PE Tech Report


Like this article?

Sign up to our free newsletter

Beyond the numbers: The benefits of middle-office outsourcing

When reviewing middle-office outsourcing proposals, this comment is not uncommon. However, the inclination to evaluate outsourcing by extrapolating in-house operating budgets and comparing them to outsourcing proposals is an insufficient method for determining the total value of a proposed outsourcing relationship. 

When reviewing middle-office outsourcing proposals, this comment is not uncommon. However, the inclination to evaluate outsourcing by extrapolating in-house operating budgets and comparing them to outsourcing proposals is an insufficient method for determining the total value of a proposed outsourcing relationship. 

What is missing from this initial reaction is an array of underlying benefits and possible cost-saving scenarios. Asset managers stand to benefit from partnerships that remodel their front and middle offices to focus on core competencies while leveraging premium technology and expertise. 

Benefits include gaining an increased ability to focus on top-line growth with a newly streamlined operating model, gaining access to hard-to-find operations and technology skills, and acquiring a scalable technology platform without the associated costs of upgrading and maintaining it. 

In this brief, we aim to uncover some of the less apparent advantages of outsourcing to help asset managers make an informed decision about whether outsourcing could be a fit for their business, as well as understand some of the latent cost advantages that are gained through an outsourcing partnership. 

Today’s competitive environment has forced asset managers to re-examine their core competencies. Firms must be structured to accommodate new business growth, while controlling costs and managing risks. Simultaneously, asset managers are recognising that value is not only derived from the front office. Firms are realising that modern middle-office operations can be a source for competitive advantage and are looking to understand what is required to harness this unrealised value. 

An essential step for asset managers looking for this understanding is to envision and compare different future-state operating models. This can be achieved by undertaking a strategic assessment designed to analyse the cost-benefit of an outsourced solution using a time horizon that aligns with the horizon of the asset manager’s current business strategy. For asset managers with an in-house middle office, the assessment’s output should include a determination of the following: 

• The core functions required to make investment decisions 

• The noncore functions that inform investment decisions, and can be performed efficiently in-house, without incremental cost, when:

Introducing new investment strategies (eg, multi-asset class strategist)
Expanding into new markets (eg, restricted markets, exotic markets)
Trading new instrument types (eg, derivatives)
Increasing trade volume and frequency

• The support functions that do not directly inform investment decisions, and can be outsourced to a service provider who considers these same functions as core to their business

• The support functions that can be scaled back to only support the front office (eg, human resources, real estate and other corporate support functions) 

For some firms, such an assessment reveals opportunity for narrowing the in-house scope of functions to the asset manager’s core competencies. Outsourcing the other noncore functions offers a firm the potential benefits gained from a service provider’s expertise in these areas. 

Decreased operational risk is often a significant benefit of focusing on core competencies by entering into a middle-office outsourcing partnership. From trade errors and misstated performance to failures in regulatory compliance, there is no certainty as to which operational issues have the potential to metastasise into reputational, financial or even existential risks for an asset manager. Because of the uncertainty, pricing this benefit is difficult. Few would argue, however, that decreasing or avoiding operational risk is the safest course of action.

Upon entering into an outsourcing partnership, asset managers are effectively sharing operational risk with service providers whose core business is the competent management of middle-office operational risks. More often than not, outsourcers are at the forefront of operational thought leadership; they are continuously redefining best practices on topics from pricing hierarchies, to corporate action processing, to onboarding new investors for their asset management clients.

Access to specialised operations and technology skills 

Finding and retaining the right operations and technology talent with up-to-date skills is an industrywide business challenge during periods of technological innovation. For asset managers with in-house middle offices, this challenge is intensified by two notable factors. First, asset managers still frequently define their in-house middle-office organisations as cost centres. Defined as such, middle-office talent is perceived as an expense to be managed down. For top talent, this environment can be unappealing.

Meanwhile, the same up-to-date skills needed to run an effective in-house middle office are largely fungible to vendors, service providers and fintech startups – organisations which frequently define this same talent as part of a profit centre to be nurtured. This environment, in contrast, may be appealing to top talent, creating a situation where top talent may be drawn away and the comparative cost of finding and retaining the right operations and technology talent for in-house middle-office organisations may increase.

Current labour- related cost pressures for asset managers are echoed in a 2017 Ignites article:

“Skilled personnel in just about every role can use the threat of defection to seek a raise,” says Doug Rickart, division director for the financial services group at Robert Half International. “It’s not just competitive for investment professionals, but also the middle office and back office.” 

While avoiding these types of costs are a quantifiable benefit of middle-office outsourcing, the benefit of having immediate access to an outsourcing partner’s expertise and specialised skills is not as quantifiable, but significant. 

The acceleration of regulatory changes provides one example as to why immediate access to expertise and hard-to-find skills may be beneficial. From the general data protection regulation (GDPR) to SEC modernisation rules, the need to correctly interpret and comply with new regulations requires skill sets that are not part of most in-house middle- office organisations. Subsequently, in-house organisations are forced to search for these skills in the labour market at exactly the time they are most in demand, and therefore, most scarce. On the other hand, asset managers with outsourced middle offices have, and can benefit from, their outsourcing relationships due to immediate access to a broad range of subject matter expertise, including regulatory expertise. This on-demand access can reduce or eliminate the need to procure specialised staff or consultants, especially under tight timelines. Additionally, asset managers that outsource their middle offices may not be affected by workflow redesigns that are often required to achieve and maintain regulatory compliance. 

While regulatory changes are not optional to asset managers, the choice to invest in new markets or complex security types is. As more managers look to such complex investment strategies, those with in-house operations are often constrained by lack of staff expertise, bandwidth or technical capabilities. As discussed in a previously released paper, operations should never be the cause of a firm not investing in complex securities, launching innovative products or entering new markets. Rather, an optimally designed operational and data management infrastructure can be used to gain economic leverage, meet the demands of investors and regulators, gain new insights into business dynamics and fuel product development. 

To support the technological and operational complexities of these investment strategies, asset managers need staff with a nuanced understanding of the markets and culture in which they are looking to invest—such expertise is often as difficult to find as regulatory expertise. Asset managers who have outsourced their middle office to a service provider will likely benefit from faster time to market when launching new products or strategies. This agility is invaluable as the investment landscape grows increasingly competitive. Just as asset managers have diversified their investment strategies to keep pace with evolving markets, middle-office outsourcers have substantially increased the number of functional capabilities included in their service offerings. 

This expansion of offerings has helped asset managers reach other in-demand functional skills through their outsourcing providers. As trade settlement and accounting services become more commoditised, outsourcers have expanded their offerings up the value chain and effectively blurred lines between perceptions of where the middle office ends and where the front office begins. Among the latest capabilities to become relatively common service offerings are the generation of core risk and attribution data and enterprise data management. This general trend of expanded service provider capabilities was underscored in an Ignites article, “Demands of Shifting Data Reshape Service Provider Contracts.”

As a result of this trend, asset managers benefit from access to and consultation with experts in optimising front-office interfaces—and the related best practices—which directly shape investment decisions. For asset management clients, access to specific subject matter experts is not predicated on which outsourcing services the client has contracted for. Perhaps surprisingly, the consultative approach that service providers take with their clients, especially in relation to front-office adjacent functions, is one of the lesser discussed benefits of middle-office outsourcing. 

Premium technology without investing in a new platform 

The benefits of middle-office operations outsourcing are not limited to processes and people. One of the primary drivers to outsource is access to premium technology and a fully integrated platform. Service providers have invested heavily over the past decade in building up their best-of-breed servicing platforms, consisting of both vendor products and proprietary applications. 

Asset managers faced with the need to upgrade or replace outdated legacy systems may find outsourcing a more attractive alternative than implementing a new platform or solution in-house. For an in-house middle-office technology stack to remain on par with industry-leading platforms, significant investment in upgrades is required. Specifically, capabilities which curate data in near real-time for front-office interfaces are necessary to keep pace with industry leaders. 

The time, effort and resources required to undertake a systems evaluation, selection and implementation that will result in industry-leading capabilities can be an overwhelming and costly undertaking. In addition, the need to maintain and fully use a complex suite of middle-office applications with updated capabilities requires skilled resources, high fixed “run” budgets, and variable “grow” budgets if a firm wants to remain competitive. 

Service providers offer clients the benefits of syndicated developments by being part of a peer group of other asset managers with similar needs. For example, a client can share the cost of regulatory requirements, as opposed to building it on their own. These economies of scale carry over to technology innovation. Outsourcers seek to continually bolster their IT expertise and advanced capabilities, including software development, automation, data warehousing, integration, reporting, cloud, and use of emerging technologies. 

Many small to mid-sized managers may not have the budget or resources to invest in transformative technologies such as the cloud or robotic process automation (RPA). Robotics, in particular, are at the forefront for firms looking to decrease costs for repetitive processes that formerly were only candidates for overseas labour arbitrage. According to specialised operations consultancy Citisoft: “In 2018, smart firms will move standard processes to an automation basis and away from an offshore or outsourced model. Robotic process automation (RPA) will become increasingly common to improve services while controlling and driving down cost. In the short term, this will require investment, but it will quickly lead to clear competitive advantages for those firms that embrace a technology-driven operating model and will be a growing theme for the coming year. If you’re not assessing where RPA could fit into your operational model in 2018, you (and your service provider) should be thinking about it.” 

Investing in “bots” is not an insignificant project and asset managers who do not have the management buy-in, budget or resources for this type of initiative may benefit from partnering with an experienced and trusted service provider who has already undertaken similar initiatives on behalf of their clients. 

Although an outsourcing transition is a complex programme, it can often be achieved more quickly than a system implementation and integration programme with less risk for an asset manager. Resource constraints and timeline risks are two of the most prevalent programme risks in either of these programmes; however, in an outsourcing transition, the majority of this risk is shifted to the service provider to manage. Given the selected service provider typically has experience and can bring best practices based on valuable lessons learned from previous transitions, they are generally better equipped to address these risks in a matter beneficial to both manager and provider. 

The typical programme to modernise in-house middle-office organisations provides a tangible example of the potential beneficial cost savings of an outsourcing partnership. The norm for modernisation programmes is a multimillion-dollar, multiyear re-platforming programmes disrupting every facet of an asset manager’s overall organisation.

Executing such large- scale integration programmes requires a willingness to take on additional operational risk, specialised expertise to complete the implementation itself, and the procurement of talent with up-to-date skills to realise the promised benefits once the modernisation programme is live. Conversely, asset managers with outsourced middle offices circumvent these challenges. This benefit is often realised over an extended timeline, and thus, easily overlooked when weighing the pros and cons of middle-office outsourcing. 


Unlike the fixed cost of an asset manager’s floor space, electricity bill or current technology stack, the cost of outsourcing can be scaled as business expands and contracts. The norm for structuring outsourcing contracts is to use a negotiated combination of AUM, trade activity, number of accounts, and other comparable metrics to determine the cost an asset manager incurs during a given period, mitigating the unpredictable cost of increasing or decreasing their technology footprint. 

The structure of outsourcing contracts further enhances an asset manager’s ability to manage volatility in its business as middle-office fee schedules are often designed to align incentives for both the service providers and their clients. An asset manager’s success is the provider’s success, and vice versa. When an asset manager’s AUM shrinks, its middle-office fees generally decrease as well, as most contracts include an AUM-based component in the fee schedule. Conversely, when an asset manager expands, its fees increase. The structural alignment of typical outsourcing contracts creates the baseline for a strategic partnership and not just a transactional relationship. 

Asset managers who outsource their middle offices effectively benefit from their providers’ global footprint at a fraction of the cost required to replicate a comparable model. Many outsourcing service providers engage a “follow the sun” model where key functions, such as data management, trade processing, performance, corporate actions, analytics, and reconciliations are performed and then passed between global centres of excellence. These seven centres of excellence are geographically positioned to allow key functions to be performed both inside and outside of a client’s business hours. 

This model can result in several cost-related benefits. The near continuous operation by providers increases the velocity of the exception identification and resolution process, resulting in cleaner start-of-day data for their clients. Decreases in start-of-day data defects translate to a reduction in trade errors, which is a source of cost. Secondly, an asset manager with an in-house middle office may be required to pay overtime to match late trades, babysit batch cycles or complete a late reconciliation. In contrast, these same late trades, reconciliations and batch cycles will be handled without the added expense of overtime when processed by an outsourcing provider. From international trade settlements to corporate action processing, having local market support without the related overhead contributes to the total value proposition of middle-office outsourcing. 

Service bundling may result in reduced fees for asset managers. For example, fund accounting/ administration and distribution are candidates for service bundling. Asset managers can typically leverage their back-office functional service needs to achieve middle-office outsourcing cost savings. Depending on an asset manager’s shape and which functions are deemed as core competencies, the bundling of services may have several variations that the client may benefit from both in terms of decreased fees and gained efficiency. 

End-client perception 

In the post-financial-crisis world, the optics of outsourced middle offices is evolving. Prospective investors are often reassured by asset managers with an outsourced middle office. The beneficial checks and balances inherent in an outsourcing partnership with a proper oversight model may reduce both the actual risk and the perceived risk of asset manager wrongdoing. For example, outsourcing providers typically have deep experience with SSAE 16 filings; their robust SSAE 16 controls provide an additional layer of credibility for reassuring end clients. These benefits along with added business resiliency have become a part of the marketing material for various outsourcing service providers and may be used as a selling point. 

Business resiliency 

Outsourcers with a global footprint offer increased business resiliency at no additional cost. The various global centres of excellence provide for a contingency for processing business critical functions in the event of a regionalised business continuity event. 
Single point of contact 

Outsourcing partnerships frequently feature a dedicated relationship manager who acts as the primary point of contact to the client, supported by the provider’s processing teams.

This delivery model decreases the number of relationship touchpoints to the middle office. Subsequently, communication from an asset manager’s front office is streamlined and simplified when compared to the communication paths between a typical front office and their in-house middle-office organisation. 

Performing a notional comparison 

It’s difficult to tell an asset manager who is considering outsourcing that they shouldn’t attempt
to extrapolate current operating costs and compare them directly to an outsourcing fee proposal. Likewise, we realise that asset managers who are considering outsourcing will need to perform a notional comparison for business-case purposes. Because of the myriad benefits previously mentioned that are difficult to quantify, it’s challenging to perform a holistic side-by- side comparison; however, when assessing the cost of in-house operations versus an outsourced middle office, there are real costs that will be affected or eliminated in the case of outsourcing. 

The following list of cost affects can be used to perform an in-house operating cost versus outsourcing fee comparison. 

• Elimination of certain software license costs and maintenance costs (operational systems, as well as operating system software, Microsoft Office fees, etc.) 

• Elimination of upgrade costs on technology packages, including standard upgrades,
as well as upgrades necessary to support new mandates, regulations, products, instruments 
• Elimination of hardware costs for servers, printers and computers

• Business Continuity (BCP) and Disaster Recovery (DR) costs, including off-site floor
space/seat count

• Data costs, including pricing, market data (albeit most of these costs will typically be passed through via the service provider)

• SSAE 16 expenses

• One-time initiatives (eg, Y2K, euro launch, T+1 settlement)

• Legal fees to support IT contracts

• Decrease in headcount, resulting in reducing or eliminating the cost of: 

Salaries and benefits
Floor space, office equipment and supplies, facilities, maintenance, utilities, parking
Recruiting, hiring, training, exit
Corporate/shared services—any corporate functions that support all employees; percentage of work reduced, potentially lowering headcount required in non-outsourced areas, (eg, HR, IT help desk, internal audit, compliance)
Other miscellaneous costs, including holiday parties, luncheons, employee gifts and awards

• Temp/consulting staff used to support peak periods or special projects 

Some of these cannot be realised on day one, and cost savings should never be the sole or even primary driver for outsourcing one’s middle office, but it’s important to understand the potential latent cost savings and intangible benefits of outsourcing to inform an asset manager’s business case. 

Gain more overall flexibility and adaptability 

While the cost of outsourcing may not be less expensive than an in-house model, determining the total value of an outsourcing partnership requires asset managers to both think holistically about their organisation’s strategy and business plans, and do an in-depth examination of the details of their middle offices. For some asset managers, the ability to gain increased focus on core competencies by outsourcing noncore functions that can be better performed by service providers is the key benefit which drives their decision to outsource. For others, the benefits related to reducing risk and the prospect of avoiding large-scale technology upgrades drives the change. Some firms also cite the ability to gain flexibility and adaptability in a volatile and constantly evolving technology environment as a key driver.

When you look beyond the numbers, many asset managers will see an attractive value proposition in the mix of comparative benefits and cost savings (both quantifiable and those you cannot put a true price tag on) with an outsourced middle office when all of the underlying details are examined in totality.

A case for middle- office outsourcing 
A mid-sized asset manager headquartered in a small Midwestern city has experienced healthy year-over-year inflows due to the introduction of several derivative-related funds. Subsequently, the volume and the complexity of both post-trade processing and the related regulatory reporting have increased significantly.
The asset manager is struggling to find and retain the expertise required to maintain high- quality middle-office support. Repeated attempts to attract, transplant and then retain specialised expertise have become costly without achieving the desired outcome. Similarly, expensive attempts to cultivate specialised expertise in-house have not positively impacted the quality middle- office support. 

The eventual solution to gaining reliable access to specialised expertise was the outsourcing of several key business functions, including accounting and reporting. 

Another case for middle-office outsourcing 
A New York City-based asset manager is planning to introduce several disparate funds to achieve a five-year growth target of doubling its AUM. Currently, the asset manager has an in-house middle-office operation and technology organisation at its midtown headquarters. 

To support its growth target while minimising expenses, the asset manager must determine which of the following options is the most scalable target state operating model: an expanded in-house middle office or an outsourced middle office. The increased cost of real estate, “city” salaries, and obtaining the new expertise needed to support disparate funds were ultimately the most notable components in determining that a fully outsourced middle office was the most scalable solution. 

Read more about SEI’s middle office services. Select format US/UK

Like this article? Sign up to our free newsletter