01 March 2008 Features

 

Green light for IT Spend

Alison Ebbage

Future-proofing your business means investing in IT today. But are banks thinking along those lines in these troubled times?

In previous times economic gloom would mean automatic IT budget slashing in financial services institutions. But today’s firms have one eye on the future and are more willing to invest now to make medium-term cost efficiencies.

Indeed, technology and the need to keep right up-to-date is accepted as crucial, rather than merely desirable. Firms unable to offer their clients efficient and effective services would almost certainly see them vote with their feet.

In that context, it’s no surprise to see that although IT spending is generally forecast to increase this year, wider economic conditions mean that it will not be up by much and will also be in line with the aim of achieving future cost efficiencies rather than investing in more ambitious changes that can wait.

“A year ago, when banking was seeing rapid growth, there was a lot of spending on new systems and product streams. Attention was also focused on back office efficiency and the ability to process more trades and transactions,” says Chris Potter, partner at PricewaterhouseCoopers. “Recent reports by bodies such as the CBI do show that IT spending will increase slightly this year, but you need only to drill down slightly to see that spending levels are linked to broader economic conditions.”

The key factor seems to be finding the balance: making efficiencies without making huge capital investments in terms of money or people. Clearly, achieving that in absolute terms would be nigh on impossible, but strategic decision making for the medium-term does look to have replaced outright cost-cutting.

Axel Perrion, senior analyst at Celent, says: “Spend obviously depends on priorities. In the wholesale arena, for example, there is a great deal of momentum to generate scale and centralisation. This is seen as important as it increases global reach but lowers operating costs by creating efficiencies of scale.”

He adds that in the securities industry high value areas such as derivatives are now taking precedence. “The past few years have been characterised by the burden of regulation but that seems to be over now, and thus funds, having been released from that area, can now be spent on added value activities as well as clawed back from budgets.”

Other strategic issues for the industry include the implementation of straight through processing, electronic execution and cross border investment strategies – all of which contribute to saving money in the medium-term. A report by Celent in January this year forecast that up to 70% of IT spend in the securities industry would be directed towards projects such as these.

But the report also cautioned that although, in general, the buy-side would be looking to make efficiencies in service-related functions and the sell-side in automation, that maintenance of existing systems would still eat a huge proportion of the budget.

Mats Berggren, sales director at Advent Software, a portfolio management software firm mainly for the wealth management and hedge fund industry, says: “Firms are undoubtedly considering how, in the long-term, advanced technology and software systems can do a better job than people, thus decreasing headcount. This sort of drive to operational efficiency does not stop and, if anything, increases when times are hard. People tend to look at downturns as an inevitable part of the cycle.”

But not all areas have been hard hit. The Celent report also looked at high margin business lines, such as wealth management and prime brokerage. Here it seems that wider economic gloom has yet to hit home and that far from discretionary spend being reduced, these industries are making significant investments and changes to accommodate structural change and growth.

“I estimate that the client base with excess of £3 million to invest will grow in the UK by some 250 to 300% in the next 10 years,” says David Thorpe, director at SEI Global Private Banking, which offers a front to back office proposition. “So in the first instance wealth managers need to plan for increased capacity. Then they need to offer top-notch systems to support their relationship managers as well as the platforms to assist in asset allocation and best execution, in addition to back office functions.”

Thorpe says that this dramatic growth in the wealth management industry makes its situation fundamentally different from the last bear market in 2000. Then there was much talk of belt tightening and people did have to make decisions regarding profitability over strategic investment in the future. The reason for this is that private banks were still largely operating on asset based pricing so when markets went down so too did their revenues. That has now changed. But in its place clients are more demanding, investments are more complex and regulations more onerous.

“Although many wealth managers are still operating on legacy systems, they know that strategic decisions now need making,” says Thorpe. “In the front office there are more clients than relationship managers and all are demanding enhanced service levels and better reporting. In the back office integration and STP is needed to make the investment decision – making the process and its operation seamless. In addition the burden of regulation means that wealth managers need to factor out the cost of compliance and outsourcing thus makes sense as it makes it no longer their problem.”

Berggren says: “Wealth managers now have to cope with far more esoteric portfolios, and so need to be able to access information and statistics on an almost real time basis to ensure optimum portfolio performance and to make sure that client reporting is as accurate and up to date as possible. This means that firms are taking a strategic decision at board level in upgrade and invest in new systems rather than manage in a legacy fashion.”

Against this outsourcing clearly makes sense as institutions look to control costs. Banks seem aware that non-core activities are best placed in the hands of experts – and the added bonus with outsourcing is that it becomes a variable not a fixed cost thus giving a degree of flexibility.

Celent’s Perrion thinks that third-party service providers could even make significant gains if economic gloom sets in beyond the next six months. “Although you would not see a large financial institution withdraw from an activity just on the basis that the IT cost would be too high, you might see the IT outsourced in order to maintain the bank’s focus on its core offering. The overall belief is still that by spending money to create efficiencies you can save money on overall operating costs,” he says.

But clearly banks with tight budgets will also be looking to get the very best service for the lowest price possible and here caution is advised to ensure that outsourcing provides a win-win solution for both client and services provider; squeezing service provision too much could eventually cost clients dearly if the service provider is then theoretically unable to keep up to date and add value in other ways.

So what would happen if things were not to improve, or even get worse? Would financial institutions be forced to cut right down on discretionary spend? Outsource absolutely everything seen as non-core or even abandon long-term strategic projects that are not considered to be absolutely essential?

PwC’s Potter thinks that such a scenario would not happen until this time next year at the earliest: “It would take poor economic conditions this time next year to force a real rethink on IT spending. Then the real focus would be on keeping the day-to-day operations of the business running not investing in new efficiencies or other ‘nice to have’ initiatives, such as making internet banking more secure.”

He says that current cutbacks, such as not replacing old PCs for example, are annoying but not business critical. “It’s a deferment of discretionary spend and a clampdown on longer term projects. This is entirely normal and has happened on both of the two previous downturns in 1994 and 2001.”