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White Paper
Industry Utilities
Over the last few years, sell side firms have
experienced intense pressure on operating margins,
largely due to the simultaneous impact of a global
economic slowdown and an increasingly rigorous
regulatory environment.
In response, sell side firms are exploring innovative
cost restructuring strategies that go beyond the
savings realized by labor arbitrage and instead target
a fundamental transformation in core operations.
Back office industry utilities have been a familiar
service focused on providing cross counterparty
facilitation of trade execution, clearance, payments,
and settlement. These utilities are characterized by a
few key features:
n
Multi-tenant shared service across multiple entities
in the marketplace
n
Standard platform of people, process, and
technology used for delivery of the service
n
Consortium-based ownership by key market
participants or vendor owned service
n
Variable pricing model based upon service
consumption
This model is now being looked upon with renewed
interest as one of the fundamental means to drive
further cost restructuring through its relevance,
scope, and usage in a broader spectrum within the
capital market space.
Recent market trends have caused reconciliations to
become a source of increasing cost escalation and
risk, driving firms to focus on addressing these
emerging issues. Creation of a utility to serve the
industry’s reconciliation needs is currently looked
upon as a potential solution.
This paper highlights TCS' point of view around the
current industry trends and how it can help optimize
sell side firm costs by adoption of a comprehensive
reconciliation utility solution.
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About the Authors
Kabir Bhagat
Kabir Bhagat leads Capital Markets Consulting for North America
at TCS, with more than twenty years of management consulting
experience serving clients in the Financial Services Industry.
His domain expertise covers a broad range of industry areas
including Mortgage & Commercial Loan Servicing, Risk
Management, Investment Accounting, Securities Trading,
Securities Processing and Global.
During his career Kabir has successfully led several complex
business and technology driven client assignments at several
major global banks to address improvements in measurement of
inherent portfolio risk, regulatory compliance, straight through
processing, business process reengineering, operational
efficiency and consolidation vendor selection and software
implementation.
Prior to joining TCS, Kabir’s career history includes being a Partner
at SunGard Consulting Services, A Partner at Ernst & Young and a
Vice President at CapGemini.
Jagdish Parelkar
Jagdish Parelkar is a Consulting Lead within the Capital Markets
Consulting for North America at TCS with over 18 years of
management consulting experience leading complex business
transformation, process reengineering and optimization
initiatives with extensive experience in program and project
management, business and functional analysis for leading capital
markets clients within Financial Service industry.
His primary expertise is within Fixed Income with strong
knowledge of Trade Life Cycle, Front-to-Back processing of
Repo/Stock Loan-Borrow and Secured Funding and Position
Management & Reconciliation.
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Table of Contents
1.
Banking and Financial Services Industry Watch
5
2.
TCS BFS Position
10
3.
Conclusion
14
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Banking and Financial Services Industry Watch
Market Context
Over the last few years, sell side firms have experienced significant margin pressures caused by “the
perfect storm” of global market forces. Some of the major influences include:
n
Increased risk and capital reserves: Soaring market volatility, the looming European debt crises, and
the US sovereign downgrade have had a tumultuous impact, increasing risk and capital levels within
the trading portfolios and forcing financial firms to greater provisioning of capital reserves.
n
Lower fee-based earnings: Earnings have been impacted in particular as AUM-based fee revenues
declined due to lower stock market values over the last three years, especially as major indices
retreated. Transaction-based fees have similarly experienced stagnation over the same period, due to
static trading flows in major asset classes.1
n
Volcker Rule impact: Sell side firms that are bank holding companies have divested out of profitable
proprietary trading, private equity and hedge fund businesses to comply with the emerging DoddFrank Regulation. Several major investment banks have already shed pure proprietary trading desks to
begin to comply with the Volcker Rule.
n
Significant increase in compliance requirements and costs: The financial industry is expected to spend
approximately 3 to 5 billion dollars on regulatory and compliance measures over the next 5 years.
While experiencing severe margin pressures, sell side firms are also burdened with the need to renovate
aging technology that has not kept up with the changing nature of the business. As a result, in the
current state, the entire trade lifecycle has become a complex labyrinth of systems and manual processes
that increase processing costs and heighten operational risk. Several sell side firms have embarked on
major multiyear programs to achieve greater straight-through processing (STP) through improvements to
operations and technology and realize long term cost reduction. These sell side firms are now challenged
with financing essential technology investments in a margin-compressed environment, forcing them to
realize needed funds from sustainable operating cost savings.
Business Focus
In response to these rising pressures, major sell side firms have been exploring innovative cost
restructuring strategies as a means to realize sustainable savings and improve operating margins while
also releasing funds for investment in “change the bank” initiatives. In this context, utility operating
models are becoming of increasing interest as a means to create new enterprise-wide approaches to back
office functions with different technology and processes in each division.
Third-party utility service providers have been an established feature within global capital markets for the
last 30 years. Major market drivers in the past focused service opportunities to address crosscounterparty issues such as price transparency, delivery STP, and credit risk.
(1) Although the weighted average trading volume may seem to be static, the transaction-based revenue has been impacted by the shift of trading towards more
commoditized, low-margin instruments: US equities traded across all of NYSE Euronext’s global exchanges decreased by 10.6% in average daily volume (ADV) and Treasuries
now account for 61% of the overall trading volume.
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Accordingly, the industry collaborated to create participating member owned utilities to enable sell side
trade negotiation, execution, clearance, payments, and settlements. Examples include:
n
Exchanges and execution facilities such as NYSE/LIFFE, and NASD.
n
Depositories and central counterparties such as DTCC, ICE, and LCH.
n
Payment networks such SWIFT, Worldpay, and FXNet.
n
Affirmation/confirmation/novation/compression/triparty/collateral services
Similarly, as buy side firms began to experience rising costs per trade, processing service providers
brought forth offerings that outsourced market facing delivery activities (confirmations, settlements,
collateral, and so on) for their clients as a means to rationalize respective Opex and Capex.
As product complexity and trading volumes grew exponentially, financial firms became concerned about
the high operational costs and embedded inefficiencies within the middle/back office functions
associated with redundant systems and disparate processes. Over time, the firms have realized that there
are considerable cost efficiencies and risk reduction advantages to commoditizing the middle/back office
functions through implementation of a centralized infrastructure and service model that could achieve
economies of scale from the critical mass. Firms are now exploring new back office utility models as a
means to drive further cost restructuring. Accordingly, these firms are assessing the possibility of
enterprise-wide outsourcing of embedded non-core middle/back office functions and purchasing them
as a service from a third-party provider. In contrast with earlier service offerings from vendor service
providers, the new breed being offered is not membership based. Functions recently under consideration
and level of interest in outsourcing are as follows:
n
Corporate actions: An area of significant interest for a utility service over the last ten years. However,
firms are extremely hesitant to pursue end-to-end outsourcing of this function due to significant
operational risk inherent in corporate actions processing and the inability of third-party service
providers to undertake liability for compensation in the event of claims from clients.
n
Cost basis reporting: A recent mandate from the IRS has required sell side firms to provide gain/loss
reporting for trading accounts and portfolios across all asset classes. This has required firms to
enhance technology and increase operational costs. Sell side firms are seeking options to purchase the
required processing service and reduce existing in-house support costs. The vendor landscape
continues to mature, although a full end-to-end service offering is not known to be available.
n
Reference data management: Most major sell side firms have centralized reference data
management processes into an enterprise-wide shared service. However, many of these firms are still
investing significant funds in consolidating reference data IT platforms and implementing enterprisewide data standards to reduce operational risk and total cost of ownership (TCO). Others are indicating
an interest to purchase scrubbed and cleansed reference data management as a service. Some
vendors are now offering a reference data service intended to cater to this market need, although the
solution offering has yet to be adopted by the majors.
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n
Administrative functions: Financial accounting has been a centralized, internal, shared service
function for some time. There has been limited interest in outsourcing this function, mainly due to the
level of accounting expertise and knowledge of local reporting rules required to sufficiently support
the needs of capital markets firms. However, certain general finance and administration functions such
as accounts payable and human resources are being considered as viable candidates for a utility
service. These functions do not require capital markets expertise in sub-ledger or general ledger
accounting and offer the potential to be outsourced without the same level of risk.
n
Reconciliations: Recent market trends have caused reconciliations to become a source of increasing
cost escalation and risk, driving firms to develop mitigating strategies. Contributing factors include
global rise in trade volumes and exceptions, increased instrument complexity, and increased
regulatory oversight. TCS research indicates that many risk averse financial institutions are moving
towards centralization of reconciliation and many business drivers are a correlate of risk and cost
reduction. Furthermore, many firms have significantly invested in automation to address the costs and
risks associated with reconciliations.
TCS estimates indicate that financial institutions are focusing investments in the following areas:
n
Account Reconciliation: US 35% & EUR 30%
n
Reconciliation: US 50% & EUR 25%
n
Exception Management: US 21% & EUR 30%.
There are still 35% of US and 30% of Western European firms who are undecided on investing in further
automation.
Several sell side firms have also taken significant steps in centralizing reconciliations into a shared service
organization and have engaged in business process outsourcing and applications management
arrangements with third-party providers. Most of these firms are still in transition and have yet to move a
large portion of eligible reconciliations into a central service. Interest in a full end-to-end outsourced
service is increasing as clients seek to further reduce TCO and fund the centralization and automation of
reconciliations across the enterprise.
These industry trends indicate that centralized reconciliation is a rapidly maturing operating model at
several sell side firms and offers the opportunity for further evolution into a utility service. The remainder
of this document will further elaborate on the industry landscape for reconciliations and the opportunity
for a utility service in this space.
Technology Focus
With the recent trend to move towards enterprise-wide reconciliation, the global market for multifaceted
reconciliation engines has experienced rapid growth in recent years. The global market is expected to
grow at a CAGR of 8% (US $891 million in 2012 from US $655 million in 2010). Figure 1 shows the current
market share of top reconciliation vendors.
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Figure 1. Market Share of Top Reconciliation Vendors
Figure 2 shows the share of spending on these vendors by region.
Figure 2. Spending on Reconciliation Vendors by Region
Figure 3 shows how this breaks out by market segment, with banks and brokerages spending nearly half
of all money on reconciliation services.
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Current Market Share of Spending by Segment
Custodians
17%
Banks/Brokerages
45%
Asset Managers
38%
Figure 3. Reconciliation Spending by Market Segment
Most of the major reconciliation products in the market offer similar capabilities, including the following
features:
n
Support for multi-asset types
n
Flexibility of matching rules
n
Data formats like SWIFT/ISO 15022
n
Integrated transaction management services
n
Various workflow, tracking, and reporting mechanisms
While these features have enabled firms to automate a significant pool of reconciliations in their
operations, TCS estimates that 80% of all firms are still not using full STP. The list below indicates TCS’
estimation on the average level of automation realized by financial firms:
n
Highly automated: Approximately 25%
n
Moderately automated + low manual processing: Approximately 46%
n
Very low level of automation + significant manual processing: Approximately 25%
n
Completely manual processing: Approximately 4%
Additional capabilities are needed to automate an increasingly complex portfolio of items that remain
outside their respective enterprise platforms. Firms are seeking the following additional features:
n
Detect exceptions early in the transaction lifecycle to reduce exposure
n
Gain an end-to-end view of the reconciliation breaks and root causes
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n
Provide scalable and efficient platforms that can accommodate ever increasing volumes
n
Have STP capability that can easily interface with external agencies
n
Enact low latency real-time matching and exception reporting to support pre-trade reconciliations
n
Enable smart reconciliation frameworks supporting complex products like OTC derivatives
n
Incorporate operational risk dashboard capabilities
The market leaders in standalone reconciliation applications have invested more in workflow and
exception management functionality than core-matching capabilities. As a result, smaller more
specialized vendors have recently emerged with solutions for low-volume complex matching
requirements that address the gap between customer requirements and the capabilities of larger
providers.
Major vendors are working to bridge these gaps and have product development plans that address these
needs. However, in the interim, the capability gap between client needs and major provider offerings is
leading firms to consider multi-vendor solutions within their centralized services or to delay the onboarding of certain types of reconciliations until their vendor partner is able to provide the required
features.
TCS BFS Position
TCS View on Industry Trends
While the centralization and automation strategies pursued by sell side firms are expected to realize
significant savings, TCS believes that far greater cost restructuring and risk mitigation is achievable by
pursuing more comprehensive service alternatives.
Experience indicates the following alternatives to achieving year-on-year levels of benefit against current
annual run rates:
n
Purchase third-party vendor software solutions: TCO Reduction 10% – 20%. Capex High.
n
Outsource technology and process – BPO: TCO Reduction 20% – 30%. Capex Medium.
n
In house shared services model: TCO Reduction 30% – 40%. Capex Medium.
n
On demand utility hosted by third party: TCO Reduction 60% – 70%. Capex Low
Based on TCS’ research, Table 1 provides a comparative view of cost optimization and risk reduction
achievable under various levels of purchased services from third-party software to full utility offerings.
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Third-Party Software
Outsourcing
Shared Services
ASP Model
Model
Integrated product
suite
Recon factory
Recon CoE
Recon hub /
platform-based utility
Operation
Silos based on asset
classes / geographies
Staffing in low- and
medium-cost
locations
Clusters of dedicated
reconcilers in major
operations centers
Centralized utility
TCO Reduction
Flexibility
Standardization
CAPEX
Productivity
Improvements
Economies of Scale
Operational Risk
Quality Enhancements
Degree of Automation
Regulatory and
Compliance Adherences
Cross-Border Trading
Support
Speed to Market
Examples
10 -20%
Low
Low
High
Low
30 – 40%
Low
Low
Medium
Medium
20 – 30%
Medium
Medium
Medium
Medium
60 – 70%
High
High
Low
High
Low
High
Low
High
Medium
Low
High
Low
Medium
Medium
High
High
Low
Medium
Medium
High
Low
High
High
High
Low
Low
Medium
High
Medium
SmartStream TLM
IntelliMatch
Low
TCS, HCL, Infosys
Medium
Dclear
High
MarkitServ
Source: TCS Research Team
Table 1. Evaluation of Reconciliation Services
TCS recognizes that capability gaps between client needs and major vendors could impact the speed at
which low latency and highly complex reconciliations are automated. It is anticipated that many of these
requirements will be addressed by major vendors in the next 24 months. Accordingly, complex
reconciliations can be accommodated within these platforms and the full scope of cost optimization can
be realized by adopting a phased roll-out program aligned with a vendor product maturity roadmap.
TCS Proposed Position in the Market
TCS experience suggests that a one-stop shop on-demand utility service for reconciliations will provide
firms with the greatest opportunity to achieve envisioned cost restructuring and risk mitigation. In
particular, offering a cost optimizing utility service along with a competitive and flexible contracting
framework will make it appealing and affordable to the prospective firms. Accordingly, TCS believes that a
reconciliation utility offering can be described in terms of the service attributes and contracting
framework.
Utility attributes should include:
n
Migration services to consolidate and automate reconciliation processes across the firm into a
centralized shared service unit. These services include:
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n
n
n
Consolidation and relocation: Uncoupling departmental reconciliations and consolidating them
into a shared service unit. Risk-based relocation of these reconciliations to realize optimal onsite
and offshore mix. TCS experience indicates that relocations can be accomplished within 3 to 6
months for a batch of 80 reconciliations.
n
Implementation of automated tools: Accelerated implementation of client reconciliations onto a
standard best-in-class reconciliation platform. Similarly reconciliations can be delivered in monthly
deployments after an initial ramp-up of 3 to 4 months. Teams can be scaled up to deliver several
reconciliations with each deployment.
Business process services: On and offshore support for manual aspects of reconciliation activity that
realizes cost reduction while managing risk and quality. Services should include:
n
Process standardization: Establishment of a repeatable and scalable set of processes to support
post-matching manual break analysis, investigation, and resolution
n
Quality management: Through the use of resources exclusively devoted to exception resolution
and root cause remediation. Key performance metrics to measure productivity and effectiveness.
Continuous learning and development of resource pool to improve service levels
n
Risk management: Through consistent key risk indicator monitoring and timely management of
service exceptions. Enforcement of proper segregation of duties to mitigate risks
Technology services that provide a technology platform and related support services of improved STP
of core reconciliation functionality relative to what is available internally to prospective clients. This
may include:
Advanced reconciliation tool capabilities:
n
n
Reconciliations for complex products and cross-product reconciliation
n
Low latency / real-time matching support for pre-settlement reconciliations
n
Rapid scalability to match the volumes during market volatility
n
Flexibility to adopt the required business model
n
Single sign-on integrating with client firm login protocols
n
User entitlements that support segregation of duties
n
Rule-based resolution of classified breaks
n
Workflow-based exception management
n
Applications management (L1/L2/L3) support for the reconciliation platform
n
Hosting and infrastructure support services and licensing
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Experience indicates that reconciliation utilities should offer a standard process and technology platform
through which services are delivered to clients. The differences among feature set requirements to
support pre- and post-settlement reconciliations may mandate offering more than one technology
platform. However, cost and risk drivers for such services suggest that best-of-breed technology should
be avoided. TCS believes that such utilities should optimally converge onto a unified business process
framework supported by no more than two automated reconciliation tools. Industry leaders such as
SmartStream and SunGard have the scale and flexibility to address the needs of such utilities
The contracting framework should provide:
n
Menu-based offering of services where the client can choose a single service or a suite of services
n
Single managed service contract for the single service or suite of services chosen by the client
n
Transaction-based pricing model for a suite of services
n
Implementation services costs that are funded from automation and relocation savings
Challenges & Risks
While a reconciliation utility offers a compelling solution to address cost restructuring and risk mitigation,
the industry has been relatively slow and cautious in migrating to this model. Those who have embarked
on the journey appear to be in various stages of evolution. Most have invested in building enterprisewide reconciliation platforms and in the partial outsourcing of operations and application support.
Three of the largest Wall Street firms have engaged with outsourcing partners to implement a shared
service platform. While some are in discussion to transform their current shared service into a utility
model, these firms are proceeding with some caution.
The relatively measured adoption of the utility model is largely due to following factors:
n
Lack of positive proof that a third-party service provider is able to successfully onboard and handle
end-to-end support of a reconciliation shared service
n
Difficulty making the transition between visionaries (early adopters) and pragmatists (early majority).
The operative question in the industry for vendor firms is not who will be the first to come on board
but rather who will be the second
n
Concerns whether the utility service and attendant automation can be implemented within the ROI
timescales as stated in a firm business case. A client’s own experience with implementation and
deployment delays signals the possibility that the move to a utility service could be less attractive than
presented
n
Early adopters wanting pricing advantage/ownership stake/co-branding with service provider to
reduce the risk of failure
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n
Firms having concerns around high risk and high complexity reconciliations, data security, privacy in a
multi tenant model, and the ability to uncouple reconciliations deeply embedded in core business
processes
n
Service providers having concerns with economies of transaction-based pricing and technical
challenges around handling high transactional volumes with current tools
Conclusion
Increased regulatory pressure to strengthen controls and the continued drive to reduce cost will require
sell side firms to actively pursue strategies to “horizontalize” core operations where possible.
Industry utilities offer a solution to these issues and are in varying stages of maturity to serve the
emerging demand. Reconciliation services appear to be the most advanced in capabilities available to
provide utility-like services that can be leveraged by firms to realize efficiencies and improvements in
control.
Product vendors and service providers have been maturing their offerings to broaden feature sets,
scalability, and scope of contracting arrangements in anticipation of these trends among sell side firms.
TCS' cost optimizing utility service model coupled with its competitive and flexible contracting
framework will help firms create a centralized global reconciliation process that brings greater
operational efficiency and simplicity into all aspects of the enterprise reconciliation requirements at a
reduced operating cost.
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Contact
For more information about TCS' Banking & Financial Services,
email us at [email protected]