(Previously published in OUTSOURCE, 01/04/2018, Updated 3/25/2018)
By now everyone knows about outsourcing, the big issue of the 20th century that revolutionized the 21st century! But outsourcing didn’t start in the 20th century. In the 18th and 19th century Europe developed Imperialism, setting up colonies around the world. These colonies provided the language skills and education systems that made offshoring possible.
If you look at the map of outsourcing, it matches the map of European colonies from a century earlier. India was the first to lay claim to being a destination for knowledge work outsourcing. Hong Kong, however, has an even stronger case for being the 1st global financial outsourcing destination… even though that claim is slightly muddled by Hong Kong being the “property” of England up to the 20th century, and later becoming China’s financial powerhouse.
Such changes may be the fate of ex-colonies. Still, it is undeniable that the business acumen gained from a century of British colonialism in Hong Kong provided the foundation for mainland China building hundreds of cities specifically for outsourcing. Pakistan and Bangladesh, which rose as destination centers for textile outsourcing, were formerly part of India.
In 1980’s the United States focused textile outsourcing on South America, which has former Spanish and Portuguese colonies. These colonies had their laws, financial structures, culture, etc. shaped and adapted to European institutions.
After price, the most important factor selecting a location for outsourcing was Language. In manufacturing, offshore managers need at least a moderate grasp of your language (usually, English). Contact centers go further, requiring each worker to have at least rudimentary English skills. Financial outsourcing and knowledge work required both a solid understanding of colloquial English plus expertise with the unique terms used in Investment Banking, Research, Accounting, Trading, or Healthcare.
Before the US became the financial center of the world, the UK Invented the financial today’s world. Today’s world is divided between the UK running European trading and finance, and America dominating most of the rest of the world. In the early 20th century, the financial world spoke English, French, German and other Western languages, with English as the undisputed king of the financial world.
By the end of the century, China will be the worlds largest economy and the financial leader. Chinese will undoubtedly become the second language of finance. Someday. But not yet. What is surprising is that after the dominance of English and before the dominance of Chinese, the financial world will need to learn German.
German? Yep! Big changes (big, BIG changes) are about to rewrite the rules of Wall Street, even changing the languages we speak. The first change is the Brexit. If you haven’t been following this, back in June of 2016, the UK were unhappy about how the European Union worked. Many felt that they were paying into a system that did not give back enough jobs and benefits to be worthwhile.
One improbable event followed another, and somehow the UK voted to leave the EU. Every economist, financial expert, and pundit said it would be massively expensive and politically risky to leave the EU, but it didn’t matter. The UK had until March of 2019 to complete their exit. If they don’t complete the exit, in April they will not be able to trade goods, move money across a border, or even visit another EU nation. At least that’s the threat.
There were questions if it was feasible, but on December 7th, 2017 a key agreement was settled, and the Brexit moved forward and newer agreements have moved them past the point of no return, but banks and financial firms cannot wait to see the fine details for life after the Brexit. Instead, UK financial firms are moving their headquarters to the EU before regulations are finalized in 2019. This ensures continued work with the EU, regardless of the final agreement between the UK and the EU.
Where will the UK’s financial firms go? Predominantly… Frankfurt. That means new work rules, new regulations, massive retraining and… German? Between 75,000 and 300,000 professional jobs are expected to migrate from London to Frankfurt. Let’s get back to this a little later, first let’s look at the second big change, MiFID II.
On January 3rd, 2018 MiFID II, a set of European regulations to ensure transparency in stock trading, become the law for all of the EU and UK. Formerly, when you bought stocks you were charged a fee for the transaction and were given access to “free” research. For decades this “free” research allowed the trading firms to decide the sort of research customers would need. The result? Research is concentrated in a few big firms.
Companies like Apple have 50 analysts, while others are lucky to have 1. The top 15 Investment Banks produce 40,000 research reports every week, but surveys show that less than 1% are actually read. This “throwaway” research costs billions of dollars to produce and increases the cost of stock transactions.
Now, unless trades can continue to provide free research without billing for it, customers will have a stronger say over what research is produced in 2018, and possibly over what it costs.
We can be certain that a third, half or even more of the research positions in the UK and possibly the US will disappear. Add that to the already high (50%) reduction in researcher positions over the last decade. This is just the biggest and latest step in a long process. Of course, MiFID will have other results.
MiFID II is a European regulation, but it will be followed by many US firms. Otherwise, they must follow two separate and incompatible sets of regulations. Very large financial firms, with multi-million dollar research costs, are discussing the virtues of building their own research departments.
However, big market data services… Thompson, Bloomberg, Moody’s… have incentivized the consolidation of global research departments by offering a lower price per seat. With half or more of the “seats” going away, can firms stay in business?
Changes in long-established rules, a dramatic drop in research positions, a shift from London to Frankfurt, and… that little language problem. Some seasoned British financial professionals will become Expats, and move to Germany, but new financial professionals are likely to be hired in Europe. The language of the financial world is about to be diversified. But what about the jobs already offshored from the UK to India?
India has been hugely successful in offshoring> With English language work. Outside of English, success has been more limited. The British are very used to Indian English. Others find communication more challenging. Likewise, when faced with other European languages, or even accents (such as Scottish), communications slow and mistakes rise. Other languages have been piloted in India, but the results have rarely justified moving into production. Will India lose projects, or are there alternatives?
India could rely on its programming expertise, and integrate translation technology into offshore operations. AI translation could crack the language barrier. Unfortunately, while India creates a great deal of innovative technology, it is rarely patented by Indian firms. Instead, outsourcing clients usually own the technology. With the possible exception of IBM, outsourcers have not attempted to create an Indian translation software franchise.
Without Indian translation expertise, non-English work is not “anchored” to India. That makes it a prime target for China, for several reasons. First, China is investing in translation technology and is fanatical about patents. While China has not announced any specific plans for translation, they have announced plans to be the world leader in Artificial Intelligence. Translation is a sub-category of AI. Already a leader in search engines and robotics, China has plans to buy billions of dollars of robotics and AI firms. It would be a simple matter to scoop up a translation firm.
The UK relationship with Hong Kong is as deep as the connection between the UK and India, allowing for a significant extension of financial work offshore. Of course, Hong Kong is also a direct path through to outsourcing in mainland China.
While India has created world-class Universities (IIT and IIM), it has failed to reform the overall quality of education. Outside of technology schools, China is not (yet?) known for its top-tier Universities, it has significantly reformed elementary, secondary and undergraduate schools, as well as adding at least 10 million new English speaking workers.
The “change agenda” for 2018 is already overflowing. Dealing with MiFID, moving headquarters, dealing with new languages and regulations AND moving to new outsourcing providers is a lot to take on. In all likelihood, it is more than the Financial world can manage. By the second half of 2018, we can expect disruptions in the day to day operations, including outsourcing. Here are the five key areas to closely manage…
Client Contacts: Outsourcing firms spend years developing relationships with their clients. Client contacts are highly influential. Realistically, MiFID driven terminations will result in outsourcing programs without a known contact, especially in research programs! Big Investment Banks expect to lose half or more of their research staff. Even those that stay, may be reassigned. Expand your contacts before clients make staff changes.
Shifting Priorities: Outsourcing may still be a priority, but may other items will be added to their priority list. Expect more regular meetings to be moved or suspended. Ensure that all management reports are on time and you are ready to meet customers on short(er) notice. Continue to work as normal, but prepare for drastic changes in your program. In the past, a drop in staffing at your customer meant more work. There might be a temporary addition to outsourcing, but it is likely to be transitional rather than permanent.
Eliminated Positions: Research is ground zero for budget and staff reductions. Expect that many programs will shrink, merge, or be eliminated by the end of the year. Some of you may be thinking, “Your numbers MUST be wrong! The stock market is reaching new records. How could their budgets be down?”
Unfortunately, 40% of the trades made on the stock exchange are for indexed funds. Indexed funds are based on a market basket of stock, such as the NASDAQ. Since this is just a fund based on the stocks in an exchange, it requires no stock pickers, no funds managers, and no research. As much as 70% of market activity is expected to be generated by indexed funds by 2025.
As the market moves towards products that don’t use research, plus a dramatic reduction in the number of reports for the remaining funds that do use research, we can expect major reductions in these departments.
New Positions: While the overall direction will be towards smaller outsourcing programs, with less staff… there may be new opportunities. Big fund managers, like Vanguard, are considering building their own research departments.
This may not replace all lost positions, but it will open up new positions for new clients. However, as fewer research reports are produced, only the best-crafted reports will remain. This could lead to consolidation in outsourcing. To remain in research outsourcing, you must be the best there is!
Contract Renewals: The contracts you have today may no longer be a good fit by mid-2018. Be prepared for renegotiation well before the contract expiration. Be very careful about committing to anything you’re not absolutely sure you can perform. Like, learning new languages.
Well, the future has arrived and changes are already being implemented. 2018 is going to be immensely challenging, but it’s not the last challenge you will face. Next year could have even more challenges as the Brexit arrives!