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 be a destination for knowledge work outsourcing. Hong Kong, however, has an even stronger case for being the first global financial outsourcing destination. That claim, however, is somewhat muddled by Hong Kong being the “property” of England up to the 20th century, and the later transferring into China's financial powerhouse.
Such changes may be the fate of many ex-colonies, but it is undeniable that it was the business acumen of a century of British colonialism in Hong Kong that allowed mainland China to build hundreds of cities specifically for outsourcing in the last two decades. Pakistan and Bangladesh, which have risen as destination centers for textile outsourcing, were part of India until the mid-20th century.
In the 1980s, the United States outsourced textile work to South America, to former Spanish colonies, shaped by their colonial experience. Laws, financial structures, culture, etc. were all adapted to work with European institutions.
Aside from price, the single most important factor in selecting an outsourcing location was language. For a manufacturing project to be successful, offshore managers and contact center employees must at least have a moderately good grasp of your language (usually, English), and each factory worker also needs rudimentary English skills. For financial analysts or other knowledge workers, both a solid understanding of colloquial English plus expertise with the unique terms used in investment banking, research, accounting, trading and healthcare.
Even before the US became the financial center of the world, the UK essentially invented the financial world. Today that world is divided with the UK running European trading and finance, and the US dominating the rest of the world. In the early part of the 20th century, the financial world spoke English, French, German and other languages, but English was the undisputed king.
By the end of this century, China is expected to be the biggest economy in the world…and the world’s financial leader. Chinese will undoubtedly become a world language and the language of finance someday…but not yet. What is surprising is that even though the US dominates the financial world today and China is expected to be the biggest economy in the future, the financial world will need to learn…German.
German? Yep! A couple of changes, big changes (make that big, BIG changes) will soon take place that will rewrite the rules of Wall Street and even change the languages we speak. The first change is Brexit. If you haven’t been following this, back in June of 2016, a lot of people in the UK were unhappy about how the European Union worked. They felt that they were paying into the system, and not getting back enough jobs and benefits to be worthwhile. One improbable event followed another and somehow the UK decided to have a vote on whether they would leave the EU. Despite the fact that every economist, financial leader and pundit said that it would be massively expensive and costly to leave the EU, the vote was cast to leave. The UK has until March of 2019 to complete the exit from the EU. If they don’t finish by then, on the next day they will not be able to trade goods or move money across the border to any EU member. It’s a very big deal.
There were questions if it could be done, but on December 7, 2017 a key agreement was settled and Brexit is moving forward. Many banks and financial firms, however, cannot wait to see which rules will be written for life after Brexit. UK firms are moving their headquarters to Europe before the final rules are written for 2019. This ensures that they will be able to continue to work with the EU, regardless of the final agreement between the UK and the EU.
Where will the UK's financial firms go? Predominantly to Frankfurt. That means new work rules, new regulations, massive retraining and…learning 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 the EU and UK. MiFID covers a vast number of issues, but the one that everyone is focused on is transaction fees.
Today, when you buy stocks you are charged a fee that pays the cost the transaction, the cost of “free” research customers receive and other costs. You may be thinking, “So?” But this is big…HUGE!
For decades stock trading firms have decided what sort of research customers want and how much should be provided. The result is that companies like Apple have 50 analysts writing research, while others are lucky to have one. 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 every year!
Money wasted on reports that no one reads, drives up fees. It is inevitable that customers will spend much of 2018 battling over what research will be produced in 2018, and how much will be charged. We can, however, be certain that a third, half or even more of the research positions in the UK and possibly the US will disappear next year. Keep in mind that today, a full half of the researcher positions from a decade ago have been eliminated. The not so slow grinding away of research positions is nothing new…2018 is just the biggest and latest step in a long process.
MiFID II will have other results as well. While it is a European regulation, it will be followed by many US firms, to avoid dealing with two separate and incompatible sets of regulations. Very large financial firms, that could be charged $5-10 million (or more) for research in 2018 are discussing the virtues of building their own research departments. Big market data services, e.g., Thompson, Bloomberg and Moody’s, have pushed for consolidation of global research departments in return for lower per seat pricing. With half or more of the “seats” going away, will these firms stay in business?
Changes to 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 ex-pats, and move to Germany. But most up and coming financial professionals will be hired in Germany or in surrounding locations. For the first time in a century, the language of the financial world is about to become diversified. What will happen to jobs that the UK moved offshore, primarily to India?
India has been very successful in offshoring, but when it comes to non-English work, it is a different story. Even with English language work, outsourcing client firms may quickly learn to work with Indian English, but customers of that onshore firm (that don't deal with India every day) find these accents challenging to understand. Other languages have been tried in India, but the results have not been good. Are there other options?
One option for India is to rely on its expertise in programming. Translation technology has greatly improved. Matching offshore abilities with AI-based translation could finally crack the language barrier. Unfortunately, while India creates a lot of technology that is eventually patented, India itself rarely owns the technology. Instead, outsourcing clients own the IP. Large outsourcers, except for IBM, have not yet identified this gap or attempted to develop their expertise in translation software.
With no specific expertise in translation in India, there is little to “anchor” work to India. The next logical location is China for several reasons. First, China is fanatical about patenting technology. While China has not announced any specific plans for translation, they have announced plans to be the world leader in Artificial Intelligence (translation being a sub-category of AI). China is already a leader in search engines and robotics, and has plans to buy billions of dollars of robotics and AI firms. It would be a simple matter for China to scoop up a translation firm.
There is also the UK relationship with Hong Kong, which is as deep as that between the UK and India. And of course, from Hong Kong there is a direct path to outsourcing in mainland China, which has been able to transform its educational system and teach millions of Chinese to speak solid English.
What’s next? 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? That’s a lot to take on. More, perhaps, than the financial world can manage. These changes will disrupt day to day operations, including outsourcing. With that in mind, here are five key areas that outsourcing firms should closely manage...
Client Contacts: Outsourcing firms spend years developing relationships with their clients. That client contact is incredibly influential in the operation of your program. Realistically, most of these relationships in financial firms are likely to be broken before the end of the year…especially in research programs!
If a program is about to lose half of its staff, the manager, even if he is not a researcher, is very likely to be terminated, moved to a new role or required to take on the responsibilities of
terminated colleagues (leaving less time for outsourcing). Before your contact is lost or unavailable, you need to expand your contacts.
Shifting Priorities: Outsourcing will remain a priority, but your clients are going to dramatically expand their list of priorities. Don't be too concerned if your regular meetings are moved or suspended. Make sure that you produce all management reports on time and are available to meet.
However, while you must continue to work as normal in very unusual times, you must also prepare for changes in your program in the coming months. In the past, a drop in staffing at the client did not always match a drop in staffing for the outsourcer. Work was often transferred from onshore to offshore. Now, however, many of the staff lost at the client are due to the elimination of a type of work, which will negatively impact offshoring.
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 will still be new opportunities. Some the big fund managers, like Vanguard have said that they will create new research departments, others have teased that they might.
While this may not fully compensate for all lost positions, it does open up new positions in new client firms. However, please remember that just as fewer research reports will be produced in 2018, leaving just the best reports, it is possible that the drop in work will lead to a consolidation of outsourcers in 2018. If you want to stay in this market, make sure that you are the best that there is!
Contract Renewals: Given these changes, the contracts you have in place today are not likely to still be a good fit by mid-2018. Be prepared to renegotiate these contracts well before their normal expiration…and be careful about committing to things you're not sure that you can do…like, learning new languages.
Well, the future is already here, and all the changes we're discussing are already being implemented. 2018 is going to be immensely challenging, but not the last challenging year we're going to face. Next year we can talk about what 2019 will be like!