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The third wave: A tipping point for outsourced execution services in the US

By Gary Paulin (pictured), Global Head of Integrated Trading Solutions, Northern Trust Capital Markets – The asset management industry is facing unprecedented pressure from competition, fees, regulatory and compliance challenges, technology costs and shifting product demand. The resulting squeeze on margins is forcing many to lower operating costs and increase scale via consolidation and/or outsourcing. 

In recent years, asset servicing has experienced two distinct cycles of outsourcing. In the 1980s, it was the back office. In the early 2000s, it was the middle office. Pressure on asset management is leading to a third wave of outsourcing, this time around the front office. This third wave will establish a new ‘status quo’ in the industry.

The industry must radically address their cost base and given the front office has been relatively immune from previous outsourcing trends, it represents the greatest opportunity for cost reduction now. 

The pace of change and innovation is acting as a significant disruptor. And in this age of disruption, trading is becoming an outsourced service, rather than an internal function. 

In the future, Northern Trust expects to see more companies adopt front office outsourcing models as they focus on core alpha-generating functions and outsource high-capital intensive or non-core functions of their business.

The trends to outsource will evolve similarly to that of cloud computing, where IT companies, for example, in-house their intellectual property, and where all the high-capital, intensive, non-core functions are outsourced to a safe and secure hyper-scale provider like Microsoft or Amazon. In this case, it will involve outsourcing to secure, professional and well-capitalised counterparties that are free from conflicts and are able to provide operational resilience. 

The new wave of outsourcing of the front office is only just beginning. Outsourcing is here to stay, and while managers can choose not to make use of it, they should not ignore the trends that are driving this shift.

Asset servicing has experienced two distinct cycles and looks likely to be in the midst of a third. Bull markets are often characterised by rising assets under management, but also rising costs and cost complacency. When the tide goes out on AuM growth, costs get magnified and managers are forced to review their operating models. They tend to focus on core functions, and outsource non-core activities if scale offerings exist. The market downturn after the ‘80’s bull market led growth in back-office outsourcing. The peak in the internet bubble led to middle-office outsourcing. And the market downtown last year combined with the relentless march of zero based passive funds, regulations and technology costs, could be leading to growth in front-office outsourcing. In the future, we expect to see the majority of funds adopt outsourcing models as they focus on alpha generation.

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