The investment required to comply with the new SEC Modernization and DOL Fiduciary Rules, the Form ADV Part 1 Amendments, and to continue to maintain a robust Cyber-Security program will be substantial. It will be especially challenging for small and mid-sized advisers with under $10 billion in assets under management.
By Ultimus Fund Solutions
In the August 2016 (Issue 6), the Fund Operations trade publication addressed the need for making investments in the middle-office to better support the adviser’s primary mission of attracting and retaining clients through their investment performance and superior client service. A study cited in that issue identified the top focus of advisers in 2017 to be regulatory compliance and data governance.
A brief review of how small and mid-sized advisers have established their middle office operations will help to frame the challenges which many advisers are struggling with today. Historically, small and mid-sized advisers who only offer mutual funds typically outsource their middle and back office to the fund’s custodian bank or an independent fund administrator. As such, the adviser relies on the custodian/administrator to provide their mission critical data required by their front office investment decision support systems (including risk and performance) as well as order management and trading systems.
In contrast, advisers that offer separately managed accounts (SMAs) to institutions and/or high net worth investors have typically established their own middle office operations as their custodian bank’s infrastructure did not fully support all the requirements of SMA programs. These in-house operations, many of which were created 10+ years ago, are still in place today using legacy technologies and processes that are simply not keeping up with the current demands placed on advisers. For example, many of the investment accounting systems in use are over 15 years old with limited multi-currency capabilities and do not support the wide range of asset classes required by today’s complex investment strategies. But perhaps the most significant deficiency in many of the in-house operations is the lack of a data management system.
While many of the large advisers have adopted robust data governance programs requiring significant investment in data warehouses, small and mid-sized advisers continue to rely on their legacy accounting system as their de-facto data warehouse. This will make it very challenging for these small and mid-sized advisers to comply with the pending regulatory changes as so many of these regulations are heavily dependent on rich investment and time series data.
With that background, how should small and mid-sized advisers think about upgrading their middle office operations? Should they make new investment in technology, invest in new talent, streamline their daily operations and workflows, or outsource everything or only certain components of their operations? “These are some of the questions that we asked our clients at the Ultimus Fund Solutions client summit held this past September in Cincinnati,” said Mike Ciotola, Director of Middle Office Services at Ultimus. “Our middle office services team moderated a lively round table discussion with more than 20 of our clients and we all came away with four key insights regarding the future of their middle office operations.”
Insight #1 – many investment advisers are looking to upgrade their technology landscape with a particular emphasis on their investment accounting platforms. There has been consolidation of many of the lower cost investment accounting systems and the concern is that the R&D for these aging systems will be cut. With that in mind, many advisers are looking at a few start-up fintech companies to replace legacy systems. The other technology components being reviewed by investment advisers include trade/order management, performance, client reporting (including web/mobile solutions), billing and CRM systems.
Insight #2 – many investment advisers agree that a strong data governance program supported by an investment data repository/data warehouse is going to be essential in order to comply with the aforementioned regulations that go into effect over the next 18 months.
Insight #3 – the SEC is heavily focused on adviser’s cyber security programs and one adviser said, “Maintaining a robust cyber security program is uncharted waters for us and with limited guidance from the regulators and small budgets it is an ongoing concern for our firm.”
Insight #4 – outsourcing some or all of the middle office business functions is looking more attractive than ever before with a few service providers offering a full complement of middle office services to small and mid-sized advisers with an affordable fee schedule. One adviser remarked, “If we outsource our investment accounting and reconciliation process, we can avoid a costly and risky investment accounting system conversion while moving from a fixed to variable cost operating model and transferring some of the cyber security concerns to our outsourcing partner.”
Over the past decade, there has been a certain level of complacency with middle office operations and the technologies deployed by small and mid-sized advisers. This new wave of regulations has fueled fintech companies to offer new technology solutions and for outsourcing providers to build, scale, and price their solutions to appeal to small and mid-sized advisers. The old adage, “if it ain’t broke, don’t fix it” has been the prevailing attitude but that is clearly changing as advisers seek to comply with the new regulations and to grow their firms over the next decade.
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