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Data Management

01:50 PM
Ian Danic
Ian Danic

The Inefficient Back Office: A Checklist of Pain Points

Many firms consider their reconciliation process fully automated, but "automated" doesn't necessarily mean "efficient."

Have you considered the costs associated with an inefficient back office? Functions such as settlements, data management, reconciliation, performance measurement, fee management, corporate actions, and collateral management play a significant role in determining an investment management firm's profitability and credibility.

Consider the settlement process, where many firms do not "same-day" affirm their trades and leave themselves susceptible to failed trades. On occasion, a trader will execute duplicate trade orders that are difficult to spot, because they were placed at different times using different average price and net amounts. When the settlement date arrives, the custodian is likely to settle both trades, leaving both the investment manager and broker exposed to the change in market price and potentially an overdraft in the client's account. Someone will need to be compensated for the oversight. Having a fully automated, same-day affirmation process may have prevented the duplicate trade issue altogether. At the very least, it would have identified the duplicate trade prior to the settlement date, which would have reduced or eliminated the costs associated with resolving the matter.

[Read more on this topic: Survey Shows an Urgency to Automate the Back Office]

The costs associated with an inefficient back-office don't stop there. Once trades have been settled by the custodian, the back office is responsible for ensuring that its books and records align with those of the custodians from both cash and securities perspectives. Before reconciling any investment data, staff must retrieve cash, transaction, and position data from the custodians. This process can be very time consuming, given the number of custodian relationships an investment manager might have and the steps required to acquire data from each. Once the raw custodian data has been gathered, staff may be required to perform several data normalization routines in order to load the data into the reconciliation process.

After the custodian data has been collected and normalized, it is introduced to the reconciliation process, which could be an Excel spreadsheet, an accounting system add-on, or a commercial reconciliation solution. Many firms consider their reconciliation process fully automated, but "automated" doesn't necessarily mean "efficient."

Most reconciliation solutions, including Excel and even those commercial products considered best of breed, are inefficient in how they address the reconciliation process. For example, most solutions on the market promote a silo-based reconciliation approach, where positions, transactions, and cash are reconciled independently, rather than holistically, with all three reconciliation silos being intelligently integrated. What does "intelligent integration" mean for your team? It allows your fund accountants to look at a transaction break and see the impact on both the cash and the related security position in one view. It also allows the fund accountant to identify the root cause of an exception quickly without having to sift through multiple screens, applications, and external data sources such as custodian websites. This approach saves valuable time and reduces the firm's overall costs.

Another way to improve efficiency within the reconciliation process is by attacking exceptions at the security level, rather than the account level. This dramatically expedites the reconciliation process, because many position and transaction breaks resonate at the security level across all accounts that hold that particular security. Instead of having multiple fund accountants investigating the same issue (factor issue on fixed income, for example), firms should invest in solutions that allow the first responder to address the exception at a security level across all accounts simultaneously. This approach helps eliminate the costs associated with redundant investigation workflows frequently found in today's reconciliation solutions.

Collateral management is another back-office area where firms struggle with automation. Many firms manually collect valuation statements, which are reconciled in spreadsheets to identify the presence of a margin call. Investment firms cannot afford the risk associated with manually inputting and reconciling collateral information. The opportunity costs associated with missing or incorrectly satisfying a margin call due to a mistake within a manual process could be very high. In many cases, the cost of that mistake could have funded the purchase of an automated collateral management solution.

To this point, we've discussed how an inefficient back office can lead to increased operating costs that affect a firm's profitability, but what about the potential loss of business associated with an inefficient back office? The operational due diligence process has undergone significant changes in recent years, with the back office placed squarely in the crosshairs of investors. Prior to the Madoff scandal, 9/11, and Hurricane Sandy, the operational due diligence process was primarily focused on investment strategy and performance, with BCP, DR, and operational controls taking a back seat. To illustrate this point, consider the makeup of today's operational due diligence team. It has shifted from one made up of mostly investment professionals to one that includes back-office operations and data security experts, who are closely familiar with the trade lifecycle and where potential risk is lurking.

Investment firms that embrace technology will be rewarded through greater efficiency and institutional credibility. Firms that stick to manual processes and spreadsheets will struggle with asset growth, regulatory changes, and more rigorous operational due diligence scrutiny. Rather than fretting over the initial costs of implementing technology today, think about the ongoing costs associated with remaining in a manual environment. In many cases, having the proper back-office technology in place may be the difference between securing new investment dollars and watching them land at one of your competitors.

Ian Danic has nearly 30 years' experience in the global financial services industry, successfully launching, marketing and selling products and services-software, data, prime brokerage, securities lending and telecommunications. Ian is currently the Executive Director of ... View Full Bio
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