US asset managers reaching ‘tipping point’ to outsource front-office, says Northern Trust

Custodians are aiming to evolve their outsourcing business model and leverage new technology to accommodate front-office solutions.

A new report from Northern Trust has suggested the outsourcing of the front-office is nearing a ‘tipping point’ among large US asset managers as the industry continues to suffer from declining performance and increased costs.

The paper highlights the onset of a ‘third wave’ of outsourcing, which will not only include trading desks but all front-office functions, such as foreign exchange and transition management.

“This third wave is likely to establish a new status quo across the industry – helping asset managers enhance their resources and focus on specialist skill-sets by drawing on external best-on class asses servicing and fund operations expertise,” the paper said.

Outsourced trading was once considered a niche solution that appealed primarily to smaller or emerging funds, however the paper suggests this concept has emerged as a viable solution for larger funds looking to enhance their scale and reduce costs.

Costs for North American asset managers have increased by an average of 5% per-year, and 6% in the last 12 months, according to McKinsey.  Figures from Morningstar and Mercer also predict a 35% fall in active management revenues by 2023.

At the same time, passive funds now represent over 50% of all stock ownership in the US.

The Northern Trust report forecasts a potential cost saving of 25% from outsourced trading among asset managers and asset owners. This will be achieved through reduced headcount, as well as reduced technology, transaction and regulatory costs.

“We believe that, over time, many asset managers will at least look to outsource some or all of the costs and complexities of trading to a third-party, one that replicates the function of the trading desk, not just in their office and not on their P&L,” the report added.

“In our opinion, 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.”

Custodians see these trends as a perfect opportunity to evolve their outsourcing business model and leverage new technology to accommodate front-office solutions.

Northern Trust launched its Integrated Trading Solution last year to capitalise on smaller-sized European asset managers, pressured by MiFID II, to outsource their front-office operations. It now expects this trend to migrate to the US.

Elsewhere, State Street is also planning to launch an outsourced trading service and will use the technology it acquired when it bought Charles River.

“As traditional methods of doing business have changed, global custodians have similarly evolved, and are leveraging their many years of expertise in working with data, security, and technology to create innovate solutions for clients,” the report said. “For them, outsourced trading is a natural progression of other outsourcing trends over the past few decades in the back and middle-offices.”