New operating models
Winter 2015/2016

Across the board, buy-side and sell-side firms are adopting new operating models in the face of a wide array of commercial and regulatory challenges. Broker-dealers and investment banks are locked into a return-on-equity crisis. Among institutional investors, there is a trend for bringing in-house the management of some investments. Meanwhile, asset managers, wealth managers and the retail distribution chain are entering a period of frantic evolution.

A key driver of change is the steady convergence of traditional and alternative investments, which cuts across the asset-class silos typically found at traditional asset managers. "Multi-asset expansion is currently one of the biggest drivers of growth for asset managers and their service providers. It's also one of the reasons why asset managers' middle and back offices have become considerably more challenging to maintain in-house," notes Patrick Colle, CEO of BNP Paribas Securities Services.

The convergence of asset classes is having an impact on the alternatives sector as well. "We're beginning to see hedge fund managers broaden their remit, both in terms of the products they are launching, which appear more liquid in nature, and indeed by the clients they are chasing – many of whom were once the domain of the traditional asset management firms," explains Tony McDonnell, HSBC's Head of Securities Services in Ireland.

"The industry as a whole is under increased pressure to comply with upcoming and ongoing regulatory and infrastructure changes such as MiFID, RDR and EMIR, while concurrently being faced with the need to remain competitive in a difficult economic environment," says Etienne Deniau, Head of Business Development – Asset Managers & Asset Owners for Société Générale Securities Services (SGSS). "Added to this, financial institutions are feeling pressure to reduce investor fees and demonstrate value for money to the end-investor. As a result, they are increasingly reassessing their business models in order to adapt their operations, which progressively include outsourcing non-core services, to future-proof their businesses."

The challenges for buy- and sell-side firms are wide-ranging and manifest themselves as a broad spectrum of requirements for the front, middle and back offices. In meeting these needs, the sheer complexity of doing business today means that tinkering with processes and technology is no longer adequate. Instead, firms must embark on what is often a multi-year journey: defining a target operating model which has flexible business processes and technology infrastructure, along with fluid connections among employees and with customers and suppliers. The firm must have the necessary skill sets, both during the journey to the target model and thereafter to maintain operating efficiency – and, above all, the requisite leadership and commitment from the top. With a multitude of interrelated choices, and a necessary degree of trade-off among potential goals, a holistic approach is essential. The changes are likely to be all-encompassing but should not be all-consuming; having defined the target model, the roadmap should take the form of a series of achievable, bite-size steps. Each should deliver tangible benefits to all stakeholders, especially clients and in-house teams.

A marked change in the past decade, and very much a growing trend, is the need for buy- and sell-side firms to manage an expanding range of service providers and vendors. Gone are the days when an institution contracted with a global custodian or prime broker for all the post-trade services it needs. The securities value chain has become considerably more complicated – while also getting more and more broken apart. Some custodians have exited certain activities, or chosen not to add new capabilities required by clients, while an array of new vendors has emerged. The new contingent includes component outsourcing firms, which take the day-to-day management of specific activities off a client's hands, along with specialist firms in areas such as agency lending, proxy voting and tax reclaims.

In the coming years, institutions will add to their lists of vendors. "We've recently appointed a specialist technology firm to meet our new trade reporting obligations," a senior executive at a major global insurance group tells us, "and we'll be looking at other vendors as further regulatory demands come on stream. Looking further ahead, when Target-2 Securities is implemented more fully across Europe, there may be a need to contract directly with in-market local custodians and perhaps with a central securities depository. The possible adoption of blockchain technology in the securities value chain may present a need to contract with one central provider, while there is the possibility that one big data provider emerges to add further complexity to the vendor management process."

Adaptation by sector


Institutional investors

There is a marked trend among asset owners towards insourcing investment management or adopting co-investment models. One factor here is the scope for achieving cost savings against external mandates but, according to the Casey Quirk Global Fiduciary CIO Survey, the key driver is control. Tyler Cloherty, Senior Manager at the management consultancy firm, highlights the increased focus on risk and absolute return and how external managers' unconstrained strategies can be a bar to asset owners having complete transparency. "By bringing assets in-house, they have more understanding of, and control around, what they are managing," he says.

Emmanuelle Choukroun, Director, New Services – Pension Funds and Sovereigns for SGSS points out that the implementation of the various pension reforms presents the need to adapt operations, with enhanced look-through and strong data management.

Asset managers

The push for greater transparency – demanded by clients and regulators alike – is also having a marked impact in the asset management industry. Hedge funds and private equity firms have long sailed under the radar. This has changed dramatically with new compliance requirements – such as those under Dodd-Frank in the US and, in Europe, the Alternative Investment Fund Managers Directive (AIFMD) – with extension of associated obligations to retail funds under UCITS V. A host of other factors are in play, some of which are explored in our accompanying article Frantic evolution in asset management. The consequence of these is severe strain on firms' traditional operating models.

Wealth managers

Wealth management and retail fund distribution are following different paths in different countries. In rapidly developing economies, firms are riding a wave of strong growth. But in low-growth markets such as North America and Western Europe, firms are having to make a wholesale change to their operating model. They need to simplify processes while also driving profitable growth, often with static or reduced resources. Those in the European Economic Area, and also Australia and Switzerland, face regulations which ban rebates paid by fund manufactures to the distributors – and so must adapt their entire business model to the new regime.

Broker-dealers

With the downturn that followed the collapse of Lehman Brothers, broker-dealers were hit by a slump in revenues. While market indices have staged a recovery, reaching historic highs in recent years, this has been on the back of thin volumes. Many clients have not returned, the trading volumes that drive transaction processing are still sluggish, and revenue growth is hard to come by – so broker-dealers remain engulfed in a return-on-equity crisis.

Consequently, firms have been forced to use their capital and liquidity more efficiently. Since 2015, banks have faced the additional demand of compliance with the Liquidity Coverage Ratio imposed by Basel III – under which an adequate stock of unencumbered liquid assets must be held to cover potential liquidity outflows. Firms have sought to strip out costs, streamline their operations and, in some cases, consolidate or shut up shop.

"A decade ago, among many broker-dealers, it was considered commercially unacceptable for client trades not to be processed in-house. Today, clients are actively seeking value and quality executions. They look to broker-dealers which offer superior service and are not concerned about the current trend to outsource middle- and back-office functions," says Frank Colella, Head of Sales & Relationship Management for Broker Dealer Services US at BNP Paribas Securities Services. He points to several key benefits: cost savings, more efficient use of capital and access to superior infrastructure in a particular function, such as wealth management or international processing.

Driven by the regulatory mandate for strong governance, along with the need to do more with strained resources, the past decade has seen a trend towards 'near shoring' the heavy lifting involved in investment and fund servicing – moving operations from high- to low-cost jurisdictions, while retaining support for language, time zones and complex processing. This new operating model, now common among service providers, has extended to many asset management and insurance groups. Any institution operating in multiple locations, which has decided to keep investment operations in-house, will be under pressure to streamline processes into such a centralized hub. An executive at one institution tells us: "Our hub has been up and running for several years now and, as part of our migration to this new operating model, we streamlined our custodial and other vendor relationships to align them with our new internal structure and to strip out multiple vendors for a given service. On the other hand, new regulatory demands have led us to contract with other vendors as well."

"The sheer range of regulatory change has had a significant impact on firms across the entire financial industry, from hedge funds to pension funds and insurance companies," says Tom Kirkpatrick, Managing Director and Head of Europe Middle East & Africa for SS&C GlobeOp. "While different people have different problems to solve, everyone is forced to examine whether they have the right technology, the right people skills and the right specialist providers to be on top of all the changes. There is a broad range of service providers out there, helping firms in different ways," notes Mr Kirkpatrick. His firm has combined the capabilities of a technology company with those of an operational services provider to import client data, validate that data and publish it in various forms, including financial reports, investor statements, risk reports and regulatory submissions. This evolution of the role of service providers, from processing the trade life-cycle and valuing assets to becoming a major contributor to clients' data management, is a notable trend.

New regulatory and client mandates go much deeper than the immediate reporting or other issues at hand, as their impact ripples through a firm's operating model – both internally and in modifying the distribution of responsibilities with service providers. For many firms, it's a struggle to find the data that's needed and to process it in a timely and efficient manner. "Some have legacy technology which is not very flexible and it can be challenging for them to plug in new technology," says Mr Kirkpatrick. "Others have built their own, more modern technology but is it scalable and capable of handling the new demands put on it? Increasingly, firms of all sizes are redefining their operating model – to be sure they can find the data needed and process it to meet their risk, control and cost goals."

Service providers have been adapting their own operating models to align themselves with the changes being made by clients and to have the flexibility to meet the wide-ranging requirements across different businesses. Many have introduced and expanded outsourcing services, to take on more of the burden faced by asset owners, investment managers, wealth managers and broker-dealers.

The more progressive vendors have stepped up their relationship management. "Our philosophy is to provide transparency in operating all aspects of the relationship," explains Mr Kirkpatrick. His firm works with clients to ensure that all parties understand their mutual accountabilities and related work flows, where each party is to complete specified tasks to defined time-lines. "While historic metrics can help to some extent, we focus on clear accountability and effective communications, so that exceptions can be resolved as they arise and both parties can make informed assessments on the quality of service provision. This is based on creating good business relationships and communication lines so the parties can address issues quickly. This is underpinned by regular meetings at the operational level and also regular meetings at the executive level to validate."

An executive at a multinational institutional investor affirmed the importance of the vendor's client service model and its alignment with his group's structure. "We carry out an internal survey of vendors from time to time, focusing on this and other key areas of importance, such as the scope of services and pricing. For a detailed examination of vendors' services, we have relied on a range of third-party surveys."

The scope of vendor management has changed significantly over the past ten years, the same executive tells us, pointing to tighter continuity planning – defining exit plans in the event that a vendor goes bust, ensuring access to data and managing cyber security. Crucially, there is now a strong and growing focus on monitoring providers' services. "Back then, service level agreements or stand-alone key performance indicators (KPIs) were applied only to a few relationships. Now we apply them across the board. As things stand today, the KPIs we apply are not highly sophisticated and we're looking for a means of benchmarking against other institutions to identify the most useful service and risk metrics for our needs."

In dealing with an increasingly complex web of service providers and technology vendors, buy- and sell-side firms are having to step up their vendor management to manage risk, control costs and increase performance in a continually evolving business environment. This vigilance will be vital to the fulfilment of their obligations to clients and end-investors.





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Across the board, buy-side and sell-side firms are adopting new operating models in the face of a wide array of commercial and regulatory challenges. Broker-dealers and investment banks are locked into a return-on-equity crisis. Among institutional investors, there is a trend for bringing in-house the management of some investments. Meanwhile, asset managers, wealth managers and the retail distribution chain are entering a period of frantic evolution.

A key driver of change is the steady convergence of traditional and alternative investments, which cuts across the asset-class silos typically found at traditional asset managers. "Multi-asset expansion is currently one of the biggest drivers of growth for asset managers and their service providers. It's also one of the reasons why asset managers' middle and back offices have become considerably more challenging to maintain in-house," notes Patrick Colle, CEO of BNP Paribas Securities Services.

The convergence of asset classes is having an impact on the alternatives sector as well. "We're beginning to see hedge fund managers broaden their remit, both in terms of the products they are launching, which appear more liquid in nature, and indeed by the clients they are chasing – many of whom were once the domain of the traditional asset management firms," explains Tony McDonnell, HSBC's Head of Securities Services in Ireland.

"The industry as a whole is under increased pressure to comply with upcoming and ongoing regulatory and infrastructure changes such as MiFID, RDR and EMIR, while concurrently being faced with the need to remain competitive in a difficult economic environment," says Etienne Deniau, Head of Business Development – Asset Managers & Asset Owners for Société Générale Securities Services (SGSS). "Added to this, financial institutions are feeling pressure to reduce investor fees and demonstrate value for money to the end-investor. As a result, they are increasingly reassessing their business models in order to adapt their operations, which progressively include outsourcing non-core services, to future-proof their businesses."

The challenges for buy- and sell-side firms are wide-ranging and manifest themselves as a broad spectrum of requirements for the front, middle and back offices. In meeting these needs, the sheer complexity of doing business today means that tinkering with processes and technology is no longer adequate. Instead, firms must embark on what is often a multi-year journey: defining a target operating model which has flexible business processes and technology infrastructure, along with fluid connections among employees and with customers and suppliers. The firm must have the necessary skill sets, both during the journey to the target model and thereafter to maintain operating efficiency – and, above all, the requisite leadership and commitment from the top. With a multitude of interrelated choices, and a necessary degree of trade-off among potential goals, a holistic approach is essential. The changes are likely to be all-encompassing but should not be all-consuming; having defined the target model, the roadmap should take the form of a series of achievable, bite-size steps. Each should deliver tangible benefits to all stakeholders, especially clients and in-house teams.

A marked change in the past decade, and very much a growing trend, is the need for buy- and sell-side firms to manage an expanding range of service providers and vendors. Gone are the days when an institution contracted with a global custodian or prime broker for all the post-trade services it needs. The securities value chain has become considerably more complicated – while also getting more and more broken apart. Some custodians have exited certain activities, or chosen not to add new capabilities required by clients, while an array of new vendors has emerged. The new contingent includes component outsourcing firms, which take the day-to-day management of specific activities off a client's hands, along with specialist firms in areas such as agency lending, proxy voting and tax reclaims.

In the coming years, institutions will add to their lists of vendors. "We've recently appointed a specialist technology firm to meet our new trade reporting obligations," a senior executive at a major global insurance group tells us, "and we'll be looking at other vendors as further regulatory demands come on stream. Looking further ahead, when Target-2 Securities is implemented more fully across Europe, there may be a need to contract directly with in-market local custodians and perhaps with a central securities depository. The possible adoption of blockchain technology in the securities value chain may present a need to contract with one central provider, while there is the possibility that one big data provider emerges to add further complexity to the vendor management process."

Adaptation by sector


Institutional investors

There is a marked trend among asset owners towards insourcing investment management or adopting co-investment models. One factor here is the scope for achieving cost savings against external mandates but, according to the Casey Quirk Global Fiduciary CIO Survey, the key driver is control. Tyler Cloherty, Senior Manager at the management consultancy firm, highlights the increased focus on risk and absolute return and how external managers' unconstrained strategies can be a bar to asset owners having complete transparency. "By bringing assets in-house, they have more understanding of, and control around, what they are managing," he says.

Emmanuelle Choukroun, Director, New Services – Pension Funds and Sovereigns for SGSS points out that the implementation of the various pension reforms presents the need to adapt operations, with enhanced look-through and strong data management.

Asset managers

The push for greater transparency – demanded by clients and regulators alike – is also having a marked impact in the asset management industry. Hedge funds and private equity firms have long sailed under the radar. This has changed dramatically with new compliance requirements – such as those under Dodd-Frank in the US and, in Europe, the Alternative Investment Fund Managers Directive (AIFMD) – with extension of associated obligations to retail funds under UCITS V. A host of other factors are in play, some of which are explored in our accompanying article Frantic evolution in asset management. The consequence of these is severe strain on firms' traditional operating models.

Wealth managers

Wealth management and retail fund distribution are following different paths in different countries. In rapidly developing economies, firms are riding a wave of strong growth. But in low-growth markets such as North America and Western Europe, firms are having to make a wholesale change to their operating model. They need to simplify processes while also driving profitable growth, often with static or reduced resources. Those in the European Economic Area, and also Australia and Switzerland, face regulations which ban rebates paid by fund manufactures to the distributors – and so must adapt their entire business model to the new regime.

Broker-dealers

With the downturn that followed the collapse of Lehman Brothers, broker-dealers were hit by a slump in revenues. While market indices have staged a recovery, reaching historic highs in recent years, this has been on the back of thin volumes. Many clients have not returned, the trading volumes that drive transaction processing are still sluggish, and revenue growth is hard to come by – so broker-dealers remain engulfed in a return-on-equity crisis.

Consequently, firms have been forced to use their capital and liquidity more efficiently. Since 2015, banks have faced the additional demand of compliance with the Liquidity Coverage Ratio imposed by Basel III – under which an adequate stock of unencumbered liquid assets must be held to cover potential liquidity outflows. Firms have sought to strip out costs, streamline their operations and, in some cases, consolidate or shut up shop.

"A decade ago, among many broker-dealers, it was considered commercially unacceptable for client trades not to be processed in-house. Today, clients are actively seeking value and quality executions. They look to broker-dealers which offer superior service and are not concerned about the current trend to outsource middle- and back-office functions," says Frank Colella, Head of Sales & Relationship Management for Broker Dealer Services US at BNP Paribas Securities Services. He points to several key benefits: cost savings, more efficient use of capital and access to superior infrastructure in a particular function, such as wealth management or international processing.

Driven by the regulatory mandate for strong governance, along with the need to do more with strained resources, the past decade has seen a trend towards 'near shoring' the heavy lifting involved in investment and fund servicing – moving operations from high- to low-cost jurisdictions, while retaining support for language, time zones and complex processing. This new operating model, now common among service providers, has extended to many asset management and insurance groups. Any institution operating in multiple locations, which has decided to keep investment operations in-house, will be under pressure to streamline processes into such a centralized hub. An executive at one institution tells us: "Our hub has been up and running for several years now and, as part of our migration to this new operating model, we streamlined our custodial and other vendor relationships to align them with our new internal structure and to strip out multiple vendors for a given service. On the other hand, new regulatory demands have led us to contract with other vendors as well."

"The sheer range of regulatory change has had a significant impact on firms across the entire financial industry, from hedge funds to pension funds and insurance companies," says Tom Kirkpatrick, Managing Director and Head of Europe Middle East & Africa for SS&C GlobeOp. "While different people have different problems to solve, everyone is forced to examine whether they have the right technology, the right people skills and the right specialist providers to be on top of all the changes. There is a broad range of service providers out there, helping firms in different ways," notes Mr Kirkpatrick. His firm has combined the capabilities of a technology company with those of an operational services provider to import client data, validate that data and publish it in various forms, including financial reports, investor statements, risk reports and regulatory submissions. This evolution of the role of service providers, from processing the trade life-cycle and valuing assets to becoming a major contributor to clients' data management, is a notable trend.

New regulatory and client mandates go much deeper than the immediate reporting or other issues at hand, as their impact ripples through a firm's operating model – both internally and in modifying the distribution of responsibilities with service providers. For many firms, it's a struggle to find the data that's needed and to process it in a timely and efficient manner. "Some have legacy technology which is not very flexible and it can be challenging for them to plug in new technology," says Mr Kirkpatrick. "Others have built their own, more modern technology but is it scalable and capable of handling the new demands put on it? Increasingly, firms of all sizes are redefining their operating model – to be sure they can find the data needed and process it to meet their risk, control and cost goals."

Service providers have been adapting their own operating models to align themselves with the changes being made by clients and to have the flexibility to meet the wide-ranging requirements across different businesses. Many have introduced and expanded outsourcing services, to take on more of the burden faced by asset owners, investment managers, wealth managers and broker-dealers.

The more progressive vendors have stepped up their relationship management. "Our philosophy is to provide transparency in operating all aspects of the relationship," explains Mr Kirkpatrick. His firm works with clients to ensure that all parties understand their mutual accountabilities and related work flows, where each party is to complete specified tasks to defined time-lines. "While historic metrics can help to some extent, we focus on clear accountability and effective communications, so that exceptions can be resolved as they arise and both parties can make informed assessments on the quality of service provision. This is based on creating good business relationships and communication lines so the parties can address issues quickly. This is underpinned by regular meetings at the operational level and also regular meetings at the executive level to validate."

An executive at a multinational institutional investor affirmed the importance of the vendor's client service model and its alignment with his group's structure. "We carry out an internal survey of vendors from time to time, focusing on this and other key areas of importance, such as the scope of services and pricing. For a detailed examination of vendors' services, we have relied on a range of third-party surveys."

The scope of vendor management has changed significantly over the past ten years, the same executive tells us, pointing to tighter continuity planning – defining exit plans in the event that a vendor goes bust, ensuring access to data and managing cyber security. Crucially, there is now a strong and growing focus on monitoring providers' services. "Back then, service level agreements or stand-alone key performance indicators (KPIs) were applied only to a few relationships. Now we apply them across the board. As things stand today, the KPIs we apply are not highly sophisticated and we're looking for a means of benchmarking against other institutions to identify the most useful service and risk metrics for our needs."

In dealing with an increasingly complex web of service providers and technology vendors, buy- and sell-side firms are having to step up their vendor management to manage risk, control costs and increase performance in a continually evolving business environment. This vigilance will be vital to the fulfilment of their obligations to clients and end-investors.