Rethinking responsibilities; asset managers look to out-source non-core tasks

Rethinking responsibilities; asset managers look to out-source non-core tasks

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Asset managers, institutional investors and retail advisers are increasingly outsourcing tasks that are not at the core of their businesses. Asset managers are both outsourcing certain tasks and taking on business on a white-label basis. The most powerful motivation pushing them to outsource functions, in the current cycle, is the potential to share the costs associated with new regulations coming into effect. 


Research conducted by Cerulli Associates earlier this year found that independent financial advisers (IFAs) are starting to rapidly increase their appetite for outsourcing investment management. In 2015, 41.4% of those surveyed outsourced, a figure that rose marginally in 2016 to 41.7%. However, the more striking finding was that the percentage of IFAs expecting to outsource in 2017 was 45.9%.

Cerulli found that almost two-thirds (64.4%) used discretionary fund managers, followed by multi-asset funds and multi-manager/funds of funds, each of which were used by 53.3% of the advisers surveyed. Just over one-inthree (35.6%) outsourced to platforms’ model portfolios, with only 2.2% using robo-advisers.

The sheer magnitude of regulation is focusing advisers’ minds on where they can contract out parts of their service to external providers at a lower cost, according to Paul Stanfield, chief executive of the Federation of European Independent Financial Advisers. This backs up a Northern Trust survey of nearly 200 investment advisers back in 2014 that found that one in four respondents contracting out investment management had improved their ability to contain the expense of compliance.

Asset manager outsourcing

Asset managers, as well as institutional investors, are similarly seeking to outsource certain tasks due to regulatory compliance. BNY Mellon’s CEO of global financial institutions asset servicing, Daron Pearce, says that regulationdriven demand has already been an additional catalyst for service providers to invest in regulatory and compliance infrastructure.

Pearce divides the risk to the client associated with outsourcing into operational, client and regulatory factors. “From an operational perspective, institutions outsource the function but not the risk because they are still accountable,” he says. “They need to ensure they create a good oversight structure and understand the processes and the control environment of the organisation that they have outsourced to. In turn, we need to give our clients the tools they need to see how we are performing.”

In terms of client risk, the third-party provider will sometimes work directly for its client’s underlying customers, as in the case of an asset manager taking on an outside partner to directly service a pension fund. If, in this example, it provides a white label service to the pension fund and delivers inaccurate data, it would damage asset manager’s reputation.

“Finally, institutions need to ensure they have a good handle on regulatory risk,” adds Pearce. “In particular, they must understand how their outsource partner is managing its business. Institutions need to ensure the service provider’s approach to audit control and legal risk does not leave them exposed.”

Ken Back, head of business development, UK institutional investors, at BNP Paribas Securities Services, says that Solvency II’s look-through analysis requirement has demanded that asset managers either implement new systems capabilities or look to external providers for readymade solutions.

Brinda Murty, vice president financial markets solutions at Genpact, says many engagements and ongoing discussions are focused on business-process-as-a-service and managed services offerings. “Rules and guidelines governing outsourcing have been in existence for some time now and most financial services firms have strict protocols on how they manage their third-party provider relationships,” she says. “Firms have not reduced expenditure on engaging third-party providers across businesses, geographies and business functions.”

Genpact offers a checklist for assessing potential outsourcing providers: its viability; its expertise and track record; its operational risk governance and control framework; its ability to contain delivery risk and quality of output; and the client’s retention of oversight and monitoring of the activity within the financial institution.

Institutional investors

The head of the outsourcing practice at Alpha FMC, Olivia Vinden, says that there is increased interest in outsourcing from pension funds, particularly in consolidated records of mandates where the fund has outsourced its investment management to multiple providers.

Vinden recommends that asset owners undertake thorough due diligence on their service providers. “A full risk review is necessary to ensure that the client is comfortable with the level of operational risk and that strong controls are in place. Institutional investors tend to have a service provider oversight function that undertakes site visits and the larger outsourced service providers will have sophisticated internal compliance functions.”

functions.” For pension schemes outsourcing asset allocation decisions, Aon Hewitt partner Sion Cole, says there is a need for greater transparency around fees and performance. “For fiduciary management investment solutions, performance should be assessed against the investment objectives set by the trustees, specifically in relation to the scheme’s unique liabilities. Clarity on who is making decisions and who is accountable at every stage is also important.”

It should be made clear from the outset which responsibilities and accountabilities remain with the trustees (for example, setting the investment strategy and any risk/return parameters or investment guidelines) and which are being delegated (manager selection, asset allocation, portfolio management and rebalancing), concludes Cole.

For asset owners, execution risk is a risk factor associated with outsourcing that has received insufficient attention, suggests Citisoft CEO, Steve Young. “There is an assumption that the large providers can do execution, but in reality there is not a universal model and as you move up the value chain providers are offering a bespoke service to each client. To drive costs down there need to be more shared services. Clients need to spend more time looking at the operations of the service provider, and the technology that underpins it, to assure themselves they can get the level of service they need.”

Young adds that outsource providers have to deal with clients that want a bespoke service for utility pricing. “Asset owners need to take a long-term view of outsourcing rather than driving it on a cost basis. Providers face considerable technology challenges that will demand significant investment and partnership is required to create a sustainable operating model.”

Contingency crucial

The FCA has raised issues regarding the ability of asset managers and other clients to replicate an outsourced service in the event of the failure of a key thirdparty provider. It has called on asset managers to review their outsourcing arrangements and, where appropriate, enhance their contingency plans for the failure of a service provider that provides critical activities, as well as ensuring they have the required expertise to supervise the providers.

The Investment Management Association had previously set out the key issues arising for asset managers from the regulatory regime on outsourcing, in a 2013 white paper. It noted that severe operational disruption within a service provider could leave an asset manager unable to comply with its relevant regulatory requirements, contractual obligations arising under its contracts with clients or third parties, or its broader legal obligations (for example, as a fiduciary).

“There is certainly a potential risk associated with transitioning business to a new provider in the event of the withdrawal of service by any of the large third-party administrators,” says BNP Paribas’ Back. “Most services can be replicated over time, but there remains a risk that transition timelines are likely to be longer the more clients need to shift supplier.” 

Boosting business

While solutions may be expensive to provide, it is inevitable that the client will be primarily focused on reducing costs. The key to winning more outsourced business is to keep costs low, which has encouraged service providers to invest in digital solutions, says Vinden. “One of the main focus areas is improving the exchange of data, for example to make it more real-time and interactive via selfservice reports.”

Managers that are looking to generate business from independent financial advisers have two main strategy options, which are not mutually exclusive according to FEIFA’s Stanfield, who is also secretary general of the European Federation of Financial Advisers & Intermediaries. “They either need to provide complete portfolio solutions, for instance multi-asset funds, or sell into investment firms that provide such solutions and/or discretionary fund managers.”

Asset managers may look to outsourcing as a more cost effective solution to compliance issues – as well as a means of fixing their cost base – but they cannot shift the burden of their underlying compliance risk. Managers are required to be able to demonstrate adequate oversight of the third-party administrator outsource provision, while the latter needs to provide as much information as possible in terms of dashboards and data reporting to make it easier for the asset manager or institution to be compliant. 

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