The past year has been as difficult for SWIFT as it has been for most members of the finance industry. The financial crisis has provided the organisation an opportunity to overhaul its operations and step up cost-cutting plans.SWIFT had become used to seeing electronic financial transactions grow at double-digit rates in successive years until the financial crisis. But in the fourth quarter of 2008, the trend went into reverse.
“To have the bottom fall out of growth in November and December last year was certainly a wakeup call for us,” says Ian Johnston, the chief executive of SWIFT for the Asia Pacific region. “It was no longer just ‘What’s the growth picture and how do we manage it?’ Instead it was, ‘How long is this going to last, and what do we need to do?’ ”
Instead of just talking to its member banks as to how it could make bank transactions more efficient, SWIFT started examining its own operations. It stepped up an efficiency push, with a plan to reduce its costs by 30%; 20% in structural cost reductions and another 10% in savings that would be reinvested in the company.
SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication. It is a cooperative, initially set up in 1973 by banks to enable the safe and efficient international transfer of large sums of money.
The system is proving increasingly popular with large companies - there are now 460 corporations on the network, including Petronas, Panasonic and DaimlerChrysler. The Hong Kong Monetary Authority also recently joined the network, replacing its own proprietary system for money transfers because it realized it was more efficient to use SWIFT.
In Asia Pacific, the monetary authorities of first Australia, and then New Zealand, were the first in the region to adopt SWIFT, followed by Thailand and the Philippines, then Singapore and now Hong Kong. Johnston says SWIFT is trying to persuade other Asian central banks that introducing a standardised system reduces costs for domestic banks and allows easier access for overseas investors and companies.The Sibos conference is SWIFT’s annual global-oriented event designed to bring together companies that use the SWIFT system. This year, the event is being held in Hong Kong from September 14-18, marking the second time the event has been held in the city.SWIFT executives joke that they hope this year’s conference will not be as stressful as last year’s, which began on Sept. 15, the day that Lehman Brothers filed for bankruptcy. “Sibos Monday” saw some bankers head directly from the conference back to their company headquarters. Others found it comforting to have colleagues and competitors all in one place, so they could discuss how to handle the crisis.
By now, hopefully we all know this is a new business environment. The old ways of doing business in asset management need to be re-engineered to cushion participants from the effects of the exceptional drops in gross revenues we have witnessed in recent times.Asset managers are now responding to the realities of the new environment and are increasingly exploring opportunities to adopt variable-cost models by outsourcing functions. This is an important structural shift in the model for the industry’s value chain. The Create consultancy’s report ‘The Future of Investment’, produced in association with Citi and Principal Global Investors, contains much that is relevant and thought-provoking for asset managers and their service providers.The Create report observes that “the ultimate reward could be a more efficient use of capital and maximization of alpha.” A variable cost model is emerging in which costs are linked directly to revenue via variable pay, slimmer product range and strategic outsourcing. Diseconomies of scale are under attack.On the structural side, they are being enhanced by outsourcing front, middle and back office activities to create a distinct craft focus.”More than ever, large asset managers are now recognising that they cannot be jacks-of-all-trades and masters of none. They are forced to make a choice between manufacturing and assembly. The latter is emerging as a major competency in its own right, as sub advisory mandates have taken off. A new supply chain is emerging, in which fees have both a low fixed component and a variable component.
Spurred by new regulation, the emerging variable cost model will target core capabilities and net margins. Investment, distribution and administration will continue to decouple. Vertical integration within a firm will be increasingly replaced by horizontal integration between firms. Large houses will develop multi-asset class capabilities by creating in-house product based boutiques, giving investment professionals the necessary autonomy, space and accountability to generate new ideas and execute them.Alliances with external managers will also become more common, either via sub advisory mandates or multi manager platforms, both of which are expected to proliferate in all regions. Institutional distribution of funds, so well established in Australia and the US, will spread elsewhere in Asia Pacific and Europe. Under it, a new breed of fund buyers will deploy institutional quality tools to select and package funds at wholesale prices and sell them to retail clients. Funds will be ‘bought’, not ‘sold’ in the first instance; and then delivered as customised solutions. Under this Darwinian process, pressure to deliver good consistent returns will intensify. Last but not least, outsourcing of back office activities will continue apace, embracing high value added services such as derivatives processing, independent valuation, attribution analysis, risk processes and general oversight. These developments will continue to amplify the craft focus in investment, mass customisation in distribution and process concentration in operations.
The continuing re-alignment in the value chain is promoting new alliances.The current crisis has shown that many investment products of recent years had hidden features such as leverage and asset class exposures that were out of sync with the expectations of those who bought them. As an adjunct, many products also promised more liquidity than was inherent in the underlying asset classes. They lacked acceptable redemption processes that aimed to minimise the quoted prices from the realised prices. In its absence, investors have been shocked into discovering the true cost of liquidity when there was a stampede for redemptions. Liquidity will be perceived as an asset class in its own right from here on, according to our post-survey interviews.Transparency also has other dimensions: execution costs, fees and business governance. Clients will require an independent oversight of performance measurement and attribution analysis, when they venture into risky asset classes as part of dynamic asset allocation.Assessing non core activities, the Create report notes that 38% of its survey respondents have outsourced the back office so far. It predicts that number will double in future. Some 17% have outsourced manufacturing: that number is expected to quadruple. Some 20% have outsourced the middle office: the number will double. Outsourcing contracts now typically have a low base fee plus a variable fee linked to the volume of activity.Back office outsourcing has been a major growth phenomenon of this decade, initially covering low value-added activities like custody and settlement and progressing to middle office activities like valuation of assets, derivatives pricing and attribution analysis. Growth is likely to continue for two reasons.First of all, post Madoff, regulators are likely to demand greater independent oversight of these and other activities such as product labelling, risk models and transparent charges. In the alternatives space, outsourcing is expected to extend to front office activities like stress testing, simulation models and product development.Secondly, rapid growth since 2003 has inevitably created complexity in asset management via a multiplicity of product classes, client segments, delivery channels, geographical locations, and legal jurisdictions. A number of unintended consequences have ensued: business has lacked focus; product propositions havebeen diluted to the detriment of client interests; and cost increases have mostly outpaced revenue increases proportionately, inflating staff egos and entitlements in equal measures.The cumulative effect has been diseconomies of scale which have undermined the scalability of asset managers as they have ramped up their growth. Even in areas like distribution and administration, it has proved difficult to extract scale economies as businesses have gained complexity.Thus, outsourcing is seen as a tool that allows senior executives to professionalise the business by concentrating on their core manufacturing capabilities. If performance is the target, focus is the silver bullet. In the new environment, asset managers are expected to outsource progressively more activities in order that that they may concentrate on four strategic areas that deliver a vibrant business: deep investment capabilities, strong service proposition, realistic charges and sound business basics. Without a clear strategic intent, outsourcing is just a cost cutting tool. The success of outsourcing and other initiatives critically depend upon how closely they are aligned to core business goals.
The Create report quotes an anonymous custodian bank commenting: “The current wave of outsourcing is now penetrating the middle office to cover activities like vendor management, performance measurement, attribution analytics, risk models and data management. Post Madoff, regulators are either planning to introduce new rules or reinterpreting the existing ones in three specific areas, all of which are raising the demand for external expertise.The first is product integrity. They would like to ensure that the product labels provide correct information on features such as risk, returns, liquidity and volatility. The second is oversight. They want to see more robust checks on asset valuations, performance attribution, risk models and transfer agent activities. The third is fees and compensation. Regulators want greater transparency around charges and also want managers to be paid on the basis of risk-adjusted returns. That these regulatory pressures are building up is not in doubt. They will be one of key drivers of growth for all the outsourced activities.Outsourcing is neither a panacea nor a bold fix. It is an important tool in a larger initiative that forces asset managers to be clear about their strategic intent and core capabilities. On their part, service providers are coming under enormous pressure to deliver scalable systems and people capabilities to cope with the new demands made by a rapidly morphing industry.”
The fact that investment managers are increasingly looking for help means securities processors shouldn’t be looking to simply retrench during this crisis. According to the Booz & Co consultancy, Instead they should be improving their offerings in three ways: reengineering processes, automating services, and optimizing the use of their global facilities. The Booz report entitled “Thriving Amid Change”, suggests, “The trick is for securities processors to make these changes (and enhance their offerings in the middle office, where many investment managers are now looking to outsource) in an environment in which every expenditure is being scrutinized and in which new investments have to be self-funding.”As the fortunes of investors deteriorated, so did the fortunes of securities processors—the prime brokers, custodians, and market infrastructure providers who handled the investors’ trades and serviced their accounts. Securities processing firms have in part suffered losses in their securities financing areas and in their investment portfolios.”Staff cuts have not been nearly as deep at securities processing firms as at banks. Indeed, some securities processors have actually seen their transaction volumes rise by as much as 15 percent since the crisis began. The new business generated by investors looking to outsource non-core functions and the acquisition of weaker rivals suggest that some securities processors will emerge from the crisis stronger.Some asset managers will try to achieve cost efficiencies on their own. For most, however, the emerging challenges and the capital investments needed to address them will become reasons to consider outsourcing more of their operations. So the time is right for securities processors to take a fresh look at the capabilities they offer across the entire value chain, particularly in the middle- and back-office. This special report from IPA magazine for Sibos 2009 highlghts some of the groups who are at the forefront of this renewed focus on client-oriented solutions.