Outsourcing in Wealth Management: A Growing Trend
2 September 2013
Outsourcing has been in use in the financial services industry for quite some time, at least for a couple of decades. However, wealth management firms have lagged the financial services industry in adopting outsourcing, primarily due to issues relating to privacy, data security, and loss of control. Many of them did not invest in technology from a strategic point of view for a long time, instead taking a siloed approach depending on specific business needs. The global financial crisis has contributed to a major paradigm shift in this regard. The crisis has significantly impacted both revenue and costs. Lacklustre market conditions have prevented them from generating superior returns impacting top line; this has been exacerbated by loss of clients, who, driven by disappointing returns and loss of trust, have looked away from their advisors or looked to diversify wealth management relationships. At the same time increasing regulatory pressures and newer regulations have compelled wealth managers to grapple with newer challenges in terms of control, compliance, risk management and streamlining operations. In this evolving environment wealth managers have slowly started to wake up and embrace technology and operations outsourcing as one of the solutions to meet the challenges. Cost cutting remains the primary driver behind adoption of outsourcing, which typically can save 20% to 30% of costs over a 3 to 5 year period. Secondly, outsourcing also offers easy scalability options; this is more relevant now as firms are either cutting down or closing operations in certain markets, while looking to expand in others – all in a short period of time. Time to market has therefore become critical. Data management, especially in large organizations offering multiple services, is another aspect that firms are looking to outsource. Along with benefits, there are a number of areas for concern with outsourcing. The most important of them is loss of control and security, both of great importance to wealth managers. Data privacy and data hosting constraints continue to be key concerns; violations in this area can be harmful for wealth managers’ brand image, which somewhat limits the universe of functionalities that wealth managers are comfortable to outsource. Another concern is around fiduciary responsibility and compliance and operational risk. Since the firm is responsible for regulatory compliance for all operations, including the ones outsourced, there is an increased need for easily accessing data and information for enhanced control and client and enterprise reporting. Firms will need to demonstrate their ability to provide the information requested by both clients and the regulatory authorities on-demand and in formats for consumption tailored to the individual’s preferences. Over time the industry has evolved a set of norms to overcome the concerns related to outsourcing. Extent of outsourcing adoption varies by region, the US being far ahead of Europe, while Asia lags the other two regions by some distance. Adoption also depends on the size and nature of wealth management firms. While Tier I and Tier II retail banks, insurance companies and brokerages have outsourced significantly, adoption of outsourcing remains moderate in smaller sized firms, especially in trust companies and family offices. In terms of functionalities, the further a wealth management function is from a client “touch point,” the more likely it is to be outsourced. Therefore, mid and back office functionalities are more likely to be outsourced. Outsourcing in the areas of global custody, securities lending, client servicing, and accounting and settlement of trades in is relatively widespread. Front office functionalities have been outsourced less; while some firms are slowly outsourcing their client on boarding or financial planning functions, outsourcing in the areas of product development, marketing, and fraud management is still limited. Outsourcing in the wealth management industry is likely to see further adoption in the near future. This will be mainly driven by firms in the US and Europe. Outsourcing practices in wealth management is still not as mature as those in other parts of the financial services industry and wealth management firms are starting to realize its benefits. In addition, existing market conditions as well as external factors like regulation will drive the growth in outsourcing business. IT budgets are expected to remain flat or decline in most markets. This will restrict firms’ ability to spend on technology. However, this also means firms will now have to do more with less and channel investments efficiently. Outsourcing provides one option for increasing efficiency without needing significant investments in infrastructure. Tier II and tier III firms will embrace outsourcing following the lead of tier I firms. While IT outsourcing has been the dominant part of outsourcing practices till now, process outsourcing is likely to gain more traction in future.