The ‘why now’ and what’s to come for middle-office outsourcing
During the post-2008 financial crisis volatility, the popularity of outsourcing key middle- and back-office functions rose as asset managers saw the value of an outsourced operating model. We have recently seen how market volatility has created operational challenges for fund managers due to the COVID-19 pandemic and the subsequent instability in the banking system. As a result, there is a renewed need for real-time transparency into counterparty exposure, securities exposure and available liquidity. Demand is growing for ready-to-deploy technology and talent to mitigate the impact of market uncertainty on managers’ portfolios.
Market uncertainty also compels managers to look for ways to control costs and make them more predictable while creating scale. Internal middle-office teams are often regarded as a business expense, susceptible to high employee turnover and replacement costs. Technology savings are also a key factor driving middle office outsourcing, as managers recognize owning and maintaining best-in-class technology makes limited financial sense in the long run.
The demand for a more efficient exchange of information, coupled with cost control measures, has motivated asset managers to look at outsourcing.
In its May 2023 Insights Report, Hedgeweek found the outsourcing trend is accelerating, with around 60% of hedge funds outsourcing back-office functions and 40% outsourcing the middle office. Some 34% of firms surveyed said they were planning to outsource more. There are three primary motivations:
- Outsourcing allows firms to focus on their core competencies and securing the best possible deals. Moreover, working with a service provider brings specialized expertise in various asset classes and geographies, shortening the time to market for new product launches. Leveraging a service provider’s resources and expertise on key business strategies makes scaling in a dynamic market easier.
- Access to advanced technology without a costly in-house build-out. Not only is there no high upfront cost nor ongoing maintenance, but an effective middle-office service provider can also rationalize and connect data across multiple processes. A centralized data approach can bring efficiency gains and data integrity.
- Outsourcing makes it easier to achieve scale while controlling costs. For firms in growth mode, increased acquisition activity, multi-jurisdictional operations, maintaining operational governance, data complexity and increased investor scrutiny are just a few challenges outsourcing helps address.
What’s to come for middle-office outsourcing?
Outsourced operating models must have the flexibility to adapt to the changing business needs of managers. Today, firms are seeking support in such areas as:
- Lifecycle support across all asset classes, including publicly traded securities, complex fixed income such as bank debt and distressed debt, illiquid OTC derivatives, real assets and other static assets.
- Consolidated investment reporting and analysis to tell the “story” so managers can extract meaningful data quickly and easily.
- Investment-level forecasting, both in terms of liquidity requirements and scenario planning, to account for varying degrees of market uncertainty.
- CSDR and T+1 settlement requirements put pressure on managers to meet strict deadlines. Outsourcing to a provider with an automation infrastructure and effective post-trade processes will enable managers to accelerate their readiness.
The full lift-out vs. select activities
As disruptions to day-to-day operations weigh on fund managers, many consider the benefits of a full lift-out of their middle and back-office operations systems and staff. In the full lift-out scenario, the most significant benefits to a firm are cost savings, scalability, immediate access to industry-leading expertise, and staff continuity. Any growing firm looking to get into new markets or reduce the cost of its operational infrastructure stands to benefit from a lift-out. Smaller managers, however, may find it easier to outsource selected operational activities.
The ways hedge funds manage their operations is evolving. Many asset and fund managers have outsourced their back-office operations for years, but more are realizing many other functions can also be performed more efficiently by an external service provider – putting the middle office in the spotlight. Funds of all sizes want to focus on investing, not operations; outsourcing allows them to find this balance.