The traditional operating model for in-house middle and back offices has become unsustainable for brokers and dealers – bulge-bracket firms need to simplify, while all players need to strip out costs, reduce risk and boost transparency. Outsourcing processes and systems offers a panacea, allowing a firm to focus on its core competencies, on growth and on the increasing demands of clients, while adapting swiftly to new regulatory demands and enjoying freedom from some of the systems-renewal burden. Switching an existing operation to a service provider which has developed its own core competencies can deliver increased operational efficiency, closing the gap towards achieving best practice.

The history

Outsourcing by sell-side institutions emerged in the late 1990s, just as it did for asset managers. To date, it has predominantly been a back-office play – encompassing settlements, asset servicing, reconciliations, books and records – and less around the firm's trading desk, its sales desk and external client liaison.

"Historically, it was smaller banks and brokers involved in this outsourcing," says Alex Krunic, Head of Sales & Relationship Management – Global Broker Dealer Services at Societe Generale Securities Services (SGSS). "One of the motivations has been the ability to rely on providers' balance sheets to be able to conduct a level of market activity which wasn't supported by their own balance sheet."

The past five years have seen a proliferation of bulge-bracket and mid-tier broker-dealers opting for the strategic outsourcing of post-trade activities, typically encompassing their entire back office or to support expansion into new markets.

While the scope of outsourcing by asset managers has moved into the middle office, the sell-side has been wary of making this move. "Simply put, a broker-dealer sees its middle office as the guardian of the business, the control framework, and hence the nervousness around outsourcing this as well as settlements," says Brian Godins, Global Head of Broker Outsourcing Securities Services at HSBC. "Day one, a broker-dealer is much more likely to go for a settlements outsource solution, and pending its success, think about the ability to move further up the post-trade processing stack and into the middle office."

The exceptions that prove the rule have been small firms expanding into a region, or large ones with only a limited regional presence or with a legacy platform which is no longer fit for purpose. Such firms are likely to be motivated to use a third-party supplier of an end-to-end solution for the entire post-trade operations as the most cost-efficient solution and to avoid the headache of running their own operations.

Societe Generale Corporate & Investment Banking

In 2013, Societe Generale Corporate & Investment Banking (SG CIB) transferred its securities processing back-office operations to Accenture Post-Trade Processing, a service launched by Accenture and Broadridge Financial Solutions. Designed to help the bank improve competitiveness, adapt to changes in regulation and market infrastructure, and reduce costs, this 'lift out' initiative involved the transfer to Accenture of a number of SG CIB employees with post-trade processing skills in more than 50 financial markets.

HSBC Global Markets, Singapore equities business

In 2013, the Global Markets business of HSBC was looking to apply for membership of the Singapore exchange and had no post-trade solution for the local market. They turned to the bank's Broker Outsourcing Securities Services business which delivered a fully compliant post-trade cash equities business within nine months of project initiation, integrating to front-end trading platforms and post-trade finance infrastructure.

Societe Generale Securities Services (SGSS)

In September 2014, SGSS partnered with Accenture Post-Trade Processing to offer a Global Broker Dealer Services (GBDS) outsourcing solution aimed at mid-tier banks, brokers and broker-dealers. This integrated solution encompasses middle-office services, back-office processing and post-trade services – with SGSS handling the provision of banking services such as securities lending, foreign exchange, execution and liquidity management while outsourcing to Accenture the management of all back-office processes and technology architecture. Among GBDS clients is a major large-in-scale platform providing a global institutional trading network to both buy-side and sell-side institutions.

Tier 1 Investment Bank in Australia

In November 2015, this Tier 1 investment bank's legacy infrastructure was replaced with a new technology infrastructure across the entire post-trade lifecycle including middle office, settlements for cash equities and stock borrow/loan, corporate actions, books and records. Some of these processes were outsourced to HSBC's Broker Outsourcing Securities Services business, resulting in a model that now allows the client to benefit from a more cost-effective and enhanced operating model, and to free itself from legacy technology whilst benefiting from support for ongoing market infrastructure changes.

Offshoring vs outsourcing

Broker-dealers have made widespread use of offshoring to switch functions to geographic locations which have brought access to cheaper skilled labour. This has extended across the back and middle offices, and to the front office too. "The past five years have seen the front office predominantly engaged in getting comfortable with offshoring or near-shoring elements such as research, fee/rate management and general data-related tasks to push these out to lower-cost locations," explains Godins.

The bulge-bracket firms have hub models that are 'beasts' – huge monolithic structures with tentacles upstream and downstream which have been built on over multi-year development lifecycles. The institutions recognize this complexity and the accompanying headache and actively seek outsourcing providers to come and solve the problem for them. "In Europe and Asia, this requires multi-year investment and patience – attributes that are not necessarily in abundance at either outsource provider or broker-dealer," adds Godins. "In the US, there's an established way of doing things and the supporting technology is deep-rooted, making for a relatively straightforward 'lift and shift' of an existing platform, with less of a conversion model required."

For smaller sell-side firms, tackling costs tends to be a big priority and therefore the motivations are slightly different to those of the large broker-dealers – with simplification requirements a lesser driver rather than being the main objective. Small brokers have an appetite and desire for outsourcing due to being less agile and perceiving a headache or cost barrier in running a post-trade operation at a relatively high fixed cost.

"Key drivers behind outsourcing by the large broker-dealers have been the need to address the surge in global regulation (in-market, regional and global) combined with the technological advances required to connect to the proliferated trading landscape and the maturing post-trade environment," explains Krunic. "As a result of a migration to outsourcing, we are seeing something of an end to labour arbitrage in countries like India, the Philippines and other Southeast Asian locations."

The drive to offshoring appears to have dampened considerably and may even have gone into reverse with these models adding to complexity in the face of the growth in regulatory, compliance, risk and legal costs. "For most sell-side firms, these factors have eaten into the benefits of the cost-reduction programmes executed," says Godins. "As more and more firms have reached saturation point with cost-saving methods such as offshoring, the scope and scale of outsourcing requirements has increased. Outsourcing is now talked about in the same breath as innovation. Broker-dealers are asking outsource providers to be innovative and help with solutions to reduce fixed costs."

Component or full outsourcing?

A few brave broker-dealers and outsourcing providers engaged in early 'lift out' transactions, with the provider taking over the whole back-office operation, including staff and systems, as a foundation for building a scalable platform from which it could serve additional clients. With such platforms established, firms can now enter into a lower-risk transformation of their operating model – an entire 'conversion' of their operations onto a provider's tried-and-tested platform. Others have opted for a still more cautious approach in handing over the reins for just one or selected functions.

A full conversion allows a firm to collapse fully its existing technology platforms and realize the consequential savings of running and upgrading these. In contrast to component outsourcing, there is a significant reduction in handovers between firm and outsourcing provider, providing the opportunity for the most efficient workflow model. "Firms can benefit from greater potential for cost savings, and thus the most competitive pricing model if they opt for a full suite of post-trade solutions from middle to back to custody," says Godins. "Such an arrangement also delivers increased transparency, faster resolution of breaks, and more scope to analyse big data when it's all in one place."

Component outsourcing allows a broker-dealer to retain control of sensitive processes such as client liaison. It's the standard, conservative, initial model adopted by many broker-dealers. Clearly, the firm will continue to carry its legacy middle-office platform costs, but it will be able to 'test the water' with tasks that it is comfortable handing over to a trusted third party under a suitable service-level agreement.

Great care needs to be taken in setting up component outsourcing, Godins warns. "It will be inefficient if it entails multiple handovers between multiple parties or if it creates ambiguity and inefficiency between the firm and its provider. It's crucial to focus in extreme detail on workflow between the service provider and the retained functions. Clear definition of RACIs (who is responsible, accountable, consulted and informed) becomes paramount, along with defining and documenting service level expectations, while everything must sit on the right technologies (firm and provider) to support the chosen arrangement."

Back or middle office?

In examining outsourcing, the natural flow of events is for a firm to focus on the back-office elements first and only then consider the middle office. "It might be argued that this sits at odds with a primary objective of reducing costs – as back-office functions carry the lowest risk and are already the cheapest, with several tasks having already been offshored," says Godins. "On the other hand, middle-office functions have a heavy proximity-support model driven by the location of the trading desk, risk, sales desk and client domicile – and consequently carry the highest costs going forward."

One of the key challenges in middle-office outsourcing is pinning down precisely what it entails, with brokers and broker-dealers adopting different definitions as to which processes fall into the middle or back office. Moreover, asset servicing (corporate actions, income collection, tax reclamation, etc.) might sit in the back or middle office or may well be treated as a stand-alone component – given that its high degree of complexity leads to most broker-dealers keeping it separate and on different technology.

"The in-house processing hubs at bulge-bracket firms are notoriously fiendish in their complexity," says Godins, "while in the regional sites there is every chance that the processing is done on a combination of legacy post-trade infrastructure and/or spreadsheets. As an outsource provider, we recognize the nature of the business executed by the broker-dealers across the regions can be very different and we need to flex accordingly."

Where are we now and what are the trends?

It is becoming the norm for firms to hand over the reins for back-office functions and routine transaction-based middle-office activities. Taking this leap of faith can lead to significant upside, with vendors managing standardized processes and delivering superior service and cost savings. Outsourcing of non-core components should not be a hurdle for any institution.

In the broader data space, whether that is know-your-client capabilities, reference and instrument data, or data event scrubbing, outsourcing has definitely become more commonplace among the bigger broker-dealers in the larger markets and a lot of the initial heavy lifting has been done and is starting to create great momentum, Godins tells us.

He adds: "We have also seen with the larger banks and broker-dealers a growing trend to outsource the processing of exchange-traded derivatives given the highly regulated nature of the futures business, and the need to run a functionally rich technology stack, in what is inherently a low-margin / high-volume business."

Another take on outsourcing is the handing over of group-wide functions of a utilitarian nature, such as reconciliations, brokerage and finance processing with their underlying technology also being outsourced. This is all about cost reduction, with minimal value-add.

Brokers and broker-dealers recognize the need for a certain level of standardization and this must underpin any outsourcing model, with ideally some 70% to 80% of any solution adopting a commoditized infrastructure while ensuring that the platform can be readily customized for the 20% to 30% of broker-dealer nuances.

"Conversations in the marketplace continue around component vs conversion models for outsourcing," says Godins. "Where available, the 'lift and shift' model is clearly one that broker-dealers like as it provides a day-one switch from fixed- to variable-cost model, whereas the conversion model goes through an investment cycle of technology replacement and at such time that the technology is ready to transform to the outsource provider's platform, that is the catalyst for the outsource commercial model to commence."

When it comes to letting go of the entire back office, small and mid-tier sell-side firms led the way. The bulge-bracket firms have now begun to adopt this approach. Driven by the search for economies of scale, some broker-dealers are going beyond the back office and even the middle office to outsource trade execution as well.

The trend among both large and small firms is expected to be greater take-up of outsourcing, driven largely by legacy systems becoming redundant and costly to upgrade. This in turn should lead to more intense competition in the outsourcing space and the emergence of elite providers which have the agility to navigate the regulatory and technological complexity along with the deep pockets, experience and proven solutions which make for very high barriers to entry.


Click a region for more information...

The United States is a vanilla processing market yet is also very highly regulated. Sell-side firms are getting more comfortable with outsourcing and this is fast-becoming an industry standard. Ever-greater take-up is putting this market on a maturing path, with further growth expected in the coming years. This is eased by there being an established way of doing things with deep-rooted supporting technology, often easing the transformation to being little more than the 'lift and shift' of an existing platform.

With the country looking towards a T+1 settlement model, this would put the onus on the outsourcing provider to ensure compliance and allow the trading desks to focus on the execution models and coverage of shorts and firm financing.

Europe has evolved over the last five years – no longer in its infancy, perhaps something more of a teenager – with outsourcing by broker-dealers gaining traction. There is a growing appetite for service providers which can help navigate an array of significant industry and regulatory changes, not least the impact of Brexit but also initiatives including the move to a T+2 settlement model and the introduction of the TARGET2-Securities pan-European settlement platform, along with the far-reaching effects of the second Markets in Financial Instruments Directive (MiFID II) and the Central Securities Depositories Regulation (CSDR). As barriers to entry come down, and current operating models are questioned, there is a real opportunity for broker-dealers to evolve and enhance their post-trade capability.

"The cost of adhering to these initiatives and regulations has been absolutely necessary but prohibitive and the amount of discretionary budget left in the pot to now re-engineer the operating model and make the most of these changes has shrunk," says Godins. "With that in mind, broker-dealers in Europe, from Tier 1 through to Tier 3 are now actively looking at ways – predominantly for the back office – to leverage an outsource provider and where possible one that also has a custodian capability to gain full end-to-end benefits and cost reduction. Clearly with Brexit around the corner, European banks are also now looking at solutions to allow the appropriate passporting and business modelling and therefore need to consider new legal entity structures in new territories and therefore new post-trade solutions. This again is opening the outsourcing door at a time when time-to-market is essential."

The experience of Platform Securities, an FIS company, is telling. The firm provides back- and middle-office outsourcing to wealth managers and broker-dealers throughout Europe, the Middle East and Africa. CEO Nigel Reynolds comments: "Interest in outsourcing has grown considerably in the 15 years we've been in the business. Where formerly firms thought that maintaining operations meant maintaining control, that is no longer the case. Nowadays firms need outside help to increase scalability, reduce risk and manage their headcount – all of which leads to greater profitability for them. The regulatory burden on firms – from the Client Assets Sourcebook (CASS) rules, applicable in the United Kingdom to any client money or safe-custody assets, through transaction reporting, all the way to client reporting – has also increased, and while they cannot outsource their regulatory responsibilities, they can work in partnership with specialist outsourcers who are themselves regulated and can help them remain compliant at all times, while delivering an optimized level of service."

From discussions with a variety of institutions, there appears to be a growing realization across Europe that the key to success in a crowded marketplace is for a firm to focus on its value-adds. This is expected to drive an increasing appetite for outsourcing in the securities processing space. However, it is still early days for the sell-side, which needs to catch up with the buy-side, for which outsourcing of back and middle offices across asset classes is now reasonably common across Europe, while outsourcing capability in fund services has evolved over some 15 years to place it at a favourable level of maturity.

The outsourcing market in South Africa is mature, with brokers having been early adopters. In converting from partnership to corporate structures with the 1995 Big Bang at the Johannesburg Stock Exchange, new management – or new investment bank owners – were highly motivated to outsource from trade execution through to settlement, as a natural extension of South Africa's very high usage of straight-through processing.

"Recent initiatives have led to continued development in South Africa with the advent of new stock exchanges – following Financial Services Board regulation of previously unregulated multilateral trading facilities (MTFs) – which has led to partnerships with service providers to offer trading middle-office registry and custody solutions," Duncan Smith, Senior Sales and Relationship Manager, Emerging Markets at SGSS tells us. "Similarly, recent regulation of hedge funds, which were previously unregulated, has led to them following the trend of the long-only managers by continuing to outsource administration to existing market providers."

Asia Pacific is very much in its infancy, arguably at the teething stage, and represents the next frontier in outsourcing opportunities. Across the region, markets have varying degrees of understanding, evolution and regulatory hurdles to overcome. There are unique challenges, not least the diversity from one country to another, each with its own regulatory environment and differing practices – making it difficult to apply a single model without extensive localization.

"Asia Pacific is 'lukewarm to hot' – the understandably risk-averse environment, based on highly regulated markets and very different ways of doing things from one country to the next, dictates that it is always going to be a slow burn, but there are signs that the broker-dealers are increasing their interest and appetite in these markets," says Godins. "Some of these locations have very stringent data laws and very definitive views on outsourcers, and require data to be held onshore as well as proximity support for these services in-country.

"The Tier 1 broker-dealers have a significant presence in the Asia Pacific markets, and a large percentage have local legacy platforms with a high dependency on subject-matter expertise. These are low-margin securities businesses but businesses they need to be in and hence the appetite for outsourcing is now starting to pick up for firms where discretionary budget for change is minimal, and even if available, comes with a nervousness around regulatory demands and technology builds."

If an outsourcing provider can evidence regulatory compliance and capability, this puts them in a very strong position. As in Europe, if this can be tied in with a clearing and custody capability, this enhances the straight-through processing, efficiency and effectiveness of a solution, and clearly has a positive impact on the price point.

"The outsourcing environment across Asia Pacific is definitely heating up and conversations are evolving driven by cost reduction," adds Godins. "One of the biggest areas of concern is the focus on regulatory adherence within country and a need to ensure that full compliance is never compromised. Recognizing that broker-dealers give up responsibility for processing is one thing but they are recognizing more and more that they cannot give up accountability."


Where are firms reluctant to 'let go'?

Outsourcing of the entire middle or back office can be perceived as a loss of control and, in the middle office, of the liaison function with the trading and sales desks. Moreover, in many cases, there is no going back. "When outsourcing the complete operation, one must be sure that there are alternate providers, in case the chosen partner decides to withdraw from the business," notes Krunic. "This is also a major concern for the regulators, who are very engaged and keen to understand outsourcing partnerships to ensure market stability and mitigate future systemic events and major market disruption."

Errors or failures in routine back- and middle-office functions, while impacting business operations, should not damage client relationships or a firm's reputation, so many firms have chosen to hand over the reins here. In contrast, functions close to the client – sometimes perceived as unique to a firm and part of its character – are held onto. These often require special skill sets, involve confidential in-house or client data, or engage with multiple, senior-level client personnel.

"The larger brokers will usually continue to retain all aspects of the front office including dealing, advising and providing technical connectivity, including smart order-routing, algos and exchange, MTF and dark-pool connectivity," says Krunic. "For banks, the traditional arrangements – credit and liquidity provisions, as well as collateral and balance sheet support are retained in-house."

Firms should be comforted by the fact that top-tier outsourcing providers are fully regulated and have a wealth of experience so can support them through the whole process and, with the right partner, they can typically benefit from having greater control of the corresponding business processes, a better service, and cheaper costs than before.

A recent client workshop held by HSBC identified concerns about outsourcing due to some of these factors:

Security, entitlements and confidentiality – Broker-dealers want to know that their information is secure, not commingled and that the controls are of the highest level.

Loss of control / key-person dependency – The broker-dealer has an interesting challenge: to rely on small pockets of subject-matter experts (especially the case in parts of Asia) which are using legacy technology that very few understand, or to outsource to a service provider which can do all of this for you with the need to manage through service- and performance-level agreements going forward.

Accountability vs responsibility – Some broker-dealers will recognize that an outsource provider only takes on responsibility and that accountability remains with the firm. Others will in effect see this as an opportunity to divest all responsibility and accountability to the outsource provider, from the project onset through to business as usual after implementation. Educating the broker-dealer is essential so they know what they are getting into and what is still expected of them.

Too scary – Outsourcing as a concept can be hard to digest. The only way to get over this is to recognize each broker-dealer's drivers for considering the issue and give them factual context that makes outsourcing resonate more, and allows them to take this on board as a viable alternative to in-house operations.

What does the future hold?

The appeal of outsourcing is expected to grow globally – continuing to mature in North America and South Africa, while stepping up in Europe and starting to pick up in Asia Pacific – as offshoring, near-shoring and other cost-saving measures reach saturation point. Outsourcing offers up economies of scale to benefit all parties involved – with the savings set to increase as more firms follow this path – while closing the gap towards best practice.

Whereas firms previously chose among technology vendors for upgrading systems, it will become commonplace to consider a new strategic solution for the middle and back office in the form of outsourcing.

The big broker-dealers with a global presence recognize the benefits of outsourcing, Godins tells us, but they are also aware of how big a challenge it is, especially if being applied across the firm's hubs. Their regional sites may well offer a more palatable time to market and provide the opportunity for proof of concept.

For several markets, such as Japan, regulatory reporting continues to be one of the most important factors, if not the most important, when looking at post-trade capability. Broker-dealers are on the lookout for more reasonably priced solutions across geographies while not being prepared to compromise in any shape or form on operational, franchise or regulatory risk.

"I envisage that over the coming years we will also see the emergence of more industry utilities that will specialize in providing niche or bespoke services," says Krunic. "There is no reason not to use an industry-wide utility for such processes as know-your-client, anti-money laundering checks, reconciliation and regulatory reporting – as most financial institutions will have similar, if not identical, needs across the same or similar client base."

Ongoing HSBC client on-boarding programmes

A number of discussions with internal and external clients of HSBC's Fixed Income and Equities Securities businesses are in flight, with the corresponding on-boarding programmes of work due to commence in 2018, including some deliverables in 2018, with a specific strategic focus of continuing to link the Broker Outsourcing Securities Services proposition with the Direct Clearing and Custody strength of HSBC Securities Services. All these initiatives have the underlying benefits of cost reduction in post-trade services for the client, while the provider gains an increasing scale and capability of its footprint across both operational and technological aspects, a greater understanding of the demands across regions and a redefinition of global post-trade solutions through a technology-led toolkit.

Artificial intelligence and machine learning, through big data and analytics, to distributed ledger technology are sure to bring wholesale change to the way financial institutions conduct business. "They offer the opportunity to improve our understanding of interacting with customers and enable us to reshape processes and reduce costs," notes Krunic. "Take the example of cloud computing which gives access to massive computing power via domestic country-based or private networks at dramatically lower cost compared to even just a few years ago. Artificial intelligence and robotic process automation are sure to have a huge impact on today's very labour-intensive processes and financial institutions will need to envision all the possibilities that these present to reduce their cost base, improve the way they serve their clients and ensure they remain competitive."

"We expect to see a larger demand for vendors and service providers to be digitally innovative and active," adds Godins. "A recent workshop has shown us that clients would like to interact with vendors and providers via application programming interfaces (APIs) to a greater extent in the future. We feel this desire will also extend to distributed ledger technology. Our evolution as an outsource provider over the last two years has very much been with this in mind."

With significant changes ahead for the post-trade landscape, brokers and dealers should invest time in understanding the respective evolutionary paths of the new initiatives in order to be aware of the impact on their businesses, but will perhaps delegate much of the associated investment to outsourcing providers.



Also in this series:

In-depth study of Outsourcing by the buy- and sell-side, Q3 2015





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The traditional operating model for in-house middle and back offices has become unsustainable for brokers and dealers – bulge-bracket firms need to simplify, while all players need to strip out costs, reduce risk and boost transparency. Outsourcing processes and systems offers a panacea, allowing a firm to focus on its core competencies, on growth and on the increasing demands of clients, while adapting swiftly to new regulatory demands and enjoying freedom from some of the systems-renewal burden. Switching an existing operation to a service provider which has developed its own core competencies can deliver increased operational efficiency, closing the gap towards achieving best practice.

The history

Outsourcing by sell-side institutions emerged in the late 1990s, just as it did for asset managers. To date, it has predominantly been a back-office play – encompassing settlements, asset servicing, reconciliations, books and records – and less around the firm's trading desk, its sales desk and external client liaison.

"Historically, it was smaller banks and brokers involved in this outsourcing," says Alex Krunic, Head of Sales & Relationship Management – Global Broker Dealer Services at Societe Generale Securities Services (SGSS). "One of the motivations has been the ability to rely on providers' balance sheets to be able to conduct a level of market activity which wasn't supported by their own balance sheet."

The past five years have seen a proliferation of bulge-bracket and mid-tier broker-dealers opting for the strategic outsourcing of post-trade activities, typically encompassing their entire back office or to support expansion into new markets.

While the scope of outsourcing by asset managers has moved into the middle office, the sell-side has been wary of making this move. "Simply put, a broker-dealer sees its middle office as the guardian of the business, the control framework, and hence the nervousness around outsourcing this as well as settlements," says Brian Godins, Global Head of Broker Outsourcing Securities Services at HSBC. "Day one, a broker-dealer is much more likely to go for a settlements outsource solution, and pending its success, think about the ability to move further up the post-trade processing stack and into the middle office."

The exceptions that prove the rule have been small firms expanding into a region, or large ones with only a limited regional presence or with a legacy platform which is no longer fit for purpose. Such firms are likely to be motivated to use a third-party supplier of an end-to-end solution for the entire post-trade operations as the most cost-efficient solution and to avoid the headache of running their own operations.

Societe Generale Corporate & Investment Banking

In 2013, Societe Generale Corporate & Investment Banking (SG CIB) transferred its securities processing back-office operations to Accenture Post-Trade Processing, a service launched by Accenture and Broadridge Financial Solutions. Designed to help the bank improve competitiveness, adapt to changes in regulation and market infrastructure, and reduce costs, this 'lift out' initiative involved the transfer to Accenture of a number of SG CIB employees with post-trade processing skills in more than 50 financial markets.

HSBC Global Markets, Singapore equities business

In 2013, the Global Markets business of HSBC was looking to apply for membership of the Singapore exchange and had no post-trade solution for the local market. They turned to the bank's Broker Outsourcing Securities Services business which delivered a fully compliant post-trade cash equities business within nine months of project initiation, integrating to front-end trading platforms and post-trade finance infrastructure.

Societe Generale Securities Services (SGSS)

In September 2014, SGSS partnered with Accenture Post-Trade Processing to offer a Global Broker Dealer Services (GBDS) outsourcing solution aimed at mid-tier banks, brokers and broker-dealers. This integrated solution encompasses middle-office services, back-office processing and post-trade services – with SGSS handling the provision of banking services such as securities lending, foreign exchange, execution and liquidity management while outsourcing to Accenture the management of all back-office processes and technology architecture. Among GBDS clients is a major large-in-scale platform providing a global institutional trading network to both buy-side and sell-side institutions.

Tier 1 Investment Bank in Australia

In November 2015, this Tier 1 investment bank's legacy infrastructure was replaced with a new technology infrastructure across the entire post-trade lifecycle including middle office, settlements for cash equities and stock borrow/loan, corporate actions, books and records. Some of these processes were outsourced to HSBC's Broker Outsourcing Securities Services business, resulting in a model that now allows the client to benefit from a more cost-effective and enhanced operating model, and to free itself from legacy technology whilst benefiting from support for ongoing market infrastructure changes.

Offshoring vs outsourcing

Broker-dealers have made widespread use of offshoring to switch functions to geographic locations which have brought access to cheaper skilled labour. This has extended across the back and middle offices, and to the front office too. "The past five years have seen the front office predominantly engaged in getting comfortable with offshoring or near-shoring elements such as research, fee/rate management and general data-related tasks to push these out to lower-cost locations," explains Godins.

The bulge-bracket firms have hub models that are 'beasts' – huge monolithic structures with tentacles upstream and downstream which have been built on over multi-year development lifecycles. The institutions recognize this complexity and the accompanying headache and actively seek outsourcing providers to come and solve the problem for them. "In Europe and Asia, this requires multi-year investment and patience – attributes that are not necessarily in abundance at either outsource provider or broker-dealer," adds Godins. "In the US, there's an established way of doing things and the supporting technology is deep-rooted, making for a relatively straightforward 'lift and shift' of an existing platform, with less of a conversion model required."

For smaller sell-side firms, tackling costs tends to be a big priority and therefore the motivations are slightly different to those of the large broker-dealers – with simplification requirements a lesser driver rather than being the main objective. Small brokers have an appetite and desire for outsourcing due to being less agile and perceiving a headache or cost barrier in running a post-trade operation at a relatively high fixed cost.

"Key drivers behind outsourcing by the large broker-dealers have been the need to address the surge in global regulation (in-market, regional and global) combined with the technological advances required to connect to the proliferated trading landscape and the maturing post-trade environment," explains Krunic. "As a result of a migration to outsourcing, we are seeing something of an end to labour arbitrage in countries like India, the Philippines and other Southeast Asian locations."

The drive to offshoring appears to have dampened considerably and may even have gone into reverse with these models adding to complexity in the face of the growth in regulatory, compliance, risk and legal costs. "For most sell-side firms, these factors have eaten into the benefits of the cost-reduction programmes executed," says Godins. "As more and more firms have reached saturation point with cost-saving methods such as offshoring, the scope and scale of outsourcing requirements has increased. Outsourcing is now talked about in the same breath as innovation. Broker-dealers are asking outsource providers to be innovative and help with solutions to reduce fixed costs."

Component or full outsourcing?

A few brave broker-dealers and outsourcing providers engaged in early 'lift out' transactions, with the provider taking over the whole back-office operation, including staff and systems, as a foundation for building a scalable platform from which it could serve additional clients. With such platforms established, firms can now enter into a lower-risk transformation of their operating model – an entire 'conversion' of their operations onto a provider's tried-and-tested platform. Others have opted for a still more cautious approach in handing over the reins for just one or selected functions.

A full conversion allows a firm to collapse fully its existing technology platforms and realize the consequential savings of running and upgrading these. In contrast to component outsourcing, there is a significant reduction in handovers between firm and outsourcing provider, providing the opportunity for the most efficient workflow model. "Firms can benefit from greater potential for cost savings, and thus the most competitive pricing model if they opt for a full suite of post-trade solutions from middle to back to custody," says Godins. "Such an arrangement also delivers increased transparency, faster resolution of breaks, and more scope to analyse big data when it's all in one place."

Component outsourcing allows a broker-dealer to retain control of sensitive processes such as client liaison. It's the standard, conservative, initial model adopted by many broker-dealers. Clearly, the firm will continue to carry its legacy middle-office platform costs, but it will be able to 'test the water' with tasks that it is comfortable handing over to a trusted third party under a suitable service-level agreement.

Great care needs to be taken in setting up component outsourcing, Godins warns. "It will be inefficient if it entails multiple handovers between multiple parties or if it creates ambiguity and inefficiency between the firm and its provider. It's crucial to focus in extreme detail on workflow between the service provider and the retained functions. Clear definition of RACIs (who is responsible, accountable, consulted and informed) becomes paramount, along with defining and documenting service level expectations, while everything must sit on the right technologies (firm and provider) to support the chosen arrangement."

Back or middle office?

In examining outsourcing, the natural flow of events is for a firm to focus on the back-office elements first and only then consider the middle office. "It might be argued that this sits at odds with a primary objective of reducing costs – as back-office functions carry the lowest risk and are already the cheapest, with several tasks having already been offshored," says Godins. "On the other hand, middle-office functions have a heavy proximity-support model driven by the location of the trading desk, risk, sales desk and client domicile – and consequently carry the highest costs going forward."

One of the key challenges in middle-office outsourcing is pinning down precisely what it entails, with brokers and broker-dealers adopting different definitions as to which processes fall into the middle or back office. Moreover, asset servicing (corporate actions, income collection, tax reclamation, etc.) might sit in the back or middle office or may well be treated as a stand-alone component – given that its high degree of complexity leads to most broker-dealers keeping it separate and on different technology.

"The in-house processing hubs at bulge-bracket firms are notoriously fiendish in their complexity," says Godins, "while in the regional sites there is every chance that the processing is done on a combination of legacy post-trade infrastructure and/or spreadsheets. As an outsource provider, we recognize the nature of the business executed by the broker-dealers across the regions can be very different and we need to flex accordingly."

Where are we now and what are the trends?

It is becoming the norm for firms to hand over the reins for back-office functions and routine transaction-based middle-office activities. Taking this leap of faith can lead to significant upside, with vendors managing standardized processes and delivering superior service and cost savings. Outsourcing of non-core components should not be a hurdle for any institution.

In the broader data space, whether that is know-your-client capabilities, reference and instrument data, or data event scrubbing, outsourcing has definitely become more commonplace among the bigger broker-dealers in the larger markets and a lot of the initial heavy lifting has been done and is starting to create great momentum, Godins tells us.

He adds: "We have also seen with the larger banks and broker-dealers a growing trend to outsource the processing of exchange-traded derivatives given the highly regulated nature of the futures business, and the need to run a functionally rich technology stack, in what is inherently a low-margin / high-volume business."

Another take on outsourcing is the handing over of group-wide functions of a utilitarian nature, such as reconciliations, brokerage and finance processing with their underlying technology also being outsourced. This is all about cost reduction, with minimal value-add.

Brokers and broker-dealers recognize the need for a certain level of standardization and this must underpin any outsourcing model, with ideally some 70% to 80% of any solution adopting a commoditized infrastructure while ensuring that the platform can be readily customized for the 20% to 30% of broker-dealer nuances.

"Conversations in the marketplace continue around component vs conversion models for outsourcing," says Godins. "Where available, the 'lift and shift' model is clearly one that broker-dealers like as it provides a day-one switch from fixed- to variable-cost model, whereas the conversion model goes through an investment cycle of technology replacement and at such time that the technology is ready to transform to the outsource provider's platform, that is the catalyst for the outsource commercial model to commence."

When it comes to letting go of the entire back office, small and mid-tier sell-side firms led the way. The bulge-bracket firms have now begun to adopt this approach. Driven by the search for economies of scale, some broker-dealers are going beyond the back office and even the middle office to outsource trade execution as well.

The trend among both large and small firms is expected to be greater take-up of outsourcing, driven largely by legacy systems becoming redundant and costly to upgrade. This in turn should lead to more intense competition in the outsourcing space and the emergence of elite providers which have the agility to navigate the regulatory and technological complexity along with the deep pockets, experience and proven solutions which make for very high barriers to entry.


Click a region for more information...

The United States is a vanilla processing market yet is also very highly regulated. Sell-side firms are getting more comfortable with outsourcing and this is fast-becoming an industry standard. Ever-greater take-up is putting this market on a maturing path, with further growth expected in the coming years. This is eased by there being an established way of doing things with deep-rooted supporting technology, often easing the transformation to being little more than the 'lift and shift' of an existing platform.

With the country looking towards a T+1 settlement model, this would put the onus on the outsourcing provider to ensure compliance and allow the trading desks to focus on the execution models and coverage of shorts and firm financing.

Europe has evolved over the last five years – no longer in its infancy, perhaps something more of a teenager – with outsourcing by broker-dealers gaining traction. There is a growing appetite for service providers which can help navigate an array of significant industry and regulatory changes, not least the impact of Brexit but also initiatives including the move to a T+2 settlement model and the introduction of the TARGET2-Securities pan-European settlement platform, along with the far-reaching effects of the second Markets in Financial Instruments Directive (MiFID II) and the Central Securities Depositories Regulation (CSDR). As barriers to entry come down, and current operating models are questioned, there is a real opportunity for broker-dealers to evolve and enhance their post-trade capability.

"The cost of adhering to these initiatives and regulations has been absolutely necessary but prohibitive and the amount of discretionary budget left in the pot to now re-engineer the operating model and make the most of these changes has shrunk," says Godins. "With that in mind, broker-dealers in Europe, from Tier 1 through to Tier 3 are now actively looking at ways – predominantly for the back office – to leverage an outsource provider and where possible one that also has a custodian capability to gain full end-to-end benefits and cost reduction. Clearly with Brexit around the corner, European banks are also now looking at solutions to allow the appropriate passporting and business modelling and therefore need to consider new legal entity structures in new territories and therefore new post-trade solutions. This again is opening the outsourcing door at a time when time-to-market is essential."

The experience of Platform Securities, an FIS company, is telling. The firm provides back- and middle-office outsourcing to wealth managers and broker-dealers throughout Europe, the Middle East and Africa. CEO Nigel Reynolds comments: "Interest in outsourcing has grown considerably in the 15 years we've been in the business. Where formerly firms thought that maintaining operations meant maintaining control, that is no longer the case. Nowadays firms need outside help to increase scalability, reduce risk and manage their headcount – all of which leads to greater profitability for them. The regulatory burden on firms – from the Client Assets Sourcebook (CASS) rules, applicable in the United Kingdom to any client money or safe-custody assets, through transaction reporting, all the way to client reporting – has also increased, and while they cannot outsource their regulatory responsibilities, they can work in partnership with specialist outsourcers who are themselves regulated and can help them remain compliant at all times, while delivering an optimized level of service."

From discussions with a variety of institutions, there appears to be a growing realization across Europe that the key to success in a crowded marketplace is for a firm to focus on its value-adds. This is expected to drive an increasing appetite for outsourcing in the securities processing space. However, it is still early days for the sell-side, which needs to catch up with the buy-side, for which outsourcing of back and middle offices across asset classes is now reasonably common across Europe, while outsourcing capability in fund services has evolved over some 15 years to place it at a favourable level of maturity.

The outsourcing market in South Africa is mature, with brokers having been early adopters. In converting from partnership to corporate structures with the 1995 Big Bang at the Johannesburg Stock Exchange, new management – or new investment bank owners – were highly motivated to outsource from trade execution through to settlement, as a natural extension of South Africa's very high usage of straight-through processing.

"Recent initiatives have led to continued development in South Africa with the advent of new stock exchanges – following Financial Services Board regulation of previously unregulated multilateral trading facilities (MTFs) – which has led to partnerships with service providers to offer trading middle-office registry and custody solutions," Duncan Smith, Senior Sales and Relationship Manager, Emerging Markets at SGSS tells us. "Similarly, recent regulation of hedge funds, which were previously unregulated, has led to them following the trend of the long-only managers by continuing to outsource administration to existing market providers."

Asia Pacific is very much in its infancy, arguably at the teething stage, and represents the next frontier in outsourcing opportunities. Across the region, markets have varying degrees of understanding, evolution and regulatory hurdles to overcome. There are unique challenges, not least the diversity from one country to another, each with its own regulatory environment and differing practices – making it difficult to apply a single model without extensive localization.

"Asia Pacific is 'lukewarm to hot' – the understandably risk-averse environment, based on highly regulated markets and very different ways of doing things from one country to the next, dictates that it is always going to be a slow burn, but there are signs that the broker-dealers are increasing their interest and appetite in these markets," says Godins. "Some of these locations have very stringent data laws and very definitive views on outsourcers, and require data to be held onshore as well as proximity support for these services in-country.

"The Tier 1 broker-dealers have a significant presence in the Asia Pacific markets, and a large percentage have local legacy platforms with a high dependency on subject-matter expertise. These are low-margin securities businesses but businesses they need to be in and hence the appetite for outsourcing is now starting to pick up for firms where discretionary budget for change is minimal, and even if available, comes with a nervousness around regulatory demands and technology builds."

If an outsourcing provider can evidence regulatory compliance and capability, this puts them in a very strong position. As in Europe, if this can be tied in with a clearing and custody capability, this enhances the straight-through processing, efficiency and effectiveness of a solution, and clearly has a positive impact on the price point.

"The outsourcing environment across Asia Pacific is definitely heating up and conversations are evolving driven by cost reduction," adds Godins. "One of the biggest areas of concern is the focus on regulatory adherence within country and a need to ensure that full compliance is never compromised. Recognizing that broker-dealers give up responsibility for processing is one thing but they are recognizing more and more that they cannot give up accountability."


Where are firms reluctant to 'let go'?

Outsourcing of the entire middle or back office can be perceived as a loss of control and, in the middle office, of the liaison function with the trading and sales desks. Moreover, in many cases, there is no going back. "When outsourcing the complete operation, one must be sure that there are alternate providers, in case the chosen partner decides to withdraw from the business," notes Krunic. "This is also a major concern for the regulators, who are very engaged and keen to understand outsourcing partnerships to ensure market stability and mitigate future systemic events and major market disruption."

Errors or failures in routine back- and middle-office functions, while impacting business operations, should not damage client relationships or a firm's reputation, so many firms have chosen to hand over the reins here. In contrast, functions close to the client – sometimes perceived as unique to a firm and part of its character – are held onto. These often require special skill sets, involve confidential in-house or client data, or engage with multiple, senior-level client personnel.

"The larger brokers will usually continue to retain all aspects of the front office including dealing, advising and providing technical connectivity, including smart order-routing, algos and exchange, MTF and dark-pool connectivity," says Krunic. "For banks, the traditional arrangements – credit and liquidity provisions, as well as collateral and balance sheet support are retained in-house."

Firms should be comforted by the fact that top-tier outsourcing providers are fully regulated and have a wealth of experience so can support them through the whole process and, with the right partner, they can typically benefit from having greater control of the corresponding business processes, a better service, and cheaper costs than before.

A recent client workshop held by HSBC identified concerns about outsourcing due to some of these factors:

Security, entitlements and confidentiality – Broker-dealers want to know that their information is secure, not commingled and that the controls are of the highest level.

Loss of control / key-person dependency – The broker-dealer has an interesting challenge: to rely on small pockets of subject-matter experts (especially the case in parts of Asia) which are using legacy technology that very few understand, or to outsource to a service provider which can do all of this for you with the need to manage through service- and performance-level agreements going forward.

Accountability vs responsibility – Some broker-dealers will recognize that an outsource provider only takes on responsibility and that accountability remains with the firm. Others will in effect see this as an opportunity to divest all responsibility and accountability to the outsource provider, from the project onset through to business as usual after implementation. Educating the broker-dealer is essential so they know what they are getting into and what is still expected of them.

Too scary – Outsourcing as a concept can be hard to digest. The only way to get over this is to recognize each broker-dealer's drivers for considering the issue and give them factual context that makes outsourcing resonate more, and allows them to take this on board as a viable alternative to in-house operations.

What does the future hold?

The appeal of outsourcing is expected to grow globally – continuing to mature in North America and South Africa, while stepping up in Europe and starting to pick up in Asia Pacific – as offshoring, near-shoring and other cost-saving measures reach saturation point. Outsourcing offers up economies of scale to benefit all parties involved – with the savings set to increase as more firms follow this path – while closing the gap towards best practice.

Whereas firms previously chose among technology vendors for upgrading systems, it will become commonplace to consider a new strategic solution for the middle and back office in the form of outsourcing.

The big broker-dealers with a global presence recognize the benefits of outsourcing, Godins tells us, but they are also aware of how big a challenge it is, especially if being applied across the firm's hubs. Their regional sites may well offer a more palatable time to market and provide the opportunity for proof of concept.

For several markets, such as Japan, regulatory reporting continues to be one of the most important factors, if not the most important, when looking at post-trade capability. Broker-dealers are on the lookout for more reasonably priced solutions across geographies while not being prepared to compromise in any shape or form on operational, franchise or regulatory risk.

"I envisage that over the coming years we will also see the emergence of more industry utilities that will specialize in providing niche or bespoke services," says Krunic. "There is no reason not to use an industry-wide utility for such processes as know-your-client, anti-money laundering checks, reconciliation and regulatory reporting – as most financial institutions will have similar, if not identical, needs across the same or similar client base."

Ongoing HSBC client on-boarding programmes

A number of discussions with internal and external clients of HSBC's Fixed Income and Equities Securities businesses are in flight, with the corresponding on-boarding programmes of work due to commence in 2018, including some deliverables in 2018, with a specific strategic focus of continuing to link the Broker Outsourcing Securities Services proposition with the Direct Clearing and Custody strength of HSBC Securities Services. All these initiatives have the underlying benefits of cost reduction in post-trade services for the client, while the provider gains an increasing scale and capability of its footprint across both operational and technological aspects, a greater understanding of the demands across regions and a redefinition of global post-trade solutions through a technology-led toolkit.

Artificial intelligence and machine learning, through big data and analytics, to distributed ledger technology are sure to bring wholesale change to the way financial institutions conduct business. "They offer the opportunity to improve our understanding of interacting with customers and enable us to reshape processes and reduce costs," notes Krunic. "Take the example of cloud computing which gives access to massive computing power via domestic country-based or private networks at dramatically lower cost compared to even just a few years ago. Artificial intelligence and robotic process automation are sure to have a huge impact on today's very labour-intensive processes and financial institutions will need to envision all the possibilities that these present to reduce their cost base, improve the way they serve their clients and ensure they remain competitive."

"We expect to see a larger demand for vendors and service providers to be digitally innovative and active," adds Godins. "A recent workshop has shown us that clients would like to interact with vendors and providers via application programming interfaces (APIs) to a greater extent in the future. We feel this desire will also extend to distributed ledger technology. Our evolution as an outsource provider over the last two years has very much been with this in mind."

With significant changes ahead for the post-trade landscape, brokers and dealers should invest time in understanding the respective evolutionary paths of the new initiatives in order to be aware of the impact on their businesses, but will perhaps delegate much of the associated investment to outsourcing providers.



Also in this series:

In-depth study of Outsourcing by the buy- and sell-side, Q3 2015