A Changing Landscape
Khosla: Fitter climate for outsourcing companies and service providers
2011 proved difficult for many in the industry, and outsourcers and service providers were no exception. A clear turning point came midway through, when a year that had been shaping up strongly was rocked by turmoil.
“If we look at 2010-2011, there was a fair amount of activity and much build-up by a lot of organizations in Asia,” says Rishi Khosla, co-founder and CEO of financial research and consulting firm Copal Partners. “Demand was strong for the first half of 2011, and it came down.”
Chris Adams, head of hedge fund solutions at BNP Paribas Securities Services, says that the third quarter of 2011 was challenging, although markets improved towards the end of the year, with 2012 shaping up to be a potentially good year.
Driven by concerns
The coming year will bring with it plenty of changes, but Adams says that he remains cautiously optimistic. Regulatory changes, in particular, are of great concern, something for which managers often turn to outsourcers for help.
“Our clients are deeply concerned about regulation,” he explains. “Dodd-Frank is a good example. We are still not completely certain what the final legislation will be, and people want to make sure that whatever vehicle or product range they are launching will be future-proof. We are helping our clients prepare for the upcoming regulations, so there is plenty of work around transparency, liquidity, the quality of reporting that they provide to their clients. A great deal of time and energy is involved in striking out into areas where clients are demanding it.”
Adams: An awful lot of regulation will get much, much clearer this year
BNP Paribas is not the only institution dedicating resources to meeting clients’ increasing regulatory needs. Global solutions provider Linedata partnered with risk management solutions provider Riskdata towards the end of 2011 to allow the former to provide its clients with integrated risk functionality. This decision, according to Linedata’s head of hedge fund product management Ed Gouldstone, “was much on the back of clients coming to us wanting to see a robust risk management process. They want to see reports with risk, with sensitivities, stress tests, etc.”
Two of the most common elements on which the bank’s clients are focussing from a risk perspective are visibility and control, according to Laurence Bailey, CEO at J.P. Morgan Worldwide Securities Services (WSS) Asia Pacific. “The ability to know exactly what their exposure is across markets, sectors, asset classes and instruments is paramount, as is the flexibility to review and change those variables according to market conditions.”
Indeed, Khosla asserts that with tightening regulations making the cost of entering the market prohibitive and with clients exercising caution in an uncertain environment, the climate has become fitter than ever for outsourcing companies and service providers. “When clients have these challenges internally, they are more likely to look at the overall operating cost structure. They see how we can help in reducing costs, whereas in a truly up market, you might not get the same interest level among senior management as you do in a down market,” he explains.
“Specifically within research and analytics, we have come to a situation where clients sit down with us, explain in detail how their organization works and then ask ‘Where are the other areas that you can apply the outsourcing model?’. Generally, I would say clients are planning to do more outsourcing in more areas than previously.”
Gouldstone concurs that it can be too costly, especially for start-ups, to build in-house teams for specific functions, whether it is back-office and settlements, or middle-office and compliance.
“On the other side, the industry has got more and more complicated [in terms of regulations and the number of relationships an institution needs to have]. I think sometimes outsourcing offers better expertise. That is something you hear people talk about. You want to outsource not because it is cheaper, but you think you can get better access to that expertise that you need.”
Because of these reasons, clients across the board – be it hedge funds, asset managers, private equity managers, etc. – have been demanding an ever-widening breadth of functions from their service providers.
Gouldstone: It can be costly to build in-house teams for specific functions.
Middle-office functions, for instance, have started generating more business for these providers than before.
“Clients are seeking holistic solutions that effectively meet, what are increasingly, complex demands. It is no longer about a single product in isolation – it is about delivering the whole firm’s capabilities for the benefit of our clients,” says Bailey, who has found that “as investment strategies in Asia become more complex in terms of asset classes, investment destination and risk appetite, our clients are increasingly focused on taking a more holistic, integrated approach to managing their asset servicing requirements. Ten or even five years ago, we used to have conversations with our clients that revolved around a single solution. Today, we’re bundling several solutions, developing new products and tailoring our existing offerings.”
Sally Crane, Linedata’s managing director for Asia, anticipates more and more demand from Asian clients for middle-office services. For their regional clients – which are predominantly hedge funds, a fair part of them being startups – scalability is pivotal, something which their solutions (such as their hedge fund product Beauchamp) focus on. “The idea is you could start with them small, and you can still scale up if you are managing something like US$2 billion.”
J.P. Morgan WSS, meanwhile, has started to see a larger build-out of their collateral management solutions, driven by interest from regulators and investors. “The broader direct custody and clearing story will continue to gather pace,” remarks Bailey.
Adams says that BNP Paribas is similarly spending a lot of time, effort and money into developing their middle-office services. The group recently enhanced their collateral management and OTC derivatives valuation services. A significant proportion of BNP Paribas’ Asian clients are seeking support in their UCITS business, where they want BNP Paribas’ help and insight in understanding regulations in jurisdictions that they are geographically distanced from.
Gouldstone agrees that UCITS is starting to become interesting for many of the managers he is working with. He believes that if a manager has enough assets to make the extra cost of running UCITS worthwhile, it could offer a viable alternative to listing one’s funds elsewhere, as the UCIT set of rules is more established and widely known.
More clarity and consolidation
Another change that the outsourcing industry will soon be facing is consolidation, thanks in no small part to (once again) regulatory changes. “As the regulatory landscape continues to evolve, we would expect to see some greater clarity – if not changes – in the services offered, where these services are done, how they are managed,” Bailey predicts.
Balley: Knowing your exposure across markets, asset classes and instruments is key.
“Within this context, we will see a deeper dialogue in a number of markets, which are currently reviewing which aspects of asset servicing can be done onshore versus offshore.”
“The main thing that’s going to happen in 2012 – and I’ll be optimistic here – is that an awful lot of regulation will get much, much clearer this year,” Adams agrees.
“I believe that we will have a much clearer view of the cost base of our business as a service provider. Our clients will have a much clearer view of the burden on them as well.
That will push consolidation ever more in this industry, both in terms of service providers and our clients, because scale is obviously one way to mitigate the impact of cost.”
Khosla likewise anticipates “a meaningful amount of consolidation” in the industry.
Outsourcing continues to build momentum in the Asian region. For Khosla, Asian demand is stronger than European and US demand in terms of general momentum within the industry. China in particular generates much interest for his clients.
“Where we’ve seen a lot of demand and that continues are international clients wanting to understand the greater China region. That’s a trend that’s been accelerating the last few years.”
“Yes, there’s a lot of interest [in China], but it will take a while for the market to actually mature,” Crane notes. “We do have clients there already, and there is a lot of interest, but some of the infrastructure and market expertise is only now becoming established.”
Linedata is currently expanding its on-the-ground Asia services, having just opened an Asia-Pacific data centre in Singapore.
The providers agree that not all the growth in Asia will be coming from China and countries where the industry is already developed (such as Hong Kong and Singapore). A major trend that Adams expects within the space in 2012 is the opening up of domestic markets, notably Korea and Taiwan, and more and more funds being originated locally than from the US or Europe.
Bailey has similarly noticed a significant increase in the diversification of investments, both in terms of instruments and geographies from countries such as China, Taiwan and Korea. He has found this cross-border growth to be mirrored in Southeast Asia. As these domestic markets are created, tremendous opportunities arise for providers within that space.
Overall, providers are optimistic as 2012 nears the end of its first quarter. “If you look at the overall industry growth rates over the past three to four years, they have probably been at around the 20% level, I would estimate that the overall industry would grow at a faster level than that this year,” Khosla forecasts. “The financial services industry has its own challenges, but the reality is that [outsourcing] plays well into those challenges because it helps reduce cost and increase efficiency.”
Outsourcing aids expansion
Bailey says that providers will have to continue innovating to ensure that the industry will remain relevant. “I think one of the largest issues that we will see is a greater need for the financial sector to demonstrate continued investment in their platforms, innovation in the market and providing clients with information on new trends and new markets. A [provider’s] ability to act as a strategic partner to their clients is key.”
Crane: Outsourcing software solutions is part of the expansion picture.
There is no doubt of their relevance and importance to their clients; their greater anxiety about how their own clients will fare. “What I worry about is, honestly, my clients’ ability to make money. If my client can’t make money, nobody has a business,” Adams admits.
“It all depends on the market, doesn’t it? What we’re hearing is people are upbeat again. Not everyone believes [the rally is] here to stay, but it has lifted everybody’s spirits. So we are optimistic, and we have got a strong story in terms of helping asset managers and hedge funds grow their business. And obviously in November-December last year, people weren’t really listening because they were focused on survival,” reflects Crane.
“Now, they are a lot more optimistic and looking towards the future. People are starting to think about expansion again. Outsourcing their software solutions is part of that picture.”
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