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Beyond the sea

Despite bad publicity and nascent regulatory scrutiny, banks and brokerages are moving back-office tasks overseas.

When Alan Jebson, group chief operating officer of U.K.-based HSBC Holdings, revealed in March that the bank was to create more jobs offshore, it would have been reasonable for him to expect sniping from U.K. trade unions, which have long opposed the practice. But HSBC had to take criticism from other banks as well. One, Nationwide Building Society, which competes with HSBC for U.K. retail customers, issued a press release quoting its CEO, Philip Williamson, as saying that Nationwide had no intention of opening overseas call centers. The release singled out the firm's rival by name: "We are surprised that HSBC has seen fit to export so many jobs overseas, when research suggests that customers are so overwhelmingly against such a move."

No wonder financial institutions are reticent about their offshoring plans. The practice is no less controversial than it was last year, when it featured in headlines during the U.S. presidential election.

HSBC is one of the few financial institutions that has publicly proclaimed its offshore strategy: It expects to have 25,000 employees in offshore operations within the next three years, compared with 13,000 currently. The bank's global transaction banking division, which handles payments, cash management and trade and securities services, has already offshored 806 jobs and plans to move a further 542 offshore by year-end, according to an April investor presentation by Iain Stewart, group general manager and head of global transaction banking at HSBC in London. The division employs about 9,000 people in total.

The financial services industry, particularly the global custody business, is a prime candidate for offshoring: Many of a bank's business procedures involve processing easily transmitted bits of electronic data that can be readily handled by educated workers in India, China and other locations. But any bank or brokerage looking to move securities processing or software-

development tasks offshore must balance the labor cost savings against the administrative overhead involved in setting up an outsourcing arrangement -- and deal with the nascent regulatory concerns.

Certainly, banks are actively embracing the practice. A June 2004 survey of 43 financial institutions in seven countries published by Deloitte Research, the research arm of consulting firm Deloitte Touche Tohmatsu, found that the number of financial firms with offshore operations increased by 38 percent in the previous year; the number of offshore jobs grew sixfold in that period. A February report drafted by a joint forum of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions and the International Association of Insurance Supervisors (BCBS-IOSCO-IAIS) estimated that by 2010 about $400 billion of financial services industry expenses -- 20 percent of the total industry cost base -- would be offshore.

"Most organizations are attracted to offshoring by costs -- they can save up to 40 percent on labor," says Gopi Chelliah, London- and Singapore-based executive vice president of business process outsourcing and sourcing development at securities industry consulting and services company Capco. "Once they have offshored they will find the quality of labor so good that they will continue with the strategy."

Although Deloitte's research found that 80 percent of financial services offshoring takes place in India, other countries are keen to get in on the action. The Philippines, Mexico and Eastern European countries, such as Bulgaria, Romania and Slovakia, have all set out their stalls, as have more-developed nations, including Australia, Canada, Ireland and Singapore. Says Capco's Chelliah, "Australia argues that it has a workforce of people who have traveled and worked in the U.S. and Europe, Canada is keen to attract talent to its vast spaces, and Ireland has developed its information technology capabilities and has been reinvigorated by the government's tax incentives." None of these countries can offer the mammoth workforce of India or China, however.

Skilled workers are essential to offshoring, and India has university graduates aplenty. "In both India and, more recently, China, the number of educated graduates coming through is phenomenal," says Chelliah. "And that is something that cannot be established in a couple of years. Graduates are the fuel that will sustain the sourcing model in these two countries." India ranks third, behind China and the U.S., in terms of the number of students enrolled in institutions of higher learning.

Among the global financial institutions that have taken advantage of Asia's educated labor pool are Boston-based State Street Corp., which set up a joint venture in China with Zhejiang University to develop advanced technologies for global investors and financial institutions; and Mellon Financial Corp., headquartered in Pittsburgh, which moved back-office tasks for its European fund services business to Pune in India, at the end of last year.

For institutions looking for a slightly less exotic outsourcing experience, Singapore offers what Chelliah calls a "transit lounge." There are also so-called nearshore centers. The nearshore model provides institutions in the world's main financial centers with close, low-cost alternatives. For example, in 1986, Chase Manhattan Bank opened a technology and operations center in the U.K. seaside resort of Bournemouth that handles global custody, treasury services and investment banking processing; there are now more than 4,300 people working out of that office.

As the offshoring trend has grown, it has caught the attention of financial regulators. In April the U.K. securities regulator, the Financial Services Authority, issued a report that concluded that offshoring "can contribute a material risk to the FSA objectives of market confidence, reduction of financial crime and consumer protection." The main risk, according to the FSA, is the difficulty of achieving suitable management oversight and control from a distance. Appropriate governance frameworks and risk management systems and controls might help to identify and mitigate operational risks from offshoring, the FSA report said.

In its February report the BCBS-IOSCO-IAIS group asserted that regulators should examine outsourcing by individual financial institutions when they are assessing those firms and should also be aware of the risk of overreliance by financial services institutions on a few third-party suppliers. "The rapid rate of IT innovation, along with an increasing reliance on external service providers, have the potential of leading to systemic problems unless appropriately constrained by a combination of market and regulatory influences," the report warns.

These concerns complicate the offshoring decision. "The focus on operational risk in the current regulatory environment has made it difficult to offshore," says Thomas Abraham, London-based chief of outsourcing at Citigroup Global Transaction Services EMEA. "Also, in some countries regulations are written to protect employment in local jurisdictions, so moving jobs offshore is difficult. This is particularly the case in parts of Europe."

Providing the oversight necessary to satisfy regulators will eat into the savings yielded by offshoring. Says Abraham, "There are a number of issues that must be addressed: the ready supply of a local labor force that has the minimum capabilities required; the administrative overhead in taking functions off-site and not having line-of-sight management; and regulatory constrictions." Although offshore labor costs may in some cases be one quarter of those in the home market, explains Abraham, an organization will never fully realize the savings, because these other factors will come into play.

But, concedes Abraham: "There are definite advantages in offshoring. Citigroup will always look at where functions are located and evaluate whether they are in the best location, based on factors such as the labor supply, whether the local infrastructure provides sufficient backup and disaster-recovery capabilities, time zones and language skills." If other bankers agree, India's army of college graduates should have no trouble finding jobs in the coming years.