August 24, 2017Clare Vincent-Silk, Head of Advisory at Pentagon Consulting
The benefits of simplification and system consolidation
Read this article and learn about
Why firms are now looking at their front office system strategy
The business drivers for change
The operational benefits of change
The types of solutions that are being considered and why
Clare Vincent-Silk, Head of Advisory at Pentagon Consulting
Changes in investment strategy, the pursuit of growth and expansion into new markets, the need for data consistency, and a growing regulatory scrutiny are leading asset managers to re-evaluate their use of front office systems. This article describes these drivers and the benefits change can bring.
Historically, asset managers have adopted a best-of-breed approach to their front office platforms, whereby specific systems are deployed for specific asset classes, geographies, or markets. Whereas this may have been an effective strategy in the past when there were a limited number of specialist systems able to meet these very individual demands, the limitations of the best-of-breed approach in a complex world are becoming increasingly clear.
The move towards simplification and consolidation
Market developments in recent years have shown up the limitations of the best-of-breed approach and emphasized the need for a different strategy.
Firstly, there is a continual focus on cost efficiency and firms are no longer able to simply buy a new system on the whim of a portfolio manager that decides he wants to invest in a new instrument.
Secondly, years of buying separate systems have left firms with a sprawl of systems that are expensive to maintain, difficult to integrate, and nigh on impossible to adapt without adding further to the sprawl.
Thirdly, there are more integrated systems available now to firms enabling them to bridge any gaps in functionality.
Consequently, a growing number of asset managers are looking to adopt a new approach – one that rationalizes the number of systems they use, simplifies their operating platforms, and reduces their total cost of ownership.
At the same time, though, the low interest rate environment and intense competition have pushed portfolio managers to adopt more complex strategies and they subsequently need systems with enough flexibility and functionality to match their ambitions.
The most important driver for front office system change is growth. The ability to capitalize on new investment opportunities is paramount and the front office cannot be a hindrance to this objective. The difficulty of generating returns in the current market conditions is driving more firms to engage in more complex investment strategies involving more alternatives and illiquid assets.
To do this, firms need front office systems that support these strategic changes. Vendors are continually expanding the coverage of their front office platforms and introducing more complex and advanced analytics, but it has historically been a challenge to use the same system that has serviced mainstream traditional classes for new alternative funds.
Increasingly, vendors are meeting this challenge and developing single systems for all asset types able to track positions, monitor risk, and analyze performance more holistically - and therefore make more accurate and informed investment decisions.
In addition to exploring new asset classes, managers are growing in size – either through expansion into new markets and regions or through merger and acquisition. Front office systems therefore need to provide scale to cope with increased volumes and new clients, and quickly adapt to the structural change that comes from this expansion.
Technology advances have created a much more dynamic and sophisticated trading environment. More tools are available to dealers, enabling them to analyze trading patterns and predict the market impact of a given order, and to determine the best venues in which to transact.
It is therefore crucial that any order or execution management system is able to embed these analytics. Not only will it help firms to meet their ‘best execution’ requirements, they will also be able to improve transparency, lower internal trading costs and, should it be tightly integrated to a portfolio management system, demonstrate their transaction cost analytics to their portfolio manager colleagues.
With tighter integration of technology between the dealing desk and the portfolio management team, there is also potential to bring trade cost analytics upstream to the portfolio manager to inform their decision before entering into a trade.
Trading capability can be further enhanced by outsourcing the dealing function to a third party and one of the growing number of independent dealing desks. Such an option not only improves execution capability but also simplifies front office architecture, increases efficiency, and reduces cost. This option is particularly appealing to those looking to have a physical dealing presence in other geographical regions.
Data is integral to the front office and is central to trading and investment decisions. However, with so many firms having based their infrastructure on a best-of-breed approach where each new asset class gets its own system, it has often left a legacy of data inconsistency.
The struggle of trying to bring so many different databases together has given birth to a whole cottage industry in reconciliation. There are also different silos and systems with their own databases for different asset classes. Investment professionals are asking the same questions but getting different answers from their systems and that builds mistrust.
Firms need more timely information across assets to fuel the decision support process, better monitor risk, and meet the demands of regulators and clients for improved transparency. But firms operating with several front office systems, all with different databases, find they have multiple problems. For example, risk and compliance managers find it difficult to get a clear picture of their issuer or counterparty exposure when different databases do not speak to each other.
Every morning the portfolio manager wants to know where they stand and to have a reliable, single source of truth. Instead they are spending hours reconciling all the data from different sources. Not only does this breed mistrust, it is time-consuming and expensive. By contrast, an integrated solution delivers a consistent set of data for all areas of the front office, which streamlines integration, improves data quality, and increases confidence in results.
The need for consistent data will become increasingly important thanks to greater regulatory scrutiny and investor demands. This means more reporting and collaboration between the front office and their risk and compliance teams.
This requirement has exposed the need for integration, not just between different front office systems, platforms and applications but between compliance systems in the middle office and record-keeping systems in the back office.
The benefits of change
As more firms choose to migrate from a best-of-breed approach to a more consolidated and simplified system architecture, they are discovering a number of operational benefits.
One of the key advantages is the ability to implement change more quickly. By opting for solutions that address needs across the entire front office rather than specific asset classes, there are fewer applications that need to be modified or tested, accelerating the time to market. For example, some firms are finding that by switching systems, they are able to retire multiple applications.
In such instances there are numerous cost reductions on offer – fewer licenses to purchase or upgrades to finance. Upgrades are often the scourge of operations managers. It can take so long to perform these upgrades, which effectively offer just like-for-like capability, that there is little time or budget left to devote to implementing and testing new functionality. Therefore, so many firms are opting for a ‘software as a service’ (SaaS) model as opposed to the traditional ‘enterprise’ model. The vendor not only hosts the application but also assumes the responsibility for testing, maintaining and upgrading the solution.
Standardization of processes
System consolidation also brings greater standardization of processes, an especially important point for those firms that operate internationally and are regularly introducing new instruments to their trading desks, opening new offices in new regions or acquiring new partners.
Research shows that almost three quarters of firms in the UK are now using the same core front office system across multiple asset classes, enabling them to consolidate their views of portfolios.
Reduced vendor risk and greater self-reliance
Fewer systems also give firms reduced vendor risk, and a more sophisticated front office with its own investment book of record (IBOR) provides greater self-reliance.
The way forward
For firms that have made the decision to change their front office systems, what solution or solutions should they choose? Mainstream front office systems are now able to meet the majority of the functional requirements facing managers, especially with regard to the more traditional asset classes.
However, other factors are also key considerations. In particular, ease of installation and ongoing upgrades are high on the agenda. Firms no longer want to deal with the aggravation of continually updating their systems, ensuring they are on the latest versions and testing any changes. Instead they want a solution, ideally on a SaaS basis, that is hosted and managed by the vendors. Such an approach will reduce the cost of upgrades but there is a trade-off involved. Cost will be determined by the level of tailoring that the client requires. A one-size-fits-all approach will result in easier and cheaper upgrades but may sacrifice some much-needed functionality, whereas a bespoke system will be costly to modify or update and will need to be tested.
Ultimately firms will have to consider the various options, but there is a clear demand for stable and integrated systems with a simple architecture flexible enough to be updated in time with market changes. Vendors have recognized these needs and are adapting their offers accordingly. More systems are available on a SaaS and hosted basis. There are also systems available that are more tightly integrated with the middle and back office systems to give that enterprise-wide data consistency or to assume data management responsibilities.
Firms should weigh-up the various trade-offs involved and ensure that any system they choose gives them the required resilience and stability and enhances rather than hinders their ability to meet their future ambitions.
About the author
Clare Vincent-Silk, Head of Advisory at Pentagon Consulting
Clare has over 30 years’ experience in the financial sector with extensive expertise in the investment management front office. Assignments have included target operating model design, system selections, MiFID impact assessments, and managing complex change programs. Clare recently joined Pentagon Consulting as Head of Advisory, having previously been Managing Director at Investit. As a consultant, she has worked with around 50 investment management firms offering insight into market best practice and helping them to design, develop, and implement solutions. As an industry thought-leader, Clare is frequently quoted by the press and is engaged to speak at conferences. She is an effective chair of industry forums for senior managers in the investment management industry.