The final frontier of outsourcing
Asset managers and asset owners have long since outsourced their custody and fund administration. The Lens speculates that the next wave in outsourcing will be dealing desks.
There are some solid business reasons to do this, but there is also the matter of historical trends.
The feeling that we are living at the top end of the market cycle is palpable. Arguments about US equity valuations abound and the switch from quantitative easing to quantitative tightening is thought of as a major trigger for a new and maybe traumatic return-and-profit cycle to begin.
Each of the last two to three downturns led to a fresh wave in asset manager and pension scheme outsourcing. First, it was back offices – namely the custody function. Outsourcing back offices had been a growing trend but probably intensified after dotcom, when custody banks successfully argued that outsourcing fund manager back offices could widen fund manager margins and make operational costs more stable.
Then came the 2008 crisis and the avalanche of regulation that followed. The industry saw another spike in outsourcing, not surprisingly it was in the middle office (i.e. compliance function). Again, margins and stable operational costs were chief drivers.
But why should the next downturn lead necessarily to the outsourcing of front-office dealing desks?
Well, obviously, it might not do, but there are some compelling reasons why some of these providers – custody banks and others – are reportedly seeing their revenues from this increase. Here are a few.
As asset managers are growing in geographic scale through acquisition or organically, they may find their powers of execution in some new markets are not as good as within their core competencies.
Asset management is a scale game and funnelling trades through one provider achieves economies of scale.
Higher regulatory risk under MiFID II or the UK’s Senior Managers Certification Regime (which more clearly defines individual accountability) may make outsourced dealing to dedicated experts with strong regulatory processes an attractive risk management option – particularly for dealing heads, as long as their job doesn’t go in the process.
And finally, there is the fact that asset managers have had near on three decades to become comfortable with outsourcing in general.
But outsourcers will not find it easy to find firms so willing to outsource dealing. Dealing is thought of as a step too far for outsourcing because it is so crucial for adding alpha, and too central to the asset management business model.
However, the same was said of the middle and back offices, once upon a time.