A flexible framework is needed to free staff to support competitive initiatives, whilst ensuring cost-effective compliance and oversight.
Responsibility for risk, regulation and reporting makes the middle office mission critical, but also costly. For asset managers to compete and comply cost-effectively, these three areas must be carefully managed and deeply understood. But to handle the challenges of the coming decade, they also must become more highly automated, allowing staff to switch from day-to-day tasks to support evolving client needs in a fast-changing competitive environment.
Today’s middle-office teams are like highly alert traffic officers, keeping information flowing smoothly at a busy intersection or roundabout, knowing the rules, risks and directions to follow. In the past decade, middle office ‘traffic’ has grown exponentially, driven by tighter regulatory requirements, as well as efforts to improve transparency, reduce systemic risk and manage collateral more rigorously. Yet despite leveraging technology to automate some workflows, and outsourcing other routines to third parties, senior middle office staff spend an ever-larger share of their time directing traffic. They are expected to supply more information, manage more risks and comply with more regulations.
Perform better, pivot quicker
But directing traffic is not an end in itself. In addition to providing early warning of potentially severe problems, middle office data can help asset managers reshape processes and channels for optimized performance and provide valuable input into new initiatives. Thus, using technology and strategic outsourcing to free up middle office managers for value added activities doesn’t just prevent gridlock. It also enables firms to perform better and pivot quicker, while minimizing costs and risks.
"Middle office data can help asset managers reshape processes and channels for optimized performance."
Even before the regulatory deluge of the 2010s, middle offices were experimenting. The 2000s saw an upsurge in outsourced offerings that sought economies of scale from centralized processing capabilities, e.g. for shadow NAV calculations. Results were mixed, with processes executed more cheaply but not necessarily more efficiently, risking compliance failures and damage to client trust. In the meantime, skill and automation levels at outsourcing and offshoring facilities have increased, but so have regulatory concerns. The extension of the UK Financial Conduct Authority’s Senior Managers and Certification Regime (SM&CR) to asset managers is the latest evidence that regulators expect the most thorough oversight over all operations, outsourced or otherwise.
Insight and oversight
With fee pressure and client demands requiring firms to be ever lighter on their feet, outsourcing and partnering are increasing in appeal. A recent Deloitte survey reported 59% of asset managers implementing or planning an outsourcing/offshoring project, with 49% working on streamlining initiatives to increase control. Higher skill levels allow more complex tasks to be located offshore, but the greater shift is in technology integration. When processes and systems are re-engineered to be truly end-to-end, API-connected and cloud-hosted, insight and oversight are improved, to the satisfaction of regulators, managers and clients. Customizable NAV oversight capabilities that support validation, testing and mitigation are just one example of a more integrated and robust control environment.
But outsourcing cannot be the whole solution. As noted, compliance and reporting challenges have skyrocketed, with buy-side firms adopting triage to handle multiple deadlines and requirements from diverse regulators. This has meant greater recruitment or sell-side reliance to help shoulder the burden, incurring unsustainable costs and risks.
The pace of regulatory reform is slowing, but the landscape will continue evolve. Cyber-security threats are now a constant factor, while regulatory and client expectations on ESG have disclosure, performance measurement and position limit implications. Compliance processes may be too close to the core to be outsourced, but must become more standardized, automated and integrated with the front office as they mature. A more centralized approach to data management and greater use of cloud-based analytics and artificial intelligence/machine learning (AI/ML) can help staff focus on proactively investigating alerts and preventing breaches without sifting through files manually.
"Between the black box of outsourcing and the heavy burden of manual processes, staffing costs and legacy systems, a new middle path is emerging."
Toward a new middle path
Between the black box of outsourcing and the heavy burden of manual processes, staffing costs and legacy systems, a new middle path is emerging. It’s not the same route for every firm, but most are edging toward a more virtual, aggregated framework of tools, platforms and services that gives staff time to monitor, design and refine. Data warehouses are helping firms consolidate and normalize data for use across multiple tools and systems, a crucial pre-requisite for maximizing AI/ML’s potential to identify, flag and address flaws, breaks and inefficiencies.
We’re only in the early stages. Ten years ago, some firms were still building in-house systems. The need to reduce fixed costs means the shift is now from human-oriented processes to ones managed by machines. By 2030, the middle office could prove to be the part of the asset manager’s operations most impacted by digital technologies, from AI/ML to web-based blockchain apps.
Why so certain? In the unpredictable future we’re looking to thrive in, only flexible operating models that blend and integrate multiple services can direct traffic effectively, while granting staff the time to look further ahead, collaborating with client-facing colleagues on strategic goals.
About the author, Jonathan Hinkley
Jonathan Hinkley, is the SVP, Middle and Back Office Services at Linedata. He is a financial services leader with 20+ years’ experience in Investment Management Middle/Back Office operations and Public Accounting. Jonathan leads the Middle and Back Office Co-Sourcing business for Linedata Global Services in New York, where he leads multiple cross-functional teams enabling multi-strategy, credit, and private equity firms to maximize operating leverage. Jonathan is a trusted advisor and valuable resource to CFO and COOs, with an extensive background in creating scale servicing funds across the capital structure with a particular focus on complex Credit Funds. Jonathan holds a Bachelor of Science in Accountancy from Bentley University and has held a Certified Public Accountant license (MA) since 2001.