Pressure has been mounting for financial services firms to digitally transform for years, as significant inefficiencies in terms of operations and technology persist. In 2021, we have reached a threshold point: sustained fee pressure, regulatory complexities, a new wave of cybersecurity risks and a desperate need for cost transformation are forcing firms to transform quickly to survive. It is therefore no surprise that there is growing traction for outsourced “Software-as-a-Service” (SaaS) and Managed Services models (integrated Software, Services and Data) delivered on cloud.

Ability to deliver digital transformation acceleration is increasing competitiveness in the service provider industry and providers are rapidly evolving their offerings by leveraging public cloud, AI/ML, Automation, Data Analytics and Open APIs, as well as adapting their business models to stay relevant. The ability of service providers to manage the ever-growing complexity of investment strategies and asset classes more efficiently than the asset and fund managers themselves is fundamental to survival. In the long term, success here will continue to drive adoption of globally dispersed and digital first outsourced operating models. But what are the dominant drivers in the short term?

1. AI/ML in the front office

Use of AI and ML powered services to drive automation in the middle and back office of financial firms is not new, but recently the front office is catching up. This is particularly true for investment managers, who – driven by fee compression and increased competition – are looking at ways and means to improve overall productivity and coverage. Productivity for managers is a function of how much time they have, and the more they can introduce automation into investment data management processes, the more time they have to broaden coverage and spot new investment opportunities. It also allows more time to develop and refresh models and monitor investments already made - particularly in the credit side and more generally in private equity.

There is therefore increased demand for Service Providers who can offer automated investment data management through AI, NLP and ML, by cognitively extracting and managing data from investment sources. This frees up time for investment managers to improve their productivity from a research perspective, enabling them to stay competitive and focus on driving results for clients.

2. Cybersecurity 

Cybersecurity and the need to operate securely has become a top priority for financial firms, as endpoint attacks have gone up 700% since the pandemic began.  Remote working has made the traditional on-premise perimeter obsolete and exposed weak endpoints as employees connect work laptops and phones to unsecure Wi-Fi networks and smart devices. This, coupled with greater scrutiny from regulators particularly on the buyside, has greatly increased the need for operational resilience in dealing with cyber-attacks. As a result, we are seeing a sharp rise in investment managers, PE firms and hedge funds proactively rolling out managed cybersecurity programs in partnership with trusted Managed Service Providers (MSPs).

With many financial service providers already handling infrastructure for buyside clients, cybersecurity offerings are a natural extension. But often they will identify a threat and simply alert the company, and the service ends there. Ideally, companies want an MSP that provides the full spectrum of threat management from protection to remediation.

The most sought-after solutions are the ones that can manage incidents proactively. Using AI and ML technology, cybersecurity solutions can create models that monitor different events and incidents, prioritising them in a manageable way. Real-time access to as much data as possible from firewalls and servers, combined with threat intelligence feeds operating in the cloud, means MSPs can prevent incidents in the first place and protect client endpoints outside of the office.

3. New fund launches

There is an ongoing industry issue among asset managers and alternative funds, regarding the allocation of expenses between the managing company and the different funds. With new fund launches picking back up throughout 2021, and heightened regulatory and investor scrutiny, this is now one of the more prominent issues driving outsourcing to service providers.

There have been some examples of sizeable regulatory sanctions, where allocation of expenses was not appropriately done for large funds. The risk comes from the continued reliance on manual, Excel-driven and paper-based processes that expose firms to human error, and regulatory and investor risks if there are misallocations. The nature of these processes also come hand in hand with a lack of oversight which raises issues around transparency.

This is something that firms can outsource to MSPs that leverage digital platforms for expense management, to ensure allocation is done in a fair and transparent way in line with regulations. Mistakes can be avoided by outsourcing to a service provider who offers a digital infrastructure able to deal with allocations in an automated way, reducing the possibility of human errors and ensuring SEC compliance. 

The outlook for 2022

The trend towards outsourcing will continue to steadily increase in 2022, and recent Linedata research identified that a small majority (58%) of investment firms are developing less technology in-house compared to five years ago. The research also identified that over the next 12 months firms are looking to outsource some aspects of middle office work, such as fund accounting (32%), compared to levels in 2019. Similarly, firms are also looking to outsource certain elements of both shadow accounting (29%) and reconciliation (29%).

New services will predominantly be launched on public cloud as it becomes the industry standard. As complex regulations come into effect such as SFDR, firms will look to MSPs to stay compliant without having to invest in new in-house teams and software. This capital can be put aside to tap into new markets and create differentiated financial products to improve much-needed competitiveness.