Severine Melis-Cooper, Global Head of TLM Fees and Expense Management at SmartStream, explains how the system enables execution cost management strategies and savings realisation through accounting and invoice control.
Brokerage, Clearing and Exchange (BCE) fees are the largest, non-compensation expense for capital markets businesses. The total annual estimated spend in the BCE category across the major investment banks ranges from $12bn to $14bn. Yet, despite the size of the BCE expense category, many capital markets groups do not have the technology and processes in place to measure and optimise their BCE spend.
As a result of the gradual reduction in commission revenues and constraints in principal businesses, many investment banks are struggling with reduced profitability across asset classes. In response, over the past few years, investment banks have begun to focus intensively on managing expenses, driven both by diminishing transaction volumes and declining margins but also by a combination of regulatory constraints and higher capital requirements.
Achieving greater efficiency in this area is not without difficulty. In particular, processes and controls relating to the management of BCE costs are currently fragmented and manual. For those investment banks that have been able to reduce their BCE spend through manual analysis, the net impact has been limited and unsustainable. In order to achieve durable and sustainable savings across the entire BCE category, on an ongoing basis, as well as to realise material savings, a co-ordinated strategy is required – one which includes new processes, more automation and additional control.
There are significant challenges to be met by investment banks when trying to manage BCE expenses. Accounting control processes are fragmented and do not support the ability to post expenses in a consistent and transparent manner. As a result, the general ledger does not provide the required visibility in relation to BCE expenses across the service provider universe and business flows. The distribution of expenses is worked out using imprecise allocation methodologies and not calculated by means of equitable distribution based on usage.
Another hurdle faced by investment banks is that BCE agreements are often complex. Further, the agreements are subject to periodic change by exchanges, clearing houses and custodians. Lack of a centralised repository for these agreements makes it extremely difficult to estimate the cost of a transaction. Additionally, investment banks frequently do not have the correct internal data points or level of automation needed to accurately apply BCE agreements and to calculate fees.
The challenge faced by investment banks in relation to BCE agreements was underscored by SmartStream research, carried out with a group of 20 investment bank clients. A common theme amongst those interviewed was the complex methods brokers and exchanges utilised for calculating fees. The complicated way in which transaction fees were structured left banks without a clear idea of what they were actually being charged for, or even unsure as to whether they were being overcharged.
Leading investment banks have been partially successful at implementing process consolidation and creating efficiencies in relation to BCE expense management. This has been achieved through strategic outsourcing partnerships, supported by some level of automation in specific business areas. Investment banks, however, have not been able to build complete enterprise solutions due to the additional investment required to develop a full suite of capabilities. Another obstacle, which has prevented investment banks from realising BCE expense efficiencies is the lack of internal subject matter expertise.
Regulators have begun to scrutinise and penalise investment banks for their manual processes and lack of controls in relation to BCE expenses. Most recently, a large wealth management division of a major investment bank was fined $2.8m by FINRA. Regulators commented; “The bank lacked an adequate supervisory system to ensure that customers were billed in accordance with their contracts and disclosure documents.”
SmartStream provides well-controlled BCE services underpinned by automation. Our solution enables investment banks to manage BCE expenses strategically through data-driven decision making. TLM Fees and Expense Management is an end-to-end, automated platform that supports BCE expense management throughout its lifecycle – expense calculation and allocation, as well as accrual posting, invoice control and vendor payments.
TLM Fees and Expense Management provides a global repository of BCE expense and rate data that can be accessed by different business areas and existing financial systems. SmartStream’s technology enables BCE expenses to be allocated using complex and configurable models. Costs can be apportioned accurately to the relevant businesses, thus enabling a true assessment of business performance net of expenses. In addition, our solution enables investment banks to independently verify BCE expenses and to automate payment of third-party invoices. TLM Fees and Expense Management is deployed as a hosted on-premise service, or it can be delivered as a managed service.
TLM customers have experienced a variety of benefits. Importantly, they have been able to reduce their overall BCE expenses and ensure that all businesses are executing cost-effectively. Many customers have realised savings by identifying and recovering overbilling by service providers. In addition, the solution has enabled – and continues to support – cost-plus businesses. The solution is currently being utilised as an input to systematically measure client profitability and is also used to allocate rebates to specific businesses, on the basis of how cost-efficiently they execute. TLM’s data is harnessed by a number of firms to optimise their algorithmic trading strategies for cost-effectiveness. Finally, TLM Fees and Expense Management customers have been able to put in place improved controls in relation to accounting processes, providing transparency into BCE expense and allowing for balance sheet substation.