Appropriate oversight of an outsourcer could avert a distressed exit, says Citisoft’s Cosmo Wisniewski, but it can also yield useful ongoing business intelligence.
For any asset management firm, a distressed exit from its outsourcing arrangements should be avoided at all costs. From a commercial perspective, there is the loss of management focus, the cost of moving providers at short notice and damage to reputation in the marketplace, affecting the ability of the firm to attract new mandates. From a risk perspective, there is also considerable corporate and project risk associated with such an event.
It came as no surprise to the industry, therefore, that following the 2013 thematic review into outsourcing – where the UK’s Financial Conduct Authority (FCA) warned asset managers of the oversight and resilience risks associated with using service providers within the investment management process – the FCA’s principal focus has been on distressed exit scenarios.
SHOULD ALL SERVICE PROVIDERS BE G-SIFIS?
According to the recent thematic review, the majority of outsourcing service providers are Global Systemically Important Financial Institutions (G-Sifis), so they should already have a recovery and resolution plan in place. To make this approach watertight, however, the FCA needs to take one of two options.
First, stipulate that all service providers work towards ensuring that there is a 24-month protection guarantee for them in the event of failure of the business. In other words, if a catastrophic event should occur, these service providers would be supported for at least two years. This is the minimum length of time it would take to unravel the outsourcer arrangements.
Second, ensure that asset managers have viable plans in place in the event of a distressed exit situation.
The former scenario would appear to be unlikely. This solution is difficult to turn into a practical proposition. Regarding the latter, a clear timetable for exit plans would be helpful. From our conversations with asset managers, it appears that if an asset manager has initiated a process to review its strategic options concerning a distressed exit, then that is currently adequate. However, the expectation is that firms will need more rigorous plans in place.
The problem is that nothing is set in stone and this ambiguity is creating some anxiety within the industry.
MAKING OVERSIGHT PART OF ‘BUSINESS AS USUAL’
Irrespective of the course that the FCA takes, effective oversight needs to become a function of the asset manager’s daily way of working, part of its ‘business as usual’ framework. Oversight should not be contemplated as a one-off project as it can deliver tangible business benefits.
These benefits can be accrued through a shift in emphasis – from knowledge based upon current or past performance to the prediction of future threat. Traditional outsourcing oversight measures tend to be somewhat retrospective, ascertaining how well certain functions performed. By their very nature, service level agreements are also retrospective: for example, the service provider will settle 90% of the asset manager’s trades within 48 hours.
In contrast, a more advanced set of metrics and data visualisation tools could provide foresight into how the outsourcer may perform in the future against, for example, increased volumes or more complex products. This is where an important opportunity resides for asset managers.
When an asset management firm reviews its oversight arrangements under the FCA’s thematic review, it should be aiming to transform this process into a more forward-looking activity, providing real perception to the business. In practice, this means taking the same information and applying some business intelligence. For example, if the outsourcer is processing x number of trades and is almost up to capacity, and if the asset manager should grow its fixed income business by 10% to y as a result of an acquisition, would it be able to cope with the operational burden?
In this way, asset management firms should ensure that oversight extends beyond the failure of their outsourcer and embraces potential strategic shifts in the asset manager’s business. Outsourcing risk is as much about internal factors within the firm’s reach as it is about external failures beyond its control.
THE ACHILLES’ HEEL
The larger outsourcers have taken serious steps towards mitigating risk for their asset management clients. One might question whether it should be the asset management community that should be leading the charge on this issue as opposed to the service providers, or at least an independent third party with no vested interest. Some commentators would argue that there is an over-reliance on the service providers for these exit plans, when the FCA has clearly stated that it holds the asset managers accountable.
A bigger risk, however, is probably lurking among the smaller outsourcers performing mission-critical functions, or those larger outsourcers that themselves subcontract an element of their obligations to a smaller firm. This could be the industry’s Achilles’ heel – a hidden weakness in a seemingly powerful provider that could potentially lead to serious operational issues at the service provider and possibly even the asset management firm.
GOOD FOR ALL
Effective oversight should encompass not just the activities of the asset management firm today but also the future growth plans for the business.
As an asset manager improves its oversight, exit planning and relationship with its outsourcer, a distressed exit becomes less of an issue because the risk is being mitigated. The key is for the firm to manage its risk profile so that it is in a position to move its business to the appropriate place at the appropriate time.
With appropriate oversight and well-maintained exit plans, an asset manager should be ready and willing to migrate, rather than waiting for an Armageddon scenario to unfold first. We also believe strongly that with good management of the relationship between service provider and asset manager, the likelihood of there being a need to migrate away for purely service reasons will be substantially reduced, which is good for all parties.
Cosmo Wisniewski is a director of Citisoft
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