as the ability to deliver information in a seamless and effective way, and the quality of a custodian’s staff to handle more complex instruments.”
TCW, an asset manager with $100bn under management, has fully outsourced its back and middle office to Mellon, while a start-up firm went straight to outsourcing from day one of operations.
Mr Lattimer says the entire lift-out of the back and middle office at institutional fund manager TIA Crest in the second quarter of this year meant that Mellon enabled the start-up to get 13 strategies up and running. He says: “Our performance and attribution capabilities, in addition to our risk analytics, are helping [TIA] to manage their clients’ money. We are providing the report and statements to their clients.
“This does cross over into an area that in the past would have been traditionally regarded as front office by a custodian.” He adds that Mellon Financial is now looking at including compliance into its outsourced offering.
Margaret Harwood-Jones, head of global sales and relationship management at BNP Paribas Securities Services, says: “Stock lending services can easily be added subsequent to the outsourcing transaction. This can work irrespective of the lending model used.
“As the need for lending services is not usually a key driver of an initial outsourcing decision, developing the opportunities in this area works very well as a consequent discussion, using dedicated and experienced business experts to facilitate this.”
Moving on
Some asset managers are already onto their second outsourcing supplier. In May this year, a competitive pitch for Standard Life Investments’ fund administration back office for assets of Ł60bn saw Citigroup replace JPMorgan Chase. Aberdeen Asset Management, which has outsourced its investment operations since 1997, conducted a full market review in 2003, retaining BNP Paribas, which manages more than e260bn in outsourced assets, and extending the agreement.
However, following its merger with Bank One, JPMorgan Chase’s decision to cancel its $5bn outsourcing deal with IBM, just 18 months into the seven-year contract, and re-employ the 4000 staff that were lifted out, indicates that the global custodians are not themselves comfortable with outsourcing. The bank, however, says the decision was directly related to the acquisition of Bank One, which now brings the resources to manage its IT infrastructure in-house.
But a separate announcement by another custodian, UBS, that it would not renew its 10-year IT outsourcing deal with Perot Systems has prompted some to speculate that banks are shying away from the sort of large outsourcing deals that they market to their customers.
Octavio Marenzi, founder and CEO of research consultancy Celent, says: “Outsourcing deals where staff and technology are lifted out will become rarer and smaller, simply because there is no real economic rationale behind them. If the outsourcer takes the staff and simply runs the infrastructure, nothing fundamentally changes.”
Rethink outsourcing
Julian Wakeham, consultant at solutions provider and consultancy Capco, believes the reverse. He says that banks should be outsourcing, but that it is only now that they are being forced to seriously rethink their outsourcing models.
To date, there has been very little outsourcing of securities processing, particularly complex post-trade and exceptions processing. He says there are four main reasons why banks traditionally have not outsourced.
“Firstly, there is still a misconception of what is core to the bank,” he says. “Being able to settle securities and handle post-trade transactions is part of that business but actually owning the infrastructure is not.
“Secondly, banks still overestimate what is core in differentiating themselves to their customers, and there is still a very traditional mindset in terms of how banks work collaboratively with each other.
“Thirdly, despite increasing cost pressures, we haven’t seen a major financial pressure on banks to really transform their business models, beyond trimming 8% annually off costs. Then there is a fear that, by outsourcing, banks risk losing control over quality.”
For these reasons, only IT and some straight-forward processing functions have been outsourced to date, few of which have been securities-related. “But I think the market is changing a lot and forcing banks to rethink their outsourcing model completely,” says Mr Wakeham.
Fundamental shift
If a newer and more mature wave of outsourcing is to come, it will be one where banks will fundamentally change what they consider core and question the need for ownership.
Citigroup has steered clear of large outsourcing deals with the IT giants, tending more towards offshoring to reap the cost benefits while retaining ownership of the remote entity. However, Tom Abraham, managing director, Citigroup Global Transaction Services, believes that three fundamental hurdles still need to be overcome before banks begin outsourcing to other banks operating business processing services in securities. He says: “The idea that they will lose customers to the outsourced bank is a fallacy, as the solution can be white-labelled under their own brand name.
Tom Abraham: MD, Citigroup Global Transaction Services
“Two other considerations for banks when outsourcing are with regard to concentration of suppliers and the reciprocal relationships that may already be in place with other banks. Multiple banking relationships will impede the potential efficiencies from white-labelling or outsourcing with a single or smaller number of providers. This may not be a prudent trade-off for many banks.”
