Strategic use of technology and outsourcing to address cost pressures and enhance market position

Recent regulatory burdens on asset management businesses have resulted in additional cost pressures. Pricing transparency has resulted in an increasingly competitive market. One way in which asset managers have sought to alleviate cost pressures and make their products and services more appealing is by deploying new technology and outsourcing.

This briefing is part one of the series of two. In this briefing, we examine the use of technology and outsourcing as a business strategy to address questions of cost and competitiveness. Part two will examine the risk profile of asset management outsourcing agreements.

Costs implications of the new regulatory landscape

Complying with new and complex regulatory obligations applicable to regulated asset management businesses requires asset managers to control and manage a large amount of additional data. The volume and complexity of the new data places capacity demands on the information technology systems used to process it.

Two regulatory regimes have had a particularly significant impact in this regard:

Alternative Investment Fund Managers Directive (AIFMD)

The objectives of the AIFMD include the improvement of investor protection by enhanced transparency and increasing cross-border competition. Under the AIFMD, asset managers are required to make certain information available to investors before they invest, including: (1) a breakdown of fees, charges and expenses (this is a departure from the previous practice of disclosing only a single charge to investors); (2) details of any delegations of regulated functions; and (3) the identity of the asset manager, their depositary, auditor and other service providers, and a description of their duties. Providing and managing such data comes at an operating cost. Moreover, access to such data allows investors to compare like-for-like. Such pricing transparency has stimulated competition within the industry.

Capital adequacy rules

The Capital Requirements Regulation (Regulation 575/2013) (CRR), together with the CRD IV Directive (2013/36/EU), recast and replace the Capital Requirements Directive (2006/48/EC and 2006/49/EC). The CRR and the CRD IV Directive together comprise the CRD IV legislative package, the main role of which was to implement the main Basel III reforms in the EU. Reforms under the Solvency II Directive for insurers (2009/138/EC) have similar effects in this area. Among other things, the reforms deal with the quality and quantity of regulatory capital, counterparty credit risk, liquidity requirements (including the new liquidity ratios) and supervisory reporting. Complying with the new capital adequacy and reporting requirements inevitably involves additional cost for asset managers, in terms of both the cost of money (or the lost opportunity cost in not deploying it elsewhere) and operationally (due to the wider compliance and disclosure requirements to which they must now adhere).

Meeting client expectations

An outcome of the recession is that investors became ‘somewhat sceptical about the services they received from the wealth and asset management industry’ (EY, Global Wealth and Asset Management Industry Outlook, 2014). As a result, investors now demand either ultra-low cost transparent passive solutions or increasingly tailored solutions from asset managers. Customised solutions can require asset managers to focus on investment goals (for example, managing assets around a target date or a goal), and typically require more sophisticated processes and technology to support them.

Legacy systems used by asset managers may not be able to cope with the demands of new product and service offerings and the additional functionality required to deliver on investor expectations. In terms of maintaining market positioning, asset managers may have little choice but to upgrade existing technology, replace it completely or obtain access to new technology by way of outsourcing.

Competitive pricing pressures

The transparency requirements implemented by initiatives such as the AIFMD have meant that information about price, markets and fund managers is now more readily available, resulting in investors who are more focused on what they are being charged and the relationship between those costs and the potential returns.

These factors, coupled with recent consolidation of the asset management market as a whole and client demands, has in turn resulted in increasingly competitive pricing in what can now fairly be characterised as a ‘price war’ among the key industry players.

To deliver on price reductions, and still protect profits, asset managers increasingly look to the cost-side of the P&L account. Effective deployment of new technology and strategic use of outsourcing are two ways in which they can seek to reduce costs, while at the same time enhance the market attractiveness of their product and service offerings.

Solutions that technology and outsourcing can provide

Asset managers wishing to address cost and competitiveness through better processes and technical infrastructure have a choice. They can undertake M&A activity, enhance legacy systems, buy new systems from external suppliers, outsource, or do a combination of these things.

Working with existing legacy systems can be problematic. They may not be scalable to new data processing volumes. They typically become increasingly expensive to maintain when they have been heavily upgraded. They may also not be sufficiently flexible to accommodate later changes in regulatory requirements.

In such circumstances asset managers may look to source new technology infrastructure externally, including through the outsourcing route. A range of solutions, from software to full outsourced service provision, is available to asset managers. Solutions available include end-to-end/straight-through processing systems linking distributors and fund providers in the wealth management chain, wealth management and platform administration services (including for investment wrappers and managed funds) and administration services for retirement savings (both corporate and personal plans), pensions and loans (including structured products).

Managing contracting risk

Where an asset manager decides to source technology or to procure an outsourced solution, it will be important to ensure that the contract reflects its regulatory responsibilities.

While a regulated firm cannot outsource its regulatory responsibilities, a welladvised asset manager can nonetheless take steps to ensure that it can fully discharge its responsibilities by reflecting them in the contract in granular, backto- back tasks and deliverables for which the supplier has responsibility. This will require a legal and compliance review of detailed service descriptions, service levels, governance and other contractual provisions.

Future proofing is also a major issue for an asset manager wishing to contract for technology or outsourced services. There is little point in addressing current regulatory requirements if the contract is not flexible enough to cater for new ones. Accordingly a well-advised asset manager will seek to future proof its contract with a supplier or outsourced service provider so that changes in law and regulation can be accommodated by the contract.

Given that cost savings is a key driver in entering into such a contract, it will be important for the contract to allocate cost for system, coding and process changes necessary to achieve regulatory compliance, ideally on the basis that the supplier is required to allocate cost on a pro rata basis with the supplier’s other customers to whom it supplies a substantially similar service.