Fund management and STP

The back office is the unsung hero of the finance industry. Operations executives lack the glamour of the trader or the fund manager; they are often viewed as a mere cost centre, a necessary evil. But not only does the back office keep the machinery running, but by constantly innovating and upgrading technology, it can directly contribute to cost savings and the bottom line.

For global fund managers, if the back office is the obscure side of the business, then an Asian back office is even more so. Asia may be a growth area, but it remains a small part of most global houses' overall business.

A recent roundtable discussion at Singapore's Ritz-Carlton Millennium Hotel hosted by AsianInvestor and Omgeo highlighted the difficulties fund managers' operations executives face in Asia. Industry professionals explained the various challenges that make their jobs tough, but also demonstrated why things are improving, and how they prioritise precious IT budgets. The lesson drawn from the discussion was the importance of straight-through processing (STP) for fund management companies, not only to settlements but to the entire business - and, indeed, the industry.

Is the back office a priority?

Generally when it comes to priorities, particularly for spending on technology, the back office lags behind the front office. This reflects simple economics: the people in the front office are paid a lot more. Finding ways to make the front office more efficient or to reduce its headcount goes a lot farther to profitability than addressing back-office concerns.

The back office is meant to support what the overall business is doing; it's not an end to itself. For a lot of fund managers in Asia, the biggest source of growth has been capital-guaranteed mutual funds for retail investors. Structured products don't conform to existing systems, notes Edward Chong, associate director of investment services at DBS Asset Management. Handling these is very manual and therefore expensive, but the back office has to simply deal with it.

The middle office is hot right now. Compliance and risk management are seen by many firms as the priority, not processing structured funds. This is partly a function of the market downturn. Institutional clients are revisiting their mandates to external fund managers, which have to be especially careful they are doing the job they promised. The successful lawsuit in the United Kingdom by Unilever against Merrill Lynch, in which the company argued the manager had underperformed because it breached its mandate parameters, has added fuel to this. "So that's taking something away from the back office," says Chong.

But it would be wrong to conclude that the back offices in Asia are languishing and forgotten. In fact the opposite is increasingly true: fund management houses are turning their attention to the back office.

"Over the past couple of years there's been a greater focus on costs," says Gordon Wright, director of investment operations for Asia and Europe at Templeton Asset Management. "A lot of firms have recognized that money that's spent on the back office and STP initiatives and improving performance of processes can contribute to cost savings."

One of the most important savings is keeping the number of people to a minimum. "Everyone is facing headcount issues," says James Tan Thian-Peng, vice president of operations at Morgan Stanley Investment Management. He says the firm completed a STP infrastructure two years ago that has allowed it to maintain the same number of people in the back office regardless of trading volumes.

But headcount is only one part of the equation. The ultimate purpose of the back office and the systems it uses is to support the whole business, in any market environment. For many fund management firms in Asia, the region's complexity and diversity makes this a challenge.

These issues are particularly acute in Asia, compared to the US, because firms are still growing here, whether organically, through partnerships or by acquisition. Some firms may just have to worry about the relatively straightforward markets of Hong Kong and Singapore, but more are opening shop in growing markets such as Taiwan, Korea or India. Japan is notoriously paper-based.

So while some firms like Morgan Stanley have built a regional processing centre that can accommodate trades from across Asia, others that are still growing have to consider back-office needs.

Prudential Asset Management is a good example. Jacqueline Pang Kei-Wei, its director of regional operations, explains that the firm is growing outside of Hong Kong and Singapore both by setting up new offices or via acquisition, all at varying stages of development. "Our priority now is putting in the basic blocks, such as moving everyone on to a common back-office system," she says.

Do back offices in Asia get enough attention?

Some global firms have been in the Asia-Pacific region for decades; others are newcomers, or have recently established businesses in markets outside their traditional hubs. Moreover, for the majority of global fund managers, Asia represents a small part of the revenue stream - sometimes a very small part. So it's no surprised that operations executives working here may feel cut off from the home office in the US or Europe. Wright jokes, "We have to scream as loud as possible and hope that someone hears."

Fortunately, executives here agree that it is getting easier to catch the attention of the home office, particularly when it comes to global IT plans. Over the past two years, revenue streams from Asia have become significant, says Chew Tan-Chin, associate director of securities operations at UBS, and a representative of the sell side at the roundtable discussion. This is forcing managements to realize that their diverse Asian businesses require a common operations platform.

"There's been a recognition that Asia's been a growth engine over the past two or three years, especially with the way the markets in the West have gone," says Prudential's Pang. "We have the autonomy to build our own systems, and establish a common platform within the region."

Think globally, act locally: how do firms integrate regional systems with the head office?

This is a devilish problem for most global firms. Prudential is an example of a firm that is putting together different solutions for different regions. But they must all feed into the UK headquarters.

James Drumm, managing director at Omgeo, notes, "The challenge for our clients is if they're developing something proprietary or taking something off the shelf, it may fit their local requirements here in Asia, but is it going to provide STP outside of Asia?"

That's only part of the problem. A fund manager may come up with a fantastic solution, but find it can't communicate with counterparties such as brokers or custodian banks. And then there's a layer of regulatory risk. For example, the Securities Exchange Board of India has decreed all financial institutions must adhere to T+1 by next year.

So there is a web of complexity in achieving straight-through processing, and Asian back offices are feeling the strains of trying to meet multiple requirements.

Establishing a global system is, therefore, an important competitive edge. Templeton, for example, has built a global system that operates 24/7, and it works with partners like Omgeo who provide a 24/7 service - enabling them to move work and processes between regional sites and globally in a seamless way.

Are counterparties up to speed on STP?

Regional growth can pose challenges. "With acquisitions, people operate in silos: a broker in Hong Kong can't see its trades in New York," says Templeton's Wright. "That's inefficient for us. We want brokers to see all their trades anywhere in the world."

Kent Rossiter, head of Asia-Pacific trading at Allianz Dresdner Asset Management (Adam), says as processing deadlines tighten, it is important that brokers be able to access the same information from any of their systems, whether it's in New York, London or Singapore.

"Brokers sometimes can't send the confirmation on a trade until London time or New York time," Rossiter says. "We want confirms sent in our time zone when we do the trades."

Fund managers that are advanced in terms of STP tend to only trade with counterparts that are also automated. For example, Rossiter, who sits in the front office, notes almost all the firm's orders are routed and confirmed electronically. "From the front-office perspective, STP is there," he says.

But this can vary by market. Morgan Stanley has little trouble processing trades with brokers and custodians. But in markets such as India and Japan, counterparts are usually paper-based. "We still have to grapple with manual processing," says Tan.

Fortunately for fund managers, they are in the driver's seat. Brokers in particular are forced to match the client's pace, not the other way around. So as fund managers embrace STP, they are actually driving the entire industry forward.

These gains, however, are generally led by global counterparts, not Asia-based ones. UBS' Chew relates that her firm prefers electronic trade confirmations, for example - a basic link in the STP chain - but still must work via fax or telephone for fund management clients that aren't automated.

She believes the trend, however, is toward automation, even for local fund managers and institutional investors. For example, many local fixed-income managers are automating confirms now. "We even have two institutional clients from Korea talking about ETC," Chew says. "We've never seen interest in STP from South Korea before."

Even more encouraging, fund managers report that STP is beginning to play a role in how the front office allocates trades to brokers. Traditionally, traders based allocations on broker performance, commissions, soft dollars and research, as well as on relationships.

Edward Chong of DBS says these patterns can be hard to break. "There's an education process," he says, noting that traders need to be convinced that automation is a better way to allocate trades than a phone call.

But the trend is headed not just toward automating the trade, but rewarding counterparts with the best STP infrastructure. "The back office is now beginning to feed information to traders regarding counterparties' STP," says Wright.

Chew notes her job now requires her to regularly visit clients' back offices, to make sure UBS is meeting their STP needs. Most fund management operations execs report they have lately become much more popular with brokers. They take that as proof that their recommendations to their front offices is making an impact on trade allocations.

In Europe, this chain flows even farther back, all the way to the fund manager's client. Drumm notes that plan sponsors and trustees there are now scrutinizing the back offices of external money managers - a result of badly performing markets and the need to really pick the best fund houses. "STP is an issue that plan sponsors are looking at more," Drumm says.

This scrutiny has yet to cross to Asia, but as the institutional investor base becomes more sophisticated, and as fund managers compete harder for mandates, it seems likely that having an efficient STP solution will contribute to winning new business.

What is not yet automated?

Even for the most advanced firms, there are parts of the business that are not automated. Two oft-cited examples are allocations in the front office, and corporate actions.

Moreover, the market is always evolving, which makes it hard to keep up with new products. As mentioned earlier, structured products are a big headache now for many fund managers and their counterparts.

For brokers, structured products require extra hand-holding. STP is simply not possible in certain cases. These products can also create internal strains. For example, brokers typically will split an asset swap into its equity and fixed-income components. This requires constant communication among desks. "We try to achieve STP, but it's not possible if the two products aren't married and seen as one," says Chew.

Fund managers also find that their current systems usually lack the depth to handle new, complex products. "We have to throw spreadsheets or people

at problems," says DBS' Chong. Fortunately, even for a local powerhouse such as DBS Asset Management, structured products still are only a minority of assets (although in terms of new retail business, they would be a majority). Therefore the overall volumes remain modest, which means the firm can handle it. Chong's greater focus when it comes to building STP is what happens to volumes when the equities markets bounce back. As long as the basic systems are scalable, exception processing is tolerable.

Global firms have more options than local players: namely, they can outsource work to cheaper locations. DBS has operations in Singapore, Malaysia and Hong Kong; it can send work to Malaysia but only so much.

Morgan Stanley, on the other hand, is centralizing its processing in Mumbai. Its STP platform, built two years ago, can't handle new structured products, but instead of allocating IT dollars, the firm has found it more cost-effective to hire inexpensive help in India. "It doesn't make sense any more to invest in systems if you can put three people behind a problem at much less cost," says Tan, adding that India's supply of talented people seems limitless.

Nonetheless, there is no question that exception processing is a big frustration for operations executives. There are limits to what fund managers can do about it. They can build proprietary systems or purchase off-the-shelf packages to handle exceptions, but the cost has been deemed too high.

"The resources it would take for us to develop a system to account for these products would be massive," says Rossiter.

Wright adds the integration problems - with counterparts, with offices around the region, with the head office - are daunting. Moreover, no single vendor can meet all of a firm's needs. "Even if you pick the best of breed, bolting them together into a system that helps STP and rolling that out globally poses a problem," he says.

Have falling assets impacted the back office?

Fund managers have seen their assets under management fall. That's partly due to lost value as equity markets plummet. It's also because institutional investors such as pension funds have seen their asset sizes shrink, not just in the West but in places like Japan and Hong Kong.

This is not an issue for day-to-day operations. Fund managers note that fewer assets don't necessarily mean lower volumes. If anything portfolio managers are trading more, instead of buying and holding, so the back office has been kept quite busy.

Reductions in funds under management, however, have hit IT budgets hard - at the same time that operations departments are faced with new products and the need to integrate Asian markets onto a regional platform. This is a major reason why operations executives are frustrated. They are being asked to do more but with less.

Fortunately industry players see the equity markets are turning around. They believe that overall IT budgets will rise over the next few years - and that this time, Asia will get a bigger share.

What are IT budget priorities?

Fund managers are likely to focus less on achieving total STP for settlements, and more for special areas such as corporate actions that are currently manual. Fund managers get data feeds regarding such actions from a variety of sources - custodians, information providers - and they need an STP solution to streamline this. Templeton, for example, is now reviewing the market for corporate action solutions.

Wright says the reason for this sudden focus is that settlements, while not 100% automated (for example, FIX allocations are manual), are sufficiently electronic to handle the current environment.

This is a big change because fund managers had been gearing up to meet T+1 settlement times in the US. Now the SEC has postponed that. "Now everyone's looking around and saying, what's the next biggest area of risk?" Wright says. "And corporate actions is where their systems are still manual."

The back office will also remain beholden to where the front office is going. For example, Morgan Stanley is starting to offer separately managed accounts - a staple in America - to Asian clients. These small individual accounts for the mass affluent are a highly IT-intensive business. So that's where IT budgets will go, and the back office will get funded to the extent it can support that. Tan says he'd like to upgrade overall STP, but it's not an immediate priority, at least as long as labour in India is cheap. "IT budgets aren't about asking 'is that nice to have', but asking 'is that business-critical'," he says.

Many fund managers, however, do have back-office needs, and the most common is reporting back to the head office. Fund management firms are looking at STP solutions to aggregate all the data feeds they receive and send to the US or Europe, and consolidating everything onto a single database. This is especially important to houses that have recently gone through acquisitions.

Conclusion

If two years ago the Asian back office was the most obscure department in a global fund management company, that is no longer the case. Asian revenues are more important, and straight-through processing is vital in an environment of controlling costs and maintaining a competitive edge. But the lack of IT budgets at a time when many firms need to consolidate growing Asian operations onto a regional platform that can communicate globally, and when new products don't fit onto old systems, has made operations a frustrating job.

Industry players see STP as increasingly important. STP has its limits. In a place like Asia it is possible to throw bodies at problems, at least for a time: it leads to errors but operations people realize they must support the business, not lead the business. Nonetheless improving global markets should lead to larger IT budgets, and back offices in Asia are likely to get a bigger share going forward. More local players are realizing the benefits and cost savings of STP. Some firms are laying the basic groundwork while others will be looking at more specific, advanced solutions. Far from being an afterthought or a luxury, STP in Asia looks to become increasingly vital to the funds industry.