A Classic Rivalry: Why Hedge Fund Front and Back Offices Must Make Amends and Automate
This weekend provided joy for England football fans as the Lionesses roared to win the Euro 2022 trophy, beating their greatest rival, Germany, 2-1.
The match-up mirrors a classic rivalry in the hedge fund industry. The front and back offices have long been at odds over automation, with the front office demanding faster and slicker processes and the back office at times lacking the manpower to ditch long-standing manual ways of working.
More often than not, enhancing outdated processes in the back office is shunted down the list of priorities for firms in favour of front-facing updates and innovations that clients can see outright.
But neglect the back office for too long and the cracks in the system will eventually start to surface, slowing down operations and ultimately impacting the efficiency with which firms are able to service their clients. And with the FCA’s new operational resilience guidelines now in play, hedge funds need to cut out avoidable scope for human errors and unnecessary vulnerabilities now or risk non-compliance.
Bother in the back office
At the heart of all back office simplification is the aim of reducing inefficiencies and giving busy teams time back to focus attention and efforts elsewhere, whether that be for client-facing work or investigating and troubleshooting problems within the system.
The nature of the industry means that back offices are often made up of as many as four or five different teams, all performing different roles with different applications that require separate manual processes to translate activity across to other teams.
Part of this complexity is driven by the multiple and frequent mergers and acquisitions that hedge funds have undergone as part of their growth strategies. In doing so, they have had to consolidate differing processes and change how they run the back office. Considering how time-stretched these teams often are, this has resulted in staff compounding processes to ensure they can still function. Not only is this an inefficient use of a team’s time but with every additional step taken, the complexity of the process increases, as does the risk of human error.
Many hedge funds struggle to update processes because they are stuck in a closed loop where adding a new manual step is often the easiest way to update a process. Where firms have been around for a number of years and through many regulatory iterations, new actions for back office staff are often tacked on to existing processes to ensure compliance rather than overhauling the system entirely, which in the short term would be a much larger project.
On top of this, many back office teams are already under strain from staff shortages and therefore simply lack the capacity to take on a simplification project of this kind whilst executing their day-to-day role.
So, while adding a new step to an already complex manual process is often the quickest route to outcome, this gradually drives efficiency down and puts the back office team under unnecessary strain.
Taking advantage of technology
It’s essential that hedge fund managers approach updating the back office as a long-term investment to future-proof business models, rather than a ‘nice to have’ project that can be kicked down the road for when budget and headcount allows.
Automation should be introduced to back office process now, before any manual processes have broken down to the point of mishandling a client’s money or asset. Again, now the FCA has formalised its emphasis on operational resilience through new regulations, the onus is on firms to ensure they can continue to provide the important services relied upon by their clients.
Digital transformation has accelerated over the last few years and the capability of regulatory technology is more advanced than ever. Using technology to automate certain manual processes will allow hedge funds to unlock the potential of the back office to service clients to a higher standard. In some cases, this can deliver immediate benefits to the client (through faster processing of dividends or enhancing protection of investments, for example).
For many hedge funds, the back office has operated the same way for years – even decades – without running into many barriers. But this should by no means prevent the implementation of necessary simplifications now. As the pace of digital transformation continues to increase, it will be those firms that introduce automation into their processes before it is mandated by regulators that manage to keep pace with – and stay ahead of – the rate of change across the wider industry.
New regulations require automation
Why should hedge fund managers be thinking about simplifying the back office now? Following the market disruption of repeated lockdowns in 2020, operational resilience has quickly risen to the top of the agenda across the financial services sector. And so, what was an already complex regulatory landscape, now requires firms to identify all potential operational vulnerabilities and report how they plan to address them. What’s more, for firms operating cross-border businesses, the divergence between the EU and UK’s regimes will require firms to align new processes with two different sets of rules.
The key to managing all of this is for firms to outsource more activity to third parties that can take full responsibility for back office simplification. For many firms, the complexity surrounding this process is often the biggest barrier to the simplification of the back office and by outsourcing the entire process, businesses can implement automation in a strategic and efficient way.
Implementing automation is fundamentally about making the most of back office employees’ time and skillsets. The time gained in the automation of manual processes can be spent on activity that more actively contributes to business growth or to the direct servicing of clients. And as rates of digital transformation continue to accelerate, the need for faster, slicker client service will simultaneously continue to rise. For hedge funds to remain competitive, automating now before it is necessitated – either by client need or regulatory demand – is crucial.
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Murray Campbell is CASS Business Consultant at AutoRek
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The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group
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