Seismic shift as fund managers outsource operations
A trend towards investment operations outsourcing has increased due to growing margin pressures, according to a report from London-based consultants Clear Path Analysis.
Investment management firms need to execute their business strategy better and faster because the pace and complexity of industry change is accelerating, and meeting business demands has never been more difficult, the report said.
Interest in more complex, global products and regulatory changes mean fund managers must be more nimble than ever, and faced with such pressures, they are looking for external expertise and support. Investment operations outsourcing has evolved from a purely cost driven processing capability to a strategic tool providing access to knowledge, experience and technical expertise at every stage of growth.
Les Beale, global head of product and strategy for investment operations outsourcing at Northern Trust told the report authors that regulation and risk management is driving this trend. “In particular, the Volcker Rule is forcing investment banks to reduce proprietary trading exposure to meet capital adequacy requirements. Many are therefore spinning off their trading desks, lowering barriers to entry and offering entrepreneurial managers the opportunity to start their own businesses.”
Investment operations outsourcing is critical to the success of new investment managers, providing a cost-effective platform to manage their investments and clients, while enabling them to focus on their strategy and core competencies at critical growth phases.
The report said the financial crisis has acted as a catalyst for start-up companies, with many managers leaving their roles in investment banks and striking out on their own. It cites the case of London-headquartered Independent Franchise Partners (IFP), launched with $250mn assets under management in June 2009 and now has more than $6bn.
Management made a conscious decision to keep the business as lean as possible, focused on core activities such as stock research, portfolio construction, trading and client service capabilities. Resources and start-up expenditure would go to launching the company and marketing the business to investors, rather than the time-consuming process of building their own back office.
Another firm demonstrating the trend is New York-based Global Credit Advisers, LLC (GCA) which grew quickly due to its attractive risk-adjusted returns and institutional-grade offering to investors. It selected fund administrator Butterfield Fulcrum.
“More than anything, GCA was looking for an organisation that had built an infrastructure capable of adapting easily to any fund structure and trading strategy, making the entire back-office process much simpler and more effective,” says Glenn Henderson, President and CEO at Butterfield Fulcrum.
Northern Trust’s Beale says managers need to be very clear about individual roles and protocols, as the outsourcing provider will be undertaking duties that have regulatory and legal impacts for which their client will continue to be ultimately responsible.
Liability under outsourcing and custody arrangements has always been a difficult balance to strike with providers. Amanda Lewis, Partner at SNR Denton, warns that for the outsourcing customer, failure to get liability issues right may not only mean the outsourcing fails to achieve the desired cost savings, but also that the business has no remedy against the provider if the provider causes losses to it or its underlying clients.
In the custody market, providers usually limit their liability to damages caused by their negligence for two reasons. The first is the underlying obligation to take care of the relevant assets and to keep proper records of book-entry securities. Secondly, custody arrangements are commodity agreements which can usually be terminated at relatively short notice.
“The allocation of liability for custody is likely to change once the AIFMD is implemented,” adds Lewis. “Each alternative investment fund (AIF) manager caught by the AIFMD will need to have a written contract with a depository or custodian for each fund it manages.
The Commission will set minimum contents for this contract. The depository will be liable to the relevant fund or its investors for the loss of financial instruments held in custody (whether it is responsible for the loss or not) except if such loss has arisen as a result of an external event beyond its reasonable control, explains Lewis. It will also be liable for all other losses arising from negligently or intentionally failing to perform its AIFMD duties.
“Whether matching changes will be made to bring the UCITS Directives in line with AIFMD requirements on depositories remains unclear,” says Lewis. “The Commission is examining the UCITS depositary rules to ensure that the level of protection given there is not less than that in the AIFMD. It seems that the AIFMD requirements are to be a benchmark but not necessarily a ceiling.”