Building an orchestrated ecosystem to simplify the investment lifecycle

Six key considerations for achieving harmonious operational models with third-party solution providers

By Gerard Walsh, Global Head of Capital Markets Client Solutions, Northern Trust

As investment managers of all sizes face a cacophony of pressures from regulations, evolving technology, market volatility and inflation, many are looking to third-party providers to help solve these challenges. However, building solutions with solution providers requires careful consideration to ensure a harmonious result.

All firms ‘rent’ capacity or services or expertise from someone else. It’s a fact of modern corporate life. This is true at every ‘activity point’ in the lifecycle of an investment decision at investment management firms. At every level – whether global giant or start-up - industry participants rely on a far-reaching network of service providers. In truth, there are few functions and activities that cannot be provided on a contract basis.

Examples abound. Data provision is contracted out, for example - that’s why companies like Bloomberg and Reuters exist. Hard infrastructure and associated services are contracted out – banks don’t (in general) employ cleaners directly, they contract with services companies. The Magic Circle would be much less magical if it wasn’t for the amount of legal advice sought by financial services firms. The Big Four accountants are big for a good reason. Entire industries contract out for accounting and audit services.

Some may think contracting out is rare in the activity set that earns investment management firms a return, i.e. raising assets, managing money and driving an investment return. However, there are multiple providers delivering valued solutions and services at every step in the chain. Some firms contract out investment management.

Some contract out investment research, or trading or transaction reporting - or any number of activities, including those that are tightly regulated. A good example: contracting out compliance activity is commonplace; however, investment managers understand it is about an outside party supporting them to help meet these obligations only. It does not remove their responsibility and accountability.

Of course, choosing whether activity is ‘DBU’ (Done By Us) or ‘DBO’ (Done By Others) is almost always based on economic factors with elements of competence, expertise and resource availability in the decision-making mix too. To that end, In an investment firm, the question should be ‘does this activity add to my ability to drive improved alpha or gather more assets’? If the answer is not a resounding ‘yes’, the business case for contracting it in from a solutions provider might well be an effective option.

If the case is sound, there are key tips to ensure contracting out is implemented with as much chance of success as possible.

Tip #1

Be clear on REASONS WHY. You don’t have to delve far into the history of contracting out to find examples of it going badly. In almost all cases it went badly because the reasons for contracting out were insufficiently tested, were thus misguided, and therefore not economically or operationally robust. Whatever the reasons are for reviewing what is DBU and what can be DBO, make sure those are supported by a sensible business case that is framed, challenged, and agreed.

Tip #2

Once the reasons why are framed appropriately in a business case, an absolute priority should be a focus on PARTNERSHIP. Companies are made up of humans and the human dimension is very important here. Partnerships are based on relationships with humans, not just on the machines, technology or data lineage wrapped up in the working structure. Investment managers should (will want to) work with partners who can add measurable tangible value to their own activities.

There are multitudes of service providers in the market. Seek out global, innovative and trustworthy partners who can deliver focused local solutions at global scale.

They do exist. Look for expertise and insights. Work with potential partners who know and understand the business case for change and know how to contribute to implementing the change itself. In summary – develop strategic partnerships based on enhanced mutual benefit, long-term collaboration, and a realistic assessment of the level of innovation the other partner can bring to your benefit.

Tip #3

Know and understand the RISK inherent in a decision to contract out. Look closely and ensure you’re not accidentally introducing risks like conflicts of interest into your value chain. Of course, conflicts of interest are Janus-like for investment managers – they face both ways. Investment managers have a duty of care to manage and mitigate conflicts of interest on behalf of their clients, in their own operations and in the extensive ecosystems they use to deliver service to clients.

Tip #4

Whilst the function and activities DBU will change, your responsibilities don’t – therefore, an emphasis on ensuring the right GOVERNANCE and OVERSIGHT is very important. That means clearly defined shared objectives, appropriate measures and other KPIs set out in a partnership agreement (an enhanced Service Level Agreement is a good way of thinking about this) and an appropriate mechanism for improvement. Responsibilities and accountabilities should be clear and documented.

Tip #5

Look for relevant EXPERTISE. Capability, implementation track record, innovation, ambition and stability. Look for all of them in one proposition. The reason there are many service providers and relatively few solutions providers is that the latter is earned through expertise, created out of a proven track record of implementing at scale.

Tip #6

Extracting maximum benefit will accrue to those who can plug into an ORCHESTRATED ECOSYSTEM OF SOLUTIONS, enabling them to focus on what matters – managing assets, driving alpha and performance, and gathering assets through distribution. A fully functional ecosystem of solutions will deliver benefits through front, middle and back office.

A successful contracting relationship is akin to the way a successful orchestra combines different musicians to create a harmonious result. As the industry faces into a very different investment environment over the next decade, focusing on creating an operating model based on a mutually beneficial partnership approach of combined capabilities, strengths and expertise will drive success.

For more information or to discuss the themes in this article, contact Gerard at GCW3@ntrs.com. You can also read a longer version of this article here.