Adapting your operating model to complexity and change

It has often been said and written that the asset management industry is about to experience significant change. The triggers for these comments have typically come from macroeconomic events, significant market volatility, or regulation. We saw this most recently following the aftermath of the 2008 credit crisis. On reflection, nonetheless, the industry often continues fundamentally unchanged upon these announcements - or at best having evolved around the edges. However, things might really be changing this time. So how should asset managers respond?

Comments about significant change are increasing in frequency and volume once again. Interestingly, this time these comments are based on the disruption new technologies – or “fintech” – could bring. The expected so-called disruption may result from new entrants in the industry raising the bar on customer experience and efficiency by leveraging a different technology-based operating model. Alternatively, it may come from existing players adopting the new technology to enhance their current operating model by combining it with their brand, client relationships, and investment experience. Either way, many believe that this time significant change could really be on its way and some argue, not a moment too soon.

Current market trends triggering change and demanding asset managers to respond

Innovation occurs as a result of unmet or changing market needs. Therefore, the current market context is important. Despite the market volatility in the first quarter of 2016, the industry is seeing operating margins returning to pre-crisis levels, which continue to be the envy of other financial services sectors. However, much of this improved performance is a reflection of the general rise in financial markets over that period rather than through significant improvements in operating efficiency. However, the industry is also facing headwinds; from the shifting distribution landscape across Europe, an increased focus on fee transparency, and the unbundling of costs adding further downward pressure on margins, with both regulators and end-investors questioning the ‘value for money’ provided by active management.

Furthermore, the digital transformation occurring in other sectors is raising the bar on the level of customer experience expected to be provided also by the asset management industry, particularly for those organizations who are looking to have a direct relationship with their end investors.

Industry response to market trends

The industry is responding to these changes in a number of ways, including;

• evolving the distribution model to incorporate a component of ‘direct to consumer’,
• moving up the ‘value chain’ to offer investment advice,
• developing investment solutions as well as products unpinned by active and passive management, and
• utilizing a broader range of alternative asset classes (e.g. infrastructure, real estate, non-listed assets).

Many of these responses require a corresponding change to the asset manager’s operating model. Furthermore, asset managers are asking whether their operating model can be a source of competitive advantage.

The industry’s ability to evolve the operating model sufficiently to address these challenges may be enhanced with the emergence of a number of recent technology-based innovations: robo-advice, big data analytics, robotics, and blockchain. Not all of these will be appropriate for every organization but those that can embrace these developments may be able to expand into new client segments and services, whilst improving efficiency.

The industry’s ability to evolve the operating model sufficiently to address these challenges may be enhanced with the emergence of a number of recent technology-based innovations: robo-advice, big data analytics, robotics, and blockchain.Alex Birkin, Partner, EMEIA Industry Leader and Global Advisory Leader, Wealth & Asset Management, EY

A global operating model and the need for transformation

The ‘operating model’ is an overused and ill-defined concept. At EY, we define the operating model as the cohesion between eight core components outlined in Diagram 1.

Many asset managers have already embarked upon the journey to ‘globalize’ their operating model to improve efficiency, consistency, and control. This globalization of the operating model is occurring through ‘standardization’ and ‘centralization’.

Standardization

Standardization is occurring through the rationalization of IT applications. The once much debated ‘build versus buy’ decision has now defaulted to ‘buy’ in all but the rarest of cases, typically reserved for investment decision-making tools only. The trends towards third-party or ‘vendor’ systems has moved from the back and middle office to the front office, including order management and execution through to the investment book of record (IBOR). Asset managers are attracted to the leading-edge technology of some of these systems, which are frequently delivered in a ‘hosted environment’ and are often accompanied by risk data and analytics services. Increasingly, asset managers do not consider the systems that support these front, middle and back office processes as a source of competitive advantage and are therefore willing to sacrifice some bespoke tailoring for simplicity and convenience.

Many asset managers have already embarked upon the journey to ‘globalize’ their operating model to improve efficiency, consistency, and control. This globalization of the operating model is occurring through ‘standardization’ and ‘centralization.’ Alex Birkin, Partner, EMEIA Industry Leader and Global Advisory Leader, Wealth & Asset Management, EY

The broad footprint of many of these front office systems is leading some asset managers to reconsider the boundaries with their third-party asset administrators, who constitute a significant part of their operating model. For example, if the front office platform provides a robust ‘investment book of record’ (IBOR) then it may be efficient for the asset management to perform corporate actions processing themselves. Furthermore, those systems that can truly provide a ‘front-to-back’ platform eliminate the need for complex interfaces and reconciliations and can provide an easier path to consistent data quality and reporting.

The more forward thinking asset managers are using the implementation of these third-party systems as an opportunity to transform the way they do things, their operating model. This transformation has focused particularly on creating greater consistency of process, control, and reporting, addressing some of the weaknesses exposed in the immediate aftermath of the financial crisis. Although this standardization needs to be balanced with operational flexibility to adapt to new markets and products, it is providing the blueprint for the design of the target operating model across the entire business.

... those systems that can truly provide a ‘front-to-back’ platform eliminate the need for complex interfaces and reconciliations and can provide an easier path to consistent data quality and reporting. Alex Birkin, Partner, EMEIA Industry Leader and Global Advisory Leader, Wealth & Asset Management, EY

Centralization

Once a greater level of standardization is achieved then ‘centralization’ becomes easier. Centralization is broadly taking 2 forms: firstly, centralizing common processes in small number of in-house locations, often lower cost centers either near or off-shore. Secondly, centralizing processes with a third-party asset administrator.

Centralizing into in-house locations helps to improve specialism, can leverage a global footprint to provide a near 24/7 service, reduces costs, and can provide access to new pools of talent. Although this trend is not new, there is increasing activity outside of the typical support functions (e.g. IT and Finance) subject to this change, and into business functions such as investment research, distribution support, and operations.

Blockchain could revolutionize the operational processes in financial services, says Alex Birkin,
Partner, EMEIA Industry Leader and Global Advisory Leader, Wealth & Asset Management, EY

Blockchain

A more radical approach to improving the existing systems architecture is to replace it entirely. Distributed ledger technology (DLT) may provide the opportunity to do this, increasing transparency and reducing costs. The most well-known of the DLTs is blockchain; a technology that allows multiple parties to share data in a trusted environment, creating a single of source of truth. If blockchain was used in financial services to record ownership of assets, and trading of assets, then it could eventually become a single source of truth for all financial transactions. In this respect, blockchain could revolutionize the operational processes in financial services,

which are heavy in data reconciliations and data error handling. Payments and post-trade settlement are just one area of use cases for blockchain, but there are many more that are only just starting to be explored – for example, sharing of KYC data, fund transfer agency, and trade finance.

If blockchain was used in financial services to record ownership of assets, and trading of assets, then it could eventually become a single source of truth for all financial transactions. In this respect, blockchain could revolutionize the operational processes in financial services, which are heavy in data reconciliations and data error handling. Alex Birkin, Partner, EMEIA Industry Leader and Global Advisory Leader, Wealth & Asset Management, EY

Is data the new source of competitive advantage?

Standardized solutions will help address concerns about the disadvantages of out-of-the box solutions as consistency in data and processes gives control and a holistic, standardized, consolidated data management approach from front to back, which will enable automation, improved decision-making, and consistent reporting across the organization.

A number of forward-thinking managers are now leveraging the power of analytics to support their investment decision making. Portfolio managers are applying big data analytics to structured and unstructured data to provide new insights and understanding on shifts in market sentiment on each underlying investment. The ability gather this data and to filter and analyze it in a way that enables more informed investment decision is the key to creating a winning edge.

Robotics – the future of process automation

Whilst the industry is still in the process of simplifying the application architecture, legacy systems are often the limiting factor in re-engineering processes and increasing automation. Robotics or robotic process automation (RPA) could be a ‘silver bullet’ for this problem. Robotics enables organizations to automate existing high volume and/or complex data handling actions, significantly removing costs across the value chain, but in particular in middle and back office processes. The asset management industry has been relatively slow to embrace this technology; however, we are now seeing some exciting use cases emerging, for example, the use of robotics to assist in gathering analytics – using robots to scrape data from news sites into one single source and in client onboarding – a highly manual, time-consuming, and repetitive process for most.

Evolving the operating model and embracing new technology to stay competitive

While global AUM is set to rise along with industry share, the fight for market share will increase as the number of players fall and the big get bigger. Whilst globalization is no longer a trend but a reality, focus on optimizing the global operating model will be top of the agenda for asset managers. Standardization, simplification, and integration will be key differentiators, as cost efficiency becomes increasingly important with pressure on fees, as data quality and control become vital to improve investment decision-making, reduce risk, and meet regulations, and as operational agility has become a prerequisite for utilizing investment opportunities.

The rise of fintech and its disruptive powers may pressurize the industry to realize these ambitions. The industry is naturally cautious and never quick to adopt new innovations or technology. The industry won’t change overnight and not everything in big data analytics, robotics, or blockchain is appropriate for everyone. However, these new technologies are revolutionizing other financial services sectors and it would be a missed opportunity – and most likely risking competitive edge - if we don’t try and embrace some of them to address the challenges ahead.