Issue 2 • summer 2014
WMA JOURNAL Working for the Investment Community & their Clients
OUTSOURCING
OUTSOURCING
If you’re thinking about outsourcing – do it right In a recent survey conducted by Knadel, wealth management firms were asked about their business operating models. It came as no surprise to hear that more and more of you are choosing to outsource business functions, but what was surprising was the extent of the outsourcing that is being undertaken.
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he wealth management outsourcing market is still immature: while less than half of the wealth management industry outsource their back office administration, over 70% of institutional asset managers do so. However, when wealth managers do outsource, they tend to outsource more functions, and higher up the value chain – including dealing, execution and elements of client service. There’s nothing wrong in this, in fact, it can bring huge advantages: allowing a firm to focus totally on its core, valueadded activities, without having to gear up resources on administrative tasks. If all of its outsourcing is with a single provider, then the benefits to the firm of an end-to-end process can also mean lower costs and lower operational risk; as well as an opportunity to leverage front office tools already integrated to the service provider’s back office. We admit that, in practice, it’s not always as good as it sounds, but if you are thinking of outsourcing, then how do you go about turning your own business model into a shining example of how it should be done? Learn from the institutional asset management market Institutional managers have been outsourcing their investment back offices in UK since the mid-90s. This is a market that has matured, with a large number of second and third generation deals, where asset managers are transitioning between established suppliers. Wealth managers can learn much from this similar industry sector. As a result of our work across both institutional and wealth sectors, there are five key elements that Knadel see as the things to get right, and right up-front:
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Partnership It isn’t just about signing a contract (see later on the regulatory factor). More importantly, it means going in with the right mindset in the first place and making sure that, culturally, the provider is a company you can work with and that their strategic direction aligns to yours. In a partnership it should be a win-win situation, so pinning your service provider to the wall on commercials and service levels will only cause pain and resentment for the future. If your chosen provider can’t manage the service levels that you want day one, consider how you can work together to continuously improve (and benefit) from them over time – tie this into the contract.
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Do your homework It always surprises me how little due diligence wealth managers think they can get away with. For sure, you can make some assumptions the service provider can settle a trade, but the skill is to draw out the key differentiators (the things that matter most to you) and the things you think they might not be able to do, in an RFP. Follow this with structured workshops/site visits/ reference visits to thoroughly prove the end-to-end processes. It’s key to understand what the service provider doesn’t do, and where they do it differently to how you would like. It sometimes helps to look at the other clients that the provider is servicing in this context. If they are all advisers and you are a private client investment manager, there will be subtle differences in your requirements. Define the services you think you are engaging the provider for in the contract to a good level of detail.
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Adopt not adapt The reason a provider exists, is to do what you are asking them to do, but more efficiently (and better) than you can. The best outcome for them is to have all clients using exactly the same model. While this is not always possible, as a client, you should consider that the more you can www.thewma.co.uk
take a standardised offering, the fewer problems you will have with breaks and errors; getting enhancements to the proposition; and managing the relationship as a strategic partnership. If the supplier can’t do something you want, negotiate it as an enhancement, but as a standard offering that the supplier will leverage across other clients. That way, future upgrades are easier and the supplier benefits from a new or improved offering. It is a negotiation though, so as a client you need to be reasonable about what exactly is ‘standard market practice’. These are non-core activities or else you wouldn’t be outsourcing them. The exception to this rule is in a lift-out situation. A lift-out may mean carrying on with the same model for a time. However, you should still include a plan to standardise onto the provider’s long-term strategic platform.
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Plan to exit It’s a partnership not a marriage and though ‘it’s not just for Christmas’, your agreement is unlikely to be for life. At some point you could acquire/be acquired; expand your business proposition; your provider could be giving you bad service; your
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Firms are expected to articulate, demonstrate and document robust oversight and comprehensive contingency plans contract term could be up; or worst case your supplier could fail. You need to plan for how you would exit the relationship and work out the obligations on each side regarding who pays, what needs to be done, and in what time scales for each case.
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Govern and oversee The key to a happy relationship with your provider is making sure that both parties communicate well to each other. You haven’t off-loaded responsibility, so put in place a governance process, and retain sufficient skills to ensure that you are still knowledgeable about the functions you are outsourcing to oversee them. Governance should include: day-to-day oversight, monthly reviews, a clear process
for discussing change and a well-defined change management process. All the contracts we work on also include a dispute management process, for issues that cannot be managed under the normal relationship processes. It is beneficial to both parties to have a well-defined, contractual, set of Key Performance Indicators and a Service Level Agreement that dictate how both parties should work together, to what standard, and what the implications are if either party is not performing its obligations properly. Which brings us nicely to your obligations and responsibilities as far as the regulator is concerned… The regulatory factor The institutional assets managers have not yet quite got it all right. Over the past 18 months the FCA has expressed concerns regarding investment firms’ management of their key outsource service providers and the firms’ compliance with the obligations of SYSC 8 in the FCA Handbook, which covers outsourcing. The FCA’s issued a thematic review of outsourcing (TR 13/10), which essentially articulated two key concerns: WMA JOURNAL 9
OUTSOURCING
Firms need to ensure they have these ‘resilience planning’ deliverables in place to meet their obligations where they have a material outsource arrangement: 1. Know Your Outsourcer (KYO) Report
1. Ordinary Course of Business Exit Plan
2. Risk Assessment Report
2. Supplier Failure Exit Plan
3. Governance Framework Reports
3. Standardisation Strategy and Plan
4. Retained Skills Assessments Some of these already look familiar…! Most of these items should fall out of a good selection process, and these will then provide a framework for ongoing reviews.
• Inadequate contingency plans for the failure of a service provider providing critical activities; and • Effectiveness of oversight arrangements for critical activities outsourced to a service provider. To put it simply, while a firm may outsource functions to a third party, it cannot outsource the responsibility for those functions nor its obligations to the regulator and its clients. As a result of the FCA’s report, the Investment Managers Association (IMA), in mid 2013, formed the Outsource Working Group (OWG) – comprised mainly of institutional asset managers – to take the FCA’s concerns and to determine what should be deemed as best practice. The OWG published their Industry Response Principle in December 2013. The FCA was pleased with the level of industry discussion and engagement; it now wants to see the outcome flow into tangible actions and improvements. “Enough talk, time to get on with it.” What does this mean for wealth managers? To date, wealth managers could be forgiven for thinking that the focus of much of the attention from the FCA has been on the institutional asset management industry. However, the regulations equally apply to any investment firm, and wealth managers should expect more focus to be directed towards them in due course. Knadel’s view is that wealth managers are way behind their institutional counterparts in this field. The level of diligence at supplier selection; the protection and flexibility of outsourcing contracts; and the oversight models implemented, are nowhere near what constitutes best 10 WMA JOURNAL
practice in the majority of wealth businesses we have spoken to. But let’s not despair, there are specific actions you can take. We believe that there are seven key types of deliverable that fall out of the SYSC8 regulations, the FCA review and the OWG guidance. These are listed in the table above and, done properly, will meet your obligations where you have a material outsource arrangement In conclusion: Doing it right is all about starting with the contract. The contract sets out your intentions and the minimum requirements for your outsource to work well, on both sides. If you are not yet outsourced or about to change provider then you have a chance to tie-in contractually the resilience planning deliverables, above, and our five key elements for success – and we would strongly recommend you do so. Take advice for this from someone who has good credentials and has done it before if you want to apply best practice. If you have already outsourced we recommend that you start with an initial review of what you already have in each of these seven resilience planning categories against what ‘good practice’ looks like – then you can at least judge where you are. If the regulator comes calling, it’s always better to be seen to be knowledgeable about your compliance (or gaps!) and to have an action plan as proof of your intention to remediate. Finally, be prepared to accept that these things need to be negotiated with your provider, and it takes time to do them well. Gilly Green Wealth Management Practice Leader, Knadel www.thewma.co.uk
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