It seems to be a truism that whilst we spend much time reading about how computer technology is getting faster and cheaper the physical bills associated with implementing it seem to go up by an equal and opposite amount. The two choices any business has are to do it all in house build it and run it, or to outsource the entire problem, but just as Alastair Campbell has a third way increasingly so do buyers and users. There has been a quiet revolution taking place at those stuffy old basic service providers the custodians. Whilst custody is still an important part of what we all do many have assembled a set of additional services and businesses which have the ability to mitigate the costs of the build and run option and provide the services required without the pain of outsourcing.
Technology is always been at the heart of a custodian’s service, we have struggled with the same technology issues that the whole market has, the particularly acute challenge custodians faced was the sheer size of the systems needed to handle the volume. To add to the problem most of these systems were built in-house. However, over the last few years size has not been the principal challenge, the challenge has been diversity, and specifically meeting the many new product demands simultaneously. The strategic rationale behind our development over the 1990s was that clients would increasingly want to buy bundled solutions to all their needs from one particular provider. Custodians were not the only ones to espouse this bundled ‘one-stop shop’ strategy their parent organisations got in on the act in the furious acquisition spree of the last decade.
While it has transpired that it is true that clients have looked to us for more and more diverse offerings, there has been less take-up of a truly bundled solution than forecast. It is the custodians reaction to this has created the opportunity for buyers to better mitigate technology costs. There is now a myriad of potential areas where clients can take a technology-based product on an application service provider (ASP) basis, and not just from custodians. Many others have got themselves in on the act: from the consultants and accounting providers through to the large infrastructure outsourcers such as Capita and Accenture. This has the benefit of both helping buyers and enabling providers to better spread the fixed costs of technology.
The two keys to really benefiting from others’ technology is to look at the services you require as drivers of technology cost as opposed to looking at pure technology cost alone, although there is a burgeoning market in hardware outsourcing deals covering aspects such as capital cost and maintenance. Secondly, it is important to not look at using external providers as a total loss of control, admittedly an important aspect of this delegation is understanding your continued responsibility for meeting legal and regulatory requirements. However as these types of arrangement become more mainstream then the understanding of how they work will become more widespread.
Three good examples of ways in which pension funds, particularly self managed pension funds, can both mitigate technology cost and leveraged investment in future developments are performance measurement, outsourcing and total cost management analysis. The growing area of DC administration will also provide many opportunities to leverage external technology platforms.
Performance measurement
Performance measurement has moved seamlessly from being an in-house hobby to an external professional service over recent years, however the demands on the product have not stayed static over that period. The advent of increased frequency and the requirement for additional functionality such as risk budgeting and more detailed attribution have all their impact. There should now be no need to run your own in-house performance measurement function, there is no loss of control or functionality in outsourcing the technology, indeed there is much to be gained from buying performance measurement via an ASP model on a pay as you go basis. The future for performance measurement will not only provide standard information it will give buyers increased ability to perform specific analyses themselves from their offices using someone else’s processing power.
Total cost management
No sooner than transaction cost analysis (TCA) turned up it was quickly followed by similar packages to enable greater analysis of such things as settlement performance and analyst performance. The ability to manage the total costs involved in trading is now a reality. However none of these services would be have been possible or as effective if built in house.
Outsourcing has had a very tough childhood and has had to endure going through its teenage years in the public limelight, the media both national and trade has had a field day with outsourcing arrangements that have overrun, underperformed and exceeded budget. But we should not let these awkward teenage years put us off the benefits that are now available. In the original plans outsourcing was a start to finish product based heavily on scalable technology aimed firmly at institutional and self managed pension schemes. Now however outsourcing is increasingly unbundled which leaves many aspects of the total product accessible on an individual basis and therefore more open to consideration from a wider audience, and again giving an opportunity to take down technology cost.
Outsourcing has now been broken down into broadly the following separate categories:
o Message management: transaction routing and message handling to and from third parties;
o Market event management: income and corporate action notification and processing;
o Trade management: trade processing confirmation settlement monitoring and failed trade monitoring;
o Accounting and reporting: investment and portfolio accounting, investment manager and client reporting;
o Market data services: static data, pricing, sector classifications, etc;
o Cash administration: banking through to cash management;
o Investment record keeping: securities cash and client data management, effectively fund management support.
All of these areas present opportunities, three good examples are market event management, market data services and accounting and reporting.
Corporate actions has long been an area of significant risk and differing comparative performance from service providers, the market move to unbundling has led to number of companies and some of the custodians establishing a technology platform to better handle compare respond to instruction requests. The systems are quick simple and effectively delegate all of the responsibility for links, data aggregation and cleaning to providers away from the buyer.
Market data services, everyone will be familiar with the thankless task that is obtaining pricing market capitalisations, sector information, etc. The opportunity to pool these functions can create significant savings particularly in building data feeds and storing information whilst it has always been possible to effectively delegate this along with accounting it will soon be possible to delegate this function without accounting.
Any externally managed pension fund with multiple managers has had to overcome the difficulties of consolidating reporting, with the unbundling of outsourcing is possible to delegate this service out to an external provider thereby minimising technology costs particularly around creating links to new managers. Something of particular interest to schemes which change managers more actively.
There are many other examples of services suitable for this kind of arrangement, one of the most notable growth areas will be in the defined contribution administration (DC) arena. There are many significant hurdles to overcome in efficiently administering a DC arrangement, ranging from basic core services such as cash administration all the way through to automating and aggregating fund dealing.
Many of the old objections to relying more on external parties for the core support of your business are things of the past, in many cases there is a viable and competitive market in the services enabling any buyer to easily compare contrast. The future of technology and a lot of the services it supports, I believe, will lie in a world similar to Larry Ellison’s view of non- distributed computing power. We will be buying programs, platforms and processing power as and when they are needed on a remote basis – as opposed to maintaining the expensive hardware, software and people in-house.