Hotsourcing: rethinking the outsourcing model

Outsourced operations have long been a popular choice among financial service firms looking to reduce cost and headcount and focus on their core business processes. By contracting an external service provider, it was thought that economies of scale and technological automation could be leveraged to reduce the number of staff needed to perform non-core tasks in-house. However, over the last decade, with the growing regulatory and compliance burden, the way these firms manage their outsourced services has been steadily evolving.

In today’s post-financial crisis environment, a financial institution’s activities and reporting processes are subject to much scrutiny – so if a particular activity is fully outsourced it can be much more difficult to demonstrate to regulators that due diligence is being undertaken, especially if mistakes are made or something goes wrong.

For this reason some firms have chosen to stick to business as usual, continuing to operate legacy systems in-house rather than outsource, even where it can be inefficient to do so. As a result of underinvestment these systems have been unable to keep pace with the speed at which the financial markets are evolving. For those companies that have been able to invest in their proprietary technology, they have done so piecemeal. This has lead to overlapping spider-webs of outdated technology which cannot provide an accurate, holistic overview of a firm’s risk exposures when investing or trading with other entities.

This is compounded by the fact that for many legacy systems to work effectively there is often a reliance on the knowledge of the very people who built those systems, but who take the institutional knowledge needed for their smooth functioning and maintenance with them when they leave or retire. These archaic systems lead to redundant processes, create internal inefficiencies and subsequently increase the costs and risks for financial institutions wanting to compete effectively.

As a result, firms are increasingly realising the urgency in replacing legacy systems. Unfortunately, however, there can be significant business and project risk in seeking to replace in-house technology like-for-like, not to mention budgetary demands which can fall on deaf ears at board level.

And of course for those firms that do choose to outsource, the fear of being penalised for not demonstrating due diligence has led them to retain, if not employ additional senior staff, to closely oversee outsourced processes and ensure compliance with regulation. But, obviously, this only defeats the purpose of outsourcing and simply increases costs.

But as financial markets evolve, a third way is emerging for institutions looking at the next generation of their technology requirements known as ‘hotsourcing’. This is the term applied to outsourcing of modular technology, whereby firms can be selective, creating an optimised blend of the best of their own resources while using cost-effective operational processing. This means leveraging automation and the cloud while retaining senior oversight of operational processes in-house, which is essential in a regulated environment. Instead of doing away with legacy systems entirely, a phased approach can be taken where institutions can test outsourcing of different business processes to find the most effective mix.

The savings that can be achieved by adopting this approach are significant – firms can cut costs by up to a third of the total cost of ownership, while retaining knowledge and expertise. In fact, a study on wholesale and investment banking, published in March 2015 by Morgan Stanley and Oliver Wyman, an analyst consultancy, highlighted some of the outsourcing opportunities for banks leading to savings of between $3-5 billion. What’s more, upgrading systems to reduce manual processes and replace legacy hardware can help make firms more competitive, efficient and ease the compliance burden.

It is certainly clear that there has been a shift in thinking among financial services firms about how they choose to outsource. In the past, they tended to believe they needed to control all of their operational processes, from the moment a trade was executed to the point at which it was completed, in order to have a competitive advantage but this mindset is no longer realistic, or indeed sustainable. For an industry that is struggling to regain its footing and facing added costs to comply with new regulations, the time to ‘hotsource’ may never have been better.