Any combination of factors will be considered before a financial institution makes the decision to outsource, says Heather McKenzie. But cost and efficiency are basic requirements.

When it comes to outsourcing, definitions are as varied as the deals that are done. The simplest definition is the handing over of processes for a third party to run.

In cash management, outsourcing is a relatively well-established route for some corporates, but at the financial institution level, it is less straightforward.

Mark Davies, director of international product management at Royal Bank of Scotland, says that for a long time “one man’s outsourcing has been another man’s correspondent banking”. Few financial institutions have handed over cash management functions “lock, stock and barrel”.

One of the problems for financial institutions is that payments processing is at the heart of a bank, and every department within a bank, such as human resources and finance, connects into payments systems, says Joerg Pinkernell, head of financial institutions payments, settlement and outsourcing solutions at ABN AMRO. “In deciding to outsource, banks have to fight the perception that if they give away payments they are giving away core functionality.”

The question of what is core and non-core arises whenever an organisation considers outsourcing. “Traditionally, financial institutions have felt they could and should cover every function, but are now aware of the benefits of outsourcing some activities, says Mr Davies. “Corporates and financial institutions will try to outsource what they consider to be non-strategic and non-core activities. But the definition of strategic and core is constantly evolving.”

Cost issues

Financial institutions need to consider whether something is absolutely core to the business or whether the cost of maintaining a process outweighs its benefits, says Paul Nixon, product market manager at HSBC. “For example, someone could have a state-of-the-art payments engine but if it is not processing a massive amount of payments, or if regulatory and competitive pressures mean the business is no longer profitable, why have it? This could be a time to consider outsourcing.”

Adolfo Tunon, director, head of receivables at Citigroup Global Transaction Services – Europe, Middle East and Africa, identifies three main drivers for outsourcing: cost restructuring and operational efficiencies, the desire to offer new products to their existing markets and extend their market segments.

While the drivers may be common to different organisations, outsourcing is a very customised process, he says, with each bank or corporate having distinctive risks to address. “The outsourcing service provider must take time to understand the needs of the organisation that is outsourcing before moving on to an action plan. There are no standard solutions in outsourcing.”

Temporary solution

Take for example Coca-Cola HBC, the Athens-based central and eastern European soft drinks company. It outsourced its treasury function to Citigroup following the merger in 2000 of Athens-based Hellenic Bottling Company with London’s Coca-Cola Beverages. After the merger, the company’s main listing was on the Athens Exchange and the treasury functions were relocated to Athens. Outsourcing on a temporary basis to Citigroup helped the company to move offices and tighten its treasury controls.

Many corporates have outsourced basic functions, such as payments and liquidity management, and are now trying to outsource functions such as short-term investments and FX, which in the past were considered strategic, says Mr Tunon. “Some companies have also realised they can no longer keep pace with the investment that is needed in new technologies as they move from old treasury technology and spreadsheets into more robust real-time environments and single standard formats.”

The cost of keeping pace with regulatory developments, such as Sepa, Basel II and Sarbanes-Oxley, is pushing smaller financial institutions into outsourcing, Mr Davies believes. “The cost of staying in the game and keeping legal, let alone developing new services to attract customers, is huge.”

Although Sepa may be an outsourcing driver, Mr Davies wonders whether it might in some cases act as a brake on outsourcing. “Sepa is a cost burden but at another level, it will transform a small bank in a single country into one that has access all over Europe. In the past, such a bank would consider outsourcing to gain that reach.”

Larger banks are targeting smaller financial institutions to boost transaction processing volumes beyond those provided by the corporate world alone. For example, in October last year, Citigroup launched Borderless Banking, a series of white label offerings including payments and collections, FX dealing and clearing, securities trading and clearing, sub-custody and agency treasury.

When the service was launched, Tom Isaac, managing director of Citigroup Global Transaction Services, explained how the service operates. “In the product area, we are offering banking clients the ability to look at Citigroup’s capabilities, and where they would like to offer a certain product to their customer base, but don’t have the investment dollars to do so, they can white-label the Citigroup products as their own,” he said.

The lack of investment money in the past few years is beginning to bite. Mr Pinkernell says Sepa requires a great deal of change in the eurozone and has eaten up a lot of revenues in the medium and small-sized banks. “At the same time, there is little revenue coming out of this area, but the spend has to be enormous to comply with Sepa.”

Corporate satisfaction

In addition, tier two and three corporates are demanding the type of capabilities that one or two years ago were requested only by the top corporates, he says. “Banks need to retain these tier two and three corporates in their home markets and to do that, they have to offer very sophisticated cash management tools and front ends.”

Anne Collard, global product executive, corporate outsourcing business at JPMorgan Treasury Services, says the drive for transparency in operations and concerns about operational risk are factors when corporates decide to outsource cash management functions.

“Many CFOs are now looking at the underlying cost of managing their treasury departments, which are not a corporate’s core business,” she says. “Where banks have been managing liquidity flows and the pooling environment for corporates, they are now pushing further into the back office and doing FX settlement, confirmations and even trade – in fact, anything that will make the corporate back office more efficient, but will not lead to a loss of control for the CFO.”

Under control

Control is important, says Ms Collard, and can be delivered through web-based tools that give corporates a full view of data. “Providing information and ensuring products are delivered in a timely way is very important if you want to be an outsourcing service provider to corporates.”

A good outsourcing arrangement will enable the outsourcing organisation to retain control over the most important aspects of the business, says Mr Nixon. “The customer relationship is usually the most important element to consider and one should be wary of losing control over that. By putting your processing destiny in the hands of another organisation, you should be sure that they will be there for the long term and can provide support.”

Execution is also a key area, says Ms Collard. “If a corporate is putting its faith in the outsourcing service provider to deliver, then it must be sure that the provider can execute very well.”

The issue is the same for financial institutions, Mr Davies concludes. “Banks need to be incredibly comfortable with the execution ability of the institution to which they are outsourcing. Also, they need to be convinced by the financial institution’s strategy and ability to stay independent. A financial institution does not want to outsource to an organisation that might one day end up being owned by a potential rival.”

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