Mike Brennan, a partner in the financial services practice of CSC Consulting Group, analyses the impact of complex securities on the middle and back office.
For some time now, shrinking profit margins on mature products have been driving the industry towards higher risk and more complex securities.
At the same time, and for the same reason, the industry has been trying to transform their middle and back offices into low cost scalable organisations providing a high level of operational risk management.
Such transformation initiatives carry significant challenges, and industry leaders expected legacy processes and technology limitations to be the primary issues.
But the surprising discovery is the impact of complex securities on operating models.
Complex securities is a broad term covering different types of investments. The most common are:
a) new asset classes unsupported by reference data providers or industry utilities
b) one time issuance-only asset classes
c) packaged contractual obligations
Over time, as complex securities were introduced, industry participants added processes to their middle and back offices to support them.
Generally speaking, these processes were, and continue to be, manual and spreadsheet intensive.
Based on the incorrect belief that these products had a complex to mature product lifecycle - and would someday function as mature products do - it was assumed that the associated processes would be absorbed into the existing operating environment.
The reality is the lifecycle of products as they move from complex to mature can be very long, and some by their nature, will never function in the manner of mature products.
The unintentional result of all this is the creation of two-tiered middle and back office operating models across the industry:
Tier 1: mature products supported by mature processes, organisational structures and technologies
Tier 2: complex products supported by immature manual processes, organizational structures and limited technology/spreadsheets
Transformation initiatives uncovering this situation have stalled as the impacts are assessed.
The primary impacts are:
- Scalability. It is impossible to scale manual and spreadsheet intensive processes.
- Business continuity across multiple sites. Supporting these instruments across multiple sites is extremely difficult, as subject matter expertise usually resides in one location.
- Outsourcing limitations. Complex securities add a new dimension to outsourcing decisions, as both outsourcing providers and their clients consider the risks.
Whether beginning or re-starting a transformation initiative, industry participants would be well served to start with a process-centric current state analysis complete with detailed process mapping.
By taking the time fully understand the make up of the current state operating environment, you’ll discover unforeseen issues upfront and avoid many of the pitfalls that can stall or derail your transformation effort.