Offshore outsourcing poses serious risks for brokers

MASSACHUSETTS - A report issued in March by Massachusetts-based consulting firm TowerGroup - Offshore outsourcing onslaught to impact brokerage spending, staffing, and service landscape - examines how growing numbers of US securities firms are opting to outsource IT and administrative functions to overseas companies, especially in India.

But while these financial institutions stand to reap financial and strategic benefits by outsourcing non-core functions, an expected gradual shift of trade processing functions overseas could eventually expose them to op risks.

TowerGroup senior analyst Dushyant Shahrawat, author of the report, explains that until securities firms begin outsourcing more mission-critical operations, a significant number of them seem willing to take on risks associated with moving back-office and IT operations overseas, including the one that comes most readily to mind - political risk. "Most firms are pretty comfortable with the geopolitical risks that are in India right now," he says. "Also, they're not moving massive data centres right now - they're moving non mission-critical, back-office stuff. If there's ever a political risk involved, it's not going to stop the shop completely.

"The biggest risk right now is really the security threat of the data being sent over," Shahrawat continues. "That's the major threat. That's not to say it's a threat large enough to stop people from outsourcing, but that's the biggest threat. When you talk about operational risk issues, frankly that's not as much of an issue right now. It will not be an issue for the next year, year and a half, because people aren't really outsourcing a lot of operational issues." He points out that for now, IT functions, application maintenance, infrastucture management, and software development comprise most of the business financial firms are sending to India.

Shahrawat explains that most firms haven't yet begun outsourcing more trade processing functions for several reasons. Vendors in India and China haven't yet developed the expertise necessary to handle securities-specific issues. Also, regulatory issues such as licensing for trade processing and reconciliation still need to be resolved. Finally, and perhaps most importantly, the analyst points out that US financial firms are reluctant to outsource core operations: "While firms are getting more comfortable with the offshore idea, it's going to be a while before they get comfortable outsourcing a function that close to the chest."

According to Shahrawat, op risk will become a more prominent issue for financial institutions by 2005, as more of their business processing operations are outsourced. By then, he also expects the Securities Industry Association and other organisations to devise an approach to address the issue.Operational Risk