Regulation drives rise in IT outsourcing

Regulatory reforms throughout Europe are affecting the strategic approach of private banks to business and technology. The impact is particularly acute in Switzerland, where private banks have traditionally based their client service value proposition around banking secrecy.

But regulations such as the Foreign Account Tax Compliance Act in the US, and bilateral tax agreements such as those recently signed by Switzerland with the UK and Germany, aimed at combating offshore tax evasion, means that Swiss private banks will need to highlight portfolio management and asset allocation, rather than luring clients into secret, tax-friendly structures, if they want to remain competitive and serve their non-Swiss client base.

“New fiscal regimes and a more challenging regulatory framework will understandably impact on the needs of clients,” says Michel Longhini, CEO of Geneva-based UBP Private Banking. “Private banks will need to offer tax-optimised asset allocation, implementing specific tools taking fiscal and regulatory requirements into account. It is essential they adapt their business models to meet these needs.”

Private banks will need to offer a more sophisticated product range and improve reporting and risk-control instruments based on specific IT developments, he continues. “As these functionalities are relatively new to the Swiss market, their costs are significant.”

Impact on technology

“The time when Swiss private banks could charge high fees has gone,” states Daniel Bardini, COO at SunGard Ambit Wealth and Private Banking. “All of a sudden, Swiss private banks need to comply with UK capital gains tax and all sorts of fiscal duties, which are completely alien to the Swiss offshore way of managing money. When the value proposition changes, the technology supporting that value proposition will need to change too.”

Pressure on margins has increased. Over the past 12 to 18 months the revenue of private banks has reduced by 40 per cent on average, reports Mr Bardini.

Some smaller and medium-sized institutions do not have the resources and cannot afford to hire tax specialists or upgrade their technology systems to cater to a non-Swiss clientele. “Some of our smaller clients have no other choice than to give up their UK client base, as they do not source enough critical mass from this country and cannot bear the increasing costs,” says Mr Bardini.

In order to deal with regulation, private banks and wealth managers are increasingly outsourcing their IT operations to external technology providers, instead of investing in internal technology development. In Switzerland, there are 220 private banks but only 30 to 40 are large enough to be able to cope and invest in-house technology projects, says Mr Bardini, and this number is shrinking. “The appetite for large upfront investments is diminishing to the benefit of an on-demand value proposition.”

This approach is supposed to be more cost effective as it enables the bank to align the cost of technology with its usage and offers IT scalability. “Outsourcing technology has many advantages,” stresses Edward Glyn, director of funds at Swift. “It takes a private bank years of development to establish core private banking themselves and millions of pounds every year to maintain it.”

Software providers, on the other hand, keep ahead of technology, and are usually future-proof. Rather than upgrading technology, they are refining it, so it is a mutually beneficial relationship, he says. “It’s absolutely cheaper to outsource, and the architecture of software is much more flexible than it used to be, which means you can parameterize things for your own needs.”

Ricardo Payro, head of communications at Banque Syz, which employs third party software developers based in Switzerland, says IT outsourcing is a good way for Swiss banks to cut costs and comply with different local regulations.

Throughout Europe, a host of regulatory initiatives including Mifid II, aim at improving investor protection and increasing transparency and regulation of more opaque markets such as derivatives.

In the UK, the Retail Distribution Review is forcing wealth managers and advisers to justify investments, improve professional requirements and improve transparency around fees. The need to prove investment suitability has led to heightened interest in risk-profiling and customer relationship management technology.

In Germany, when an adviser recommends a certain security, they must distribute an information leaflet detailing how the instrument will work, what risks are involved and how market fluctuations will affect its yields.

Such information requirements might drive up the uptake of client-facing tools and portals, according to consultancy firm Celent. Outsourcing the back and middle office functions enables private banks to focus on front office technology and self-directed channels. Reducing time and effort that advisers spend on administrative tasks allows them to focus on client communication.

“When private banks outsource the factory-style ground work, they can relocate people from back office into front office roles to better service clients,” says Swift’s Mr Glyn. “One of the key differentiators of private banks is how they service their client base. You need the optimal front end tools, whether that’s around proving the right advice to client relationship managers or the CRM system itself.”

This increasing focus on front office technology is also having an impact on the business model deployed by technology providers to meet private bank’s needs.

“What we’re seeing across technology groups are roles shifting from building to tying platforms,” says Benjamin Ensor, an analyst at Forrester Research. Tying platforms implies integrating third party systems with internal systems and automating the workflow for advisers and operations staff.

Private banks are trying to tighten the integration of systems to create pre-populated fields and ensure that the data remains consistent across reports. They are also looking to reduce the number of vendor relationships they undertake, by going to a single provider from whom they can obtain an integrated wealth management system.

To make this possible, vendors are strengthening their presence by offering revamped solutions and focusing on new partnerships to create stronger offerings. For example in 2010, Temenos, a software provider, acquired Odyssey, a provider of front- and middle-office software for private banks.

Pierre Bouquieaux, product director for wealth management at Temenos believes that as the outsourcing trend  related to customer relationship management and advice. “The impact on the industry will be a need for a large organisation to provide back office functionality or all that is related to securities, settlements and transactions to the private bank,” he says.

More and more fund managers and wealth managers are outsourcing their middle and back office functions to business process outsourcers, (BPOs) states Chris John, CEO at Bonaire Software Solutions, a US-based firm selling a financial control system solution. And this trend is also affecting software providers’ distribution strategies. For them it is increasingly more profitable to sell solutions to BPOs than sell directly to individual banks.

“Instead of having to sell our product to 200 organisations, we can sell to one big BPO and use it for 50 customers. For us it is a concentration opportunity,” says Mr John.

Developing in-house solutions

While outsourcing is a strong trend, some private banks are investing heavily to revamp their technology infrastructure. Coutts Private Bank in the UK recently spent £150m (€186.6m) putting in new straight through processing automated systems via technology provider Avaloq.

“It is relatively unusual for private banks to have designs in-house. There are a number of technology firms that have that expertise and outsourcing is not an unusual development,” says Michael Morley, UK chief executive at Coutts.

This investment enables the private bank to be “as productive as possible” and upgrade the client’s experience in terms of output that the client receives. “You have to ensure that you are providing transparency around pricing. Clients want a clear view of the advice they are paying for and technology can help private banks to present that better.”

Coutts’ chief operating officer, Juergen Pulm, confirms there is a general trend of buying packaged solutions from technology providers but that does not mean fully outsourcing your technology. “There are many things you continue to do yourself to differentiate yourself in the market place,” he says.

Nevertheless, he feels that there are certain standard processes in every private bank, which they can purchase from third party providers rather than develop in-house. When looking for such a provider, private banks should consider not only the economic benefits, but the risk point of view as well.

Fee transparency

More stringent regulation around transparency and fairness to customers is driving demand for niche software solutions.

“There is a big push, particularly in the UK where regulation is ahead of the EU and far ahead the US - for control systems and transparency around how fees and expenditures are calculated and paid out,” explains Chris John, CEO at Bonaire Software Solutions. The US-based firm provides revenue and expense management and accounting software to asset managers, wealth managers, private banks and brokerage firms.

In the asset and wealth management space there is still a widespread reliance on manual processes, which are error-prone and risky, he explains.

To comply with regulation, wealth managers need to calculate customers’ fees to make sure their customers are treated fairly and in line with other customers of the same type and fees are consistent with the contract they have signed. These are functions regulators are going to audit more and more going forward.

Software solutions that automate this process make sure there are no anomalies or outliers, he says. This is particularly relevant for private banks, which tend to have very complex charging structures.

Such automated process also gives the institution very interesting insights into how it is making money and enables revenue optimisation, explains Mr John.

Security concerns

When private banks outsource their IT operations to external technology providers, the major challenge they face is to be able to preserve security around confidential data on their wealthy clients.

Security around confidential data has always been the focus of private banks. Ten years ago, Swiss private banks used to store their confidential data on paper documents locked in cupboards only accessible by a selected group people, says Mr Bardini at SunGard.

However, over the last decade, with the development of straight through processing and increasing complexity of wealth management products, there has been a tendency to abandon this model, with confidential data being increasingly integrated in operations.

The resulting effect was that almost anybody in the bank can log in the system and download the name of the clients, he states. This issue was highlighted by the scandal surrounding the Hildebrands, where IT support worker at Sarasin leaked screen shots of the Hildebrands’ portfolio holdings and associated currency transactions to a lawyer.

Sungard’s Ambit CRM CIM solution which offers an application service provider model, addresses this issue, explains Mr Bardini. “Our solution is a modern version of the cupboards. The key to our system is not in the IT people hands but in the hands of the bank’s CEO and a selected group of people.”