The competitive landscape for Custodians continues to get tougher. On one hand, the needs of their clients are becoming more complex and difficult to fulfil whilst there is a squeeze on fees and a reduction of revenues from the traditional sources such as FX, cash and stock lending.
To succeed in this competitive landscape, custodians are positioning themselves higher up the ‘value chain’ to deliver ‘middle office’ related services such as performance and risk reporting, post trade administration and client reporting.
But do Custodians really know what their clients need from a middle office service?
After advising both large and small clients over the past 10 years in the selection of middle office service providers in Australia and across Asia, we have a unique perspective on the key success factors required to deliver a competitive middle office service offer.
Success Factor #1 - Solve the Asset Manager's technology challenge
Delivering middle office services to clients is as much about delivering self-service technology solutions as providing middle office services. Asset managers may want to control the ‘last mile’ of activities such as client reporting but they are shying away from deploying expensive and complex systems that generally duplicate the infrastructure of the Custodians. Enabling clients to use the custodian’s systems to support activities such as client reporting, performance & risk analytics is a win/win as it continues to provide the manager with control over these functions whilst leveraging the technology scale of the Custodian. In the future this could also extend to ‘front office’ technology platforms such as order and execution platforms.
See our blog that further explores whether Custodians should offer order management.
Success Factor #2 - Be the information consolidator
A key objective of many Asset Managers who outsource their middle office is eliminating the need for operational interaction with external parties such as 3rd party Custodians, Transfer Agents and Data Vendors. The Custodian who has the scale and technology to integrate with multiple parties should assume the integration complexity.
Whilst most, if not all Custodians, will argue they meet this objective, our observation is they generally take a narrow interpretation of ‘information’ and Asset Managers are still required to interact directly with external parties to obtain information not provided via their primary Custodian. An example of this is FUM and cashflow data from external Transfer Agents that is required to support internal management reporting.
Custodians should endeavour to take a partnership approach with their Asset Manager clients by taking a holistic view of all information required by the Asset Managers from third parties and seek to accommodate this.
Success Factor #3 - Get involved in the strategy discussion and provide thought leadership but don't push your products
Custodians were traditionally engaged and instructed on new product or business ventures on an ‘after the fact’ basis. This often deteriorated into a ‘conversation’ about the Custodians willingness to support the new initiative and the associated. As a strategic partner, we believe Custodians should be engaged in the conversation from the outset. This provides the Asset Manager with comfort on the Custodian’s ability to implement as well as insights to the Custodian on their clients’ product and growth roadmap, thus enabling better forward business planning. Custodians often have valuable insights to assist their clients in the formation of their product strategy due to their expertise in asset administration and being part of a global organisation.
Whilst this engagement can be invaluable to the Asset Manager, Custodians should position themselves as trusted advisors and resist the temptation to up sell. Like many consulting services, custodian products are bought not sold!
Success Factor #4 - Walk in the Asset Manager's 'shoes' when deciding to customise and consider the impact on your future middle office services
A key factor behind many of the outsourcing ‘failures’ over the past few years has been the Custodian’s willingness to implement bespoke solutions to satisfy the client even though the justification of this ‘need’ was, at best, questionable. The customisation has often occurred through the sales process and was seen by the Custodian as being necessary to ‘seal the deal’. By moving outside of the Custodians standing operating model, the perceived scale benefits do not materialise and a sub optimal outcome is achieved.
Whilst Custodians are becoming stricter at enforcing rules on standardisation, this is typically based on their own operating environment and does not clearly consider the needs of the client and/or the future role of the middle office product suite. Hence, when deciding about the development of their operating model to meet the clients’ needs, Custodians should consider:
- What is the impact on the Asset Manager if we do not meet this request?
- How will the Asset Manager solve the problem and will it dilute the Asset Managers’ PERCEIVED VALUE of the middle office outsource?
- Is this an emerging requirement given the continuing re-definition of middle office services?
When engaging in these conversations, Custodians should not be afraid to reach out to Asset Managers and propose changes to their processes that may address a need. Asset Managers are often only interested solving the problem rather than winning a debate on whether services may be outsourced.
Success Factor #5 - Recognise and support the changing business model of Asset Managers
Asset managers are also operating in a challenging environment. Equity markets are volatile and yields are low. Furthermore, mny Asset Managers are pursuing regional strategies and investing in more complex instruments, which is placing greater demands on front and back office systems and the skill set required of middle and back office staff.
In delivering middle office services, Custodians should be mindful of this new paradigm and ensure their services match to these requirements. For example:
Increased market volatility – the valuation lifecycle of Custodians may need to transition to intra-day to provide more timely data to Asset Managers and to prevent arbitrage opportunities.
Complex Instruments – Custodians should have expertise, infrastructure and willingness to support the end to end lifecycle of complex instruments.
Pursuit of regional strategies – this requires the operating model of Custodians to be adapted to regional differences and to integrate with local market participants (for example integration to Korea Securities Depository).
Outsourcing middle office is a complex undertaking and the above success factors are only a subset of many other critical points. However, we see these themes persisting across many of our clients and they are key drivers for extracting value from their Custodians.
As the old saying goes “recognising the problem is the first step towards solving it”. By understanding the true drivers of outsourcing Middle Office, we remain optimistic that Custodians have the capability to deliver a solution that will truly live up to the benefits their clients expect.