Wealth and Asset Management technology trends 2023 (part 1)
Wealth and Asset Management technology trends 2023
Financial technology keeps developing apace with no signs of slowdown on the horizon. It is dynamic, transformative and disruptive. The organizations who embrace it and go all-in hope for operational efficiencies, cost reduction, improved product and service offering, and smooth user journey – in other words, competitive advantage, profitability and longevity.
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Over the past couple of years, we have witnessed technological transformation on a mass scale in the Wealth and Asset Management (WAM) industry (something the EY Wealth and Asset Management technology consulting teams experienced first-hand, with client demand leading the teams to almost double in size in 2022 alone), and we believe this will continue to scale in the foreseeable future. At the same time, we need to be mindful of the many challenges and adversities that emerged over the past several months: the war in Ukraine, record inflation, skyrocketing energy costs and the cost-of-living crisis (aptly encapsulated by “permacrisis” becoming the Collins dictionary word of the year 2022). Between Q4 2021 and Q3 2022, the world’s 40 largest asset managers experienced, on aggregate, a 14.9% fall in assets under management (AUM), a revenue decline of 22.9%, versus a fall of 12-percentage-points in operating margins[1] . Continued, prudent investments in financial technology will be vital to enable investment firms to manage their costs and to offer competitive products and services in the new, harsher environment.
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Unsurprisingly, in a field as dynamic and disruptive as financial technology, we see a lot of novel, innovative ideas (e.g., tokenization) alongside emerging trends (e.g., artificial intelligence (AI)), as well as well-established “megatrends” (the cloud, ESG). Adoption of certain trends is discretionary (e.g., tokenization), while others are self-evident (the cloud, ESG). ESG is a megatrend we at EY feel exceptionally strongly about. Mankind is not going to reach net zero in the foreseeable future without financial services playing an active part in decarbonization efforts. The WAM industry stands to play a special role in this effort by linking financing decisions in the short-term to longer-term “patient capital” investments.
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We are cognizant of the fact that different WAM firms are on different stages of their technology-driven transformation journeys. In this article, we want to focus on the megatrends that are currently most urgent for clients we work with. The other crucial dimensions of ongoing transformations are culture and talent as well as future trends (such as AI, tokenization or the rise of alternative investments) which will be covered in respective forthcoming articles.
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1.?????ESG analytics
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ESG is the only area where social, political, ethical, regulatory and business issues converge, and at an exceptional scale. Regardless of certain unique geographical, regulatory and firm-specific considerations, the overall conclusion is unambiguous: doing nothing is no longer an option.
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There are a number of broad reasons for implementing leading-edge ESG data and analytics on top of having a detailed ESG roadmap and strategy in the first place:
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-???????Regulation
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Regulatory pressure is a relatively new consideration. The EU’s Sustainable Finance Disclosure Regulation (SFDR) is a game-changer for the European market, as it mandates asset managers and investment funds to include sustainability disclosures for all their funds.
Companies covered by SFDR face a raft of new disclosure obligations: pre-contractual (annex 2 and annex 3) and periodic (annex 4 and annex 5). Despite the very detailed ESG taxonomy[2] created by the EU which underpins SFDR, classifying holdings (particularly collective investments, i.e., funds, which may include positions with vastly different ESG characteristics) remains hugely challenging and far from unambiguous. The challenges include the very definition or interpretation of sustainability (this can be seen in ESG ratings that are different for companies depending on which provider is used and what the underlying methodology is), different methodologies used for sourcing data, approaches to handling missing data points, etc.
In recent months we have seen instances whereby funds labeled Article 8 under SFDR (“Where a financial product promotes, among other characteristics, environmental or social characteristics”) had their ESG credentials either disputed by third parties or had their Article 8 credentials removed (downgraded) by the investment management firm itself.
While SFDR is the leading and arguably the most influential ESG regime worldwide, it is far from being the only one. Multiple jurisdictions, including Australia, Canada, China Mainland, Hong Kong, United Kingdom, and the United States, are either formulating new regulations or using existing laws to enable, promote, or enforce ESG investment practices.
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-???????Greenwashing
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Greenwashing has recently become a high-profile issue in investment management. 2022 saw greenwashing evolve from a reputational concern to a regulatory[3] ,[4] or even legal one (“prospectus fraud”) – a trend we expect to continue. In 2022, we saw some asset managers reclassify (“downgrade”) some of their ESG funds, which may be seen as a pre-emptive measure against potential greenwashing accusations.
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-???????Senior managers’ accountability
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There is a growing recognition of the link between ESG disclosures and senior managers’ accountability. The way no WAM firm can afford to be seen as greenwashing or otherwise bending ESG regulations, same will be the case for senior executives with vested interests in their careers.
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All these pressures make a strong case for leading-edge ESG analytics. ESG data (generated in-house, vended from a specialist third party or a mix of both) is the starting point for everything – for fulfilling the ESG regulatory requirements, for tracking ESG strategy and performance, etc. Recent EY research found 67% of firms classified data as the first or second challenge in building their sustainable investment frameworks[5] .
In our experience, many WAM firms opt for a hybrid solution: the WAM firm develops the ESG strategy and framework while a third party vendor provides data and analytics. However, certain (particularly larger) investment managers also develop their own in-house ESG data and analytics, which are then complemented by a vended solution.
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2.?????Cloud providers will be increasingly regulated as critical third parties (CTP)
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As WAM firms have been increasingly adopting a “cloud first” strategy, the systemic importance of cloud services providers (CSPs) has been growing in the industry, as many WAM firms started relying on a handful of leading cloud vendors. This concentration has concerned regulators over potential market stability implications[6] .
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It is our view that financial regulators worldwide will take CSPs into regulatory purview. This is likely to cover three key areas:
-?????????????Continued scrutiny of cloud providers as part of outsourcing;
-?????????????Use of cloud providers as part of financial institutions’ operational resilience in the post-pandemic world;
-?????????????AI solutions in finance are almost always cloud-based.
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The regulatory course has already started shifting as regulators recognize the growing importance of cloud providers to the broader financial infrastructure. The EU’s recently passed Digital Operational Resilience Act (DORA) includes an oversight framework for critical third party providers, while the UK’s proposed Financial Services and Markets Bill (FSM Bill) formally introduces a designation of a critical third party (CTP) and sets out a proposed statutory framework for[7] managing systemic risks caused by CTPs, following a policy statement by HM Treasury[8] .
It is worth mentioning that while DORA and FSM are new, and their provisions regarding CTPs enhance the governance frameworks, these frameworks are not entirely new. Both the EU and the UK have existing, comprehensive cloud regulations (EU: binding EBA guidelines; UK: non-binding FCA guidelines), which new regulations are meant to complement. In addition, multiple jurisdictions worldwide have their own cloud regulations.
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This increasing regulatory focus will have implications for the WAM industry, as WAM firms will need to strengthen compliance oversight over cloud outsourcing. Those firms that have not yet established a firm link between their compliance and cloud functions need to do it as soon as possible or risk experiencing a regulatory breach. It is our recommendation that even in the jurisdictions where cloud regulations remain non-binding soft laws, they should be treated as hard laws as we expect the regulators to pay close attention to cloud outsourcing in the foreseeable future.
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3.?????Everything begins with data
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For many years, the approach to data management and governance in the WAM industry has been relatively laissez-faire: more data points, more data attributes, more data vendors, more data terminals, more data storage (essentially “the more the better”). Technology has been outgrowing this approach for years, with data management becoming increasingly challenging, fragmented and not scalable. Trusted data layer (TDL) – high quality, silo-free data accessible enterprise-wide, supported by agile (most likely cloud) architecture and modern target operating model(s) – remains many WAM firms’ ultimate end-goal.
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Comprehensive, C-suite-driven data strategy is fundamental to the long-term success of WAM firms, and underpins multiple other developments, such as ESG analytics (something we expanded on in the ESG section above), AI solutions, or AML and KYC. It is driven by regulatory pressure on one side (GDPR and similar regulations worldwide, as well as widely accepted best practice of data minimization) and ongoing migration of WAM firms’ data into the cloud which itself is driven by scalability, cost, and operational efficiencies (the ability to retire in-house hardware in favor of leading-edge storage solutions from cloud services providers; substituting CAPEX with smoother OPEX) on the other.
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Key developments we expect to see (or are already seeing) include:
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-???????Data rationalization whereby WAM firms can appraise overlaps and duplications among their data sources, explore consolidation options, and eliminate data feeds they no longer need (e.g., unused constituent-level indices). We believe that same treatment should be given to data generated in-house (particularly personal data GDPR might be applicable to). We think that this review exercise should also be used to identify any new data needs, particularly along the lines of ESG, private markets, and alternative data.
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-???????New concepts and models in data governance. We note growing interest in novel approaches such as data fabric (managing multiple data sources from a central system) or data mesh (interconnected mesh of decentralized, domain-specific data microservices). On the services side, we note growing interest in managed data services or data as a service (DaaS; a blend of infrastructure-as-a-service, platform-as-a-service, software-as-a-service, and business processing outsourcing where the asset service provider is responsible for performing and providing data management services on behalf of the client) as well as increasing automation and augmentation of data governance.
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-????????????Data governance. While data governance can be inferred from existing regulatory principles (e.g., Principle 3 – management and control – of the FCA Handbook, which reads “A firm must take reasonable care to organize and control its affairs responsibly and effectively, with adequate risk management systems”) we expect that data governance (and possibly related ethical considerations) to become an ever-growing focus area for the regulators, potentially in lockstep with AI oversight. Furthermore, it is reasonable to expect that regulators’ data collection demands from WAM firms increase substantially in the coming years (something the UK regulators are indirectly hinting at through their data collection transformation program[9] ). Moreover, we are seeing interesting policy developments on the part of the EU with the Data Governance Act (DGA) whose aim is to start building an EU-wide data economy and a single market for safe and regulated data sharing. While the DGA only applies to public sector data, it can be seen as sending a more universal message as regards the EU’s views on data sharing and ecosystem-wide collaborations.
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Comprehensive data architecture redesign and new strategy may be a huge undertaking, reviewing and “untangling” data infrastructures dating back literally decades. It is essential that this complex journey is well planned and executed, with oversight from C-level executives and subject matter expertise from specialist talent.
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4.?????Distribution
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Recent years have popularized online investment platforms. Multiple established, brand-name investment managers have launched “investment supermarket” type platforms, on which they offer a wide selection of funds, both their own brand and others. Such platforms have been the first major technology-led innovation in the distribution space since the days of personal advisors. They have arguably lowered the barriers to entry for self-directed personal investing, as well as its costs. Today, the WAM industry is facing new questions and challenges around distribution models:
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-???????Web-based platforms may have lesser appeal to the younger, mobile-first generations compared to sleek mobile apps offered by FinTech robo-advisors.
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-???????The supermarket model does have its disadvantages, as the wide selection of funds may cause an unintended “paradox of choice”. Popular robo-advisor apps tend to have a much narrower selection of funds and a wizard-led selection process, whereby the largest web-based platforms tend to have just long lists of available funds. Wizards can be of huge help to less-experienced investors, but may potentially come with MIFID II suitability considerations.
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-???????There is a question as to whether the very concept of individual fund(s) offering needs to be rethought in favor of bespoke, investor profile- and preferences-led “pre-packaged” portfolios consisting of a number of funds (effectively bespoke fund-of-funds), whose objectives and weights reflect the unique preferences and circumstances of the investor. While having this option would likely be beneficial to the investors, who wouldn’t have to assemble their portfolios themselves, it might require substantial operational work in the background for the investment manager to enable. Interestingly, it would also blur the line between distribution and investment process proper.
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Separately, there is also an ESG consideration to be taken into account. Currently, investment funds are unconstrained as regards their use of ESG references in fund names, irrespective of their actual investment objectives (there are some regulatory proposals to change that). WAM firms should be very disciplined in aligning the nomenclature with the actual investment objectives or risk greenwashing accusations.
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5.?????End of life for hosted platforms
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With highly customized, legacy technology platforms reaching end of life, the limitations of old technologies are stalling Wealth and Asset Managers’ ability to scale and innovate. The industry remains largely wedded to in-house-hosted platforms despite knowing that they are costly and cumbersome to maintain, difficult to integrate into the technology ecosystem, and every day edging ever closer to obsolescence. The next step has been known for years: cloud platforms within a broader “cloud first” strategy. The asset management industry has been on that path en masse for some years now, while in our view wealth has been slower to embark on a cloud transformation. The entire financial technology ecosystem is geared towards the cloud, which gives Wealth and Asset Managers a multitude of options when it comes to vendor, system and tool selection, as well as service models.
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The longer Wealth Managers maintain the status quo, the harder it gets to evolve – until that evolution becomes inevitable and likely more rushed and disruptive than ideal.
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[2] https://Finance.ec.europa.eu/sustainable-finance/tools-and-standards/eu-taxonomy-sustainable-activities_en
[7] On 21-Jul-2022 the FCA, PRA, and the Bank of England jointly released a discussion paper (DP 22/3) which builds on the FSM Bill and focuses on defining and testing of the CTPs’ operational resilience as well as regulators’ proposed statutory powers (https://bankofengland.co.uk/prudential-regulation/publication/2022/july/operational-resilience-critical-third-parties-uk-financial-sector ).
[8] HM Treasury “Critical third-parties to the finance sector: policy statement”.
[9] Bank of England joint transformation program update Oct-2022.