Costs for investment outsourcing services are rising in Asia. Nicholas Pratt asks which regions are embracing the concept and what challenges the providers face.
The outsourcing of fund services has traditionally been most prevalent in the more mature Asia Pacific countries, like Japan and Australia, and those with an established offshore or cross-border market, like Hong Kong and Singapore.
In these markets, the outsourcing of both custody and investment services like transfer agency (TA) have been common for several years, and global providers like HSBC, State Street, RBC and BNP Paribas have been awarded several mandates in the past few years.
Taiwan also has a growing cross-border business, but the sentiment among service providers is that the outsourcing market is already saturated with five or six global custodians, in addition to some local providers, looking to gain a share of what is a relatively small market.
There is a small number of large asset managers, such as Franklin Templeton and Schroders, that have maintained an in-house TA function and have stated that an in-house TA service is a valued part of their offering.
The recent decision by Invesco to outsource its TA service to State Street suggests that other large players may be willing to consider outsourcing in the future if the economics are attractive enough.
One interesting area of development, says Michael Chan, Asia Pacific head of asset servicing, BNY Mellon, is with large asset owners and outsourcing. Many of the ten highest reserves are held by central banks in Asia and there has been a gradual move to invest more of these funds overseas, which has in turn led to more engagement in middle office outsourcing. However, in the case of some of the largest asset owners, things have gone full circle, says Chan.
“What we have seen is that as they learn how to perform these services more efficiently, they have taken them back in-house,” Chan says. “The largest players have the scale and the intellectual expertise to do this.”
Chan adds that there is also the issue of confidentiality. Many of these central banks do not want to disclose their portfolios. They may also use several providers and taking the service back in-house enables them to consolidate.
And then there are the domestically-focused markets – Indonesia, Malaysia and Thailand – where the relatively modest outsourcing market has been dominated by the global custodians able to offer local and direct custody services – HSBC, Citi and Deutsche Bank.
However, there are signs that the prospects for outsourcing may brighten as a result of regulatory and market developments.
Malaysia, for example, is forecast to triple its assets under management to reach 1.6 trillion Malaysian Ringgit($515 billion) by 2020.
The Malaysian government has introduced the use of multiple-currency trading to encourage the distribution of unit trust funds overseas in addition to relaxing some of the restrictions around sharia funds.
“It is a good sized market but it is still at a nascent stage so the established providers have an advantage,” says Chan.
In April, Malaysia-based AmInvest, the asset management arm of AMMB, which has more than €7.5 billion ($9.9 billion) of assets under management, outsourced its investment operations and custody services to State Street.
The operations included in the arrangement are trade matching, fund accounting, client reporting and investment analytics.
It is one of the largest outsourcing mandates outside of the more established markets and featuring a domestic manager.
“Outsourcing is becoming increasingly popular with investment managers across Asia Pacific as a way to improve operational efficiency and manage operational costs,” says Andrew Willis, vice president of investment management services in Asia Pacific at State Street.
“As a result, we are seeing interest in outsourcing both from local managers, and global managers with operations in the region.”
State Street and AmInvest worked closely with the regulator to ensure that the fund administration outsourcing was a viable option for AmInvest and the support of regulation across the region will be instrumental in growing the outsourcing the market, says Willis.
“Without it the growth of investment, administration outsourcing will be severely curtailed,” he says.
“So it is incumbent on the industry to explain to regulators the benefits of outsourcing, so that they understand how outsourcing can help investment managers mitigate operational and financial risk.”
Willis says if asset managers are to operate on a level playing field, outsourcing should be an option available to global, regional and local players alike.
As welcome as the developments in Malaysia may be, the elephant in the room, though, is China, says Chan, where the amount of foreign investment is increasing and through sheer numbers.
“There were outsourcing providers trying to get market share in China prior to the crisis when the asset managers were all making money but now, in the post-crisis era, the managers are scrambling to do some of the work in low-cost locations and this is creating some opportunity for outsourcing,” he adds.
As with Malaysia and its regulator, the Chinese authorities will be instrumental in how the outsourcing market develops in the country.
As in Korea, there are strict rules around data privacy but there are signs of a loosening of the restrictions on investors.
For example, the qualified domestic limited partner (QDLP) scheme, was announced in 2012 to complement the renminbi qualified foreign institutional investor (RQFII) scheme, which had launched a year earlier. QDLP is expected to open the door for overseas hedge funds to be marketed to Chinese investors.
Outsourcing providers are awaiting the final regulations on the servicing of these funds and whether the TA or distribution can be performed off-shore and clarity will be vital for providers.
“The last thing you want is to start servicing clients from offshore and then find out that the regulators have decided it can only be done onshore,” says Chan.
Aside from navigating the changing regulatory frameworks, the other main challenge that international outsourcing providers face in Asia is purely economic.
Outsourcing is essentially a way for Western businesses to reduce salary costs by moving jobs to lower cost locations. Asia has therefore been one of the locations that jobs are outsourced to and not from, which will make it difficult for international providers to generate the same level of savings.
In the context of investment operations outsourcing, especially the TA function, the pricing issue is exacerbated by the heavy and historic reliance on manual processes by Asia managers and distributors, says Sebastian Chaker, head of Asia for Calastone.
This means that many of the global asset servicers that have targeted the Asian market in recent years are competing with local service providers that have traditionally priced their services very low because of their low labour costs. Consequently, the global providers face hit on price in order to build market share.
In Asia, the general level of automation is around 15%, whereas in Europe, the level is closer to 80%.
And in Europe the price charged for manual transaction is as much as €25, compared with €10 for an automated transaction.
Contrastingly, in Asia and the less developed markets, the local TAs do not often differentiate between manual and automated transactions.
“This is the barrier that global operators are facing when trying to take their global platforms and pricing programmes to the Asian market,” says Chaker.
The low level of automation is often blamed on the local distributors. “Ideally, all the TAs and fund managers would agree on a standard and it would be put into use but this has not happened so far,” says Chaker.
Swift, for example, has developed a standard. But buy-side firms have not embraced it because they are not willing to invest in expensive IT projects.
“It is not that the distributors are unwilling to use automation, but they are less willing to pay heavily for it,” says Chaker.
There is some light for outsourcing providers, though, and indications that this is the beginning of a transition period from a manually intensive market to one that is more open to using automation.
The cost of labour is rising across the region, and not just the more mature markets. The technology is improving and becoming more accessible and the cost of legal and regulatory requirements is increasing the operational burden on manually-based participants.
And there is the case of Taiwan and the collaboration between the Taiwan Depositary & Clearing Corporation (TDCC) and Calastone on an automated fund order routing service, launched in September 2012.
There are more than 20 offshore fund managers and four distributor banks live on the system – the latest of which was the Union Bank of Taiwan – and, according to Chaker, there are more distributors waiting to join.
“The big difference with the TDCC model in Taiwan is that the buy-side are not charged any transaction fees to automate their orders and the investment required to connect straight-through-processing is minimal,” he says. “Other markets, like Hong-Kong and Singapore, are gradually moving towards automation even though there is no equivalent of TDCC to sit in the middle of the process. ”
It is an alternative approach to the model offered by international central securities depositaries, such as Euroclear and Clearstream, in that it is purely transactional and does not require a custodian between the distributor and the transfer agent, thereby also excluding the global custodian.
There is an equivalent in the US – the NSCC-Fund Serv, provided by the DTCC, a messaging network and settlement system designed purely for mutual funds.
Despite this exclusion, Chaker says there are still opportunities for the global custodians. “There will always be a demand for a full outsourcing service but in the fund distribution market this is likely to come from the mid-sized players that want a one-stop-shop from the global custodians.”
©2013 funds global asia