February 23, 2004
It is said that the only constant is change. The past year has illustrated this point in the financial services industry, having brought conditions and concerns to light that are dramatically changing how fund firms do business. Eliot Spitzer's exposure of illegal and questionable business practices and the SEC's and NASD's investigations into breakpoint issues have resulted in rapid changes throughout the mutual fund industry.
Direct impact of these investigations has been felt by those firms implicated in the scandals as they are forced to pay fines or cut fees as part of their case settlements. Even those firms not charged with any wrongdoing have felt increased scrutiny from shareholders and pressure to lower fees. They expect to see higher costs as liability and insurance rates rise. And they may for some time do business in an environment of investor attrition and lost shareholder confidence.
The biggest impact of the recent scrutiny and exposure will be increased industry regulation. Anticipating and complying with new regulations will continue to squeeze profit margins at fund firms as they scramble to meet a growing list of governance demands. From hiring and managing SEC-mandated compliance officers and staff to implementing new procedures and technologies for policing abuses, fund firms will face growing expenses and a heightened focus on operational costs.
This is a dynamic time in the mutual fund industry, and if it's true that change really is the only constant, then the uncertainty fund firms are feeling is here to stay. Once the issues of anti-money laundering compliance, breakpoint monitoring, market timing and late trading are settled, what's next? Once industry regulations go into effect, what happens if they are later modified or even thrown out by legislative or judicial review? What does this all imply for fund companies and their priorities?
The question ultimately becomes: How can companies leverage their investments to meet the dual objectives of staying abreast of, and accommodating new, regulations and other external changes - while continuing to innovate and differentiate themselves through their product and service offerings?
The Outsourcing Solution
Technology will certainly play a key role in addressing the changes coming fast down the pike. But the future of the financial services industry may have as much to do with business models, business process improvements and customer service as it has to do with new technological improvements.
In light of dramatic regulatory change, fund companies are struggling with whether it makes sense to divert resources from key operations to track and manage regulatory issues on their own. If fund firms step up IT efforts to institute redemption fees for short-term trades or to meet various terms of the USA Patriot Act, must they in essence take two steps backward on the new product development front? If companies build internal compliance staff to review and ensure regulatory compliance, must they pull resources from other staffing budgets? How will business processes evolve as regulations change?
The solution may lie in outsourcing.
People, Processes and Technology
Many firms have determined that it makes more sense to rely on their transfer agents or other service providers, who have the resources - not to mention the mandate from other clients - to provide technology, services (the human element) and processes to address regulatory and other logistical concerns.
Funds are demanding that their service providers demonstrate a long-standing commitment to investing in technology in order to help them adjust to ever-changing business and regulatory requirements. They expect a single, open-architecture platform that fully integrates with their existing systems.
Especially now, companies must rely on a service provider that can anticipate technology needs before they're required by regulation or consumer demand. For example, companies should demand that their service provider make account data available at not only the fund level, but at the customer and household levels. A system that provides household-level data can better track breakpoint opportunities for investors, and a system that provides customer legal/owner data is better equipped to identify individuals engaged in market-timing across different accounts.
But fund firms must also be able to rely on a provider that can offer the human expertise and business-level servicing they require to be flexible as their own needs evolve. From call center staffing to business consulting, providers' services should help firms focus on their core competencies and product development. Providers should understand firms' specific outcome measures and invest time to understand their objectives and cultures. They should be skilled at addressing costs associated with technology, staffing and regulatory issues.
Finally, workflow systems should be in place to manage changes in work volume and regulatory requirements. When service providers offer tools that allow business users - not just technology experts - to make changes to standardized business processes, those processes can easily adjust to changing business requirements.
The best way to manage change is to always be prepared. In especially dynamic times, the best way to be prepared may be to team with a provider whose very business it is to stay ahead of change.
Thomas A. McCullough is the Chief Operating Officer of DST Systems, Inc.
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