What is Middle Office (MO)?
First, let’s start with what Middle Office isn’t. You’ll read references online that it’s “the link between Front and Back Office”. First of all, that’s wrong. Secondly, even if it is true, that’s a useless explanation because it doesn’t say what functions reside in the Middle Office.
I think Middle Office (MO) is more like a control room centre of a logistics centre. MO isn’t a link in a chain; it’s an oversight and analytics function (checking and analysing a part of a chain). Let’s explore this analogy further:
| Logistics Centre | Middle Office |
| Robots are responsible for packaging and the control centre monitors. If anything doesn’t go according to plan, the staff is alerted and might need to go down to the floor to fix it. | Trade files, importing data from custody, reconciliation, etc, is all automated – until something unexpected happens. That’s when an investment operations analyst/manager is alerted (we call these exception-based workflows). |
| The logistics centre sees all orders and can inform what to keep in stock, how much, etc. | Performance attribution and risk reports. |
| The core of the logistics centre is to fulfil orders. | Trade confirmation and settlement instructions of orders. |
| Ensuring that the actual inventory matches the webshop. | Middle Office Reconciliation. |
| Managing anything that affects the inventory, e.g. keeping track of and handling goods that hit “best before date”. | Processing corporate actions and position lifecycle events. |
So, what is Middle Office? It’s the centre of the investment management workflows, where all data goes through and is controlled or calculated.
If your current Middle Office is doing the work rather than overseeing and analysing it – it’s likely a technology issue. If your investment management software doesn’t support exception-based workflows and automation, it’s like not having the robots in the logistics centre. First, you need to get the robots, only then can you change how the middle office function operates.
What are exception-based workflows? This animation shows it better than words:
Functions within the Investment Middle Office
The Middle Office function consists of 4 sub-functions:
1. Investment lifecycle management
The Investment lifecycle has 8 steps– the first 4 are performed in the Front Office, and the last 4 are part of the Middle office.
Middle Office get involved after trading is completed, to ensure that the fund administrator and custodian receive the correct information about the trades, in time for NAV and settlement. Before data is sent, trades are enriched with information such as fees and taxes – hopefully automatically.
2. Events not triggered by investment decisions
Additional events, not directly driven by active trading, can affect portfolios. These typically fall into two sub-categories:
- Events related to existing holdings, such as corporate actions (dividends, coupons, etc.), defaults, etc.
- Events related to cash, such as subscriptions/redemptions and management fees.
3. Data Control
The Middle Office is responsible for ensuring high data quality, supporting the Front Office decision-making, controlling NAV, and ensuring successful settlement and lifecycle event processing. Data quality is the intersection of accurate, timely and complete data.
- Accurate data. Instrument parameters, prices, etc. and reconciliation
- Timely data. Delivery of trades to custody, importing cash movements, etc
- Complete data. All data, incl. cash, are modelled internally for optimal investment decision-making.
An essential part of data control is Middle Office Reconciliation. By reconciling positions and cash against your custodian and fund administrator – you ensure that all parties have the same information. You might also consider reconciling transactions, corporate actions, NAV, and P&L. Read more about investment reconciliation and how to do it.
4. Performance Attribution & Risk Management
The 4th part is performing calculations and delivering reports on portfolios. Since the Middle Office function manages the portfolio data, it will maintain an Investment Book of Record (IBOR). The IBOR is all components of a portfolio (position and cash) at any point in time. The best IBORs can even maintain multiple versions of the IBOR, such as how the portfolio looks with all simulated orders vs what went into the NAV.
From the IBOR, it’s natural to calculate performance attribution and risk. Specific system, such as portfolio risk software, are fed information from the IBOR to do these calculations. Reports are generated and shared internally.
Automation of Middle Office Processes
There are 2 primary ways to decrease resource consumption from the Middle Office functions:
Reducing integration-related costs
Costs of integrations include manual work to check that data has been transferred or use Excel to reformat data. It also covers fees to vendors for integrations and internal development team costs (if applicable). We see across both small, mid and large investment managers that costs for integrations are very high. Here are some ways to reduce it:
- Holistic Investment Management Solution (IMS):
These systems provide a comprehensive solution by managing most functions (not just a middle office solution, but also covering Front Office) through a single platform. With one platform, there are fewer integration points. With fewer integrations, it’s just fewer data transfers to manage. - Built-in import/export engine:
Even if you have one holistic system, it needs to get data to and from custodians, fund administrators and brokers. The most efficient way (time and cost) is if the IMS has a built-in tool that allows you to configure data connectivity. With this setup, you’re not dependent on the vendor (waiting for their timeline and incurring a cost). You’re also not reliant on developers; you can create or change any integration in minutes. Watch a video of how Limina’s import/export engine works.
Exception-based workflows
The second way to achieve automation is by moving tasks from humans to machines. These types of functions are excellent targets for automation:
- Any task that exists as a calendar reminder
- Any task on a checklist with the description “check that …”
- Any task that involves using a spreadsheet
To confidently automate, you need to trust that system will always notify you or your team in case of issues. We call these exception-based workflows. The system performs the automation, and an exception is flagged if something unexpected happens. Resolving the issue is then the task of a team member. Book a call with an expert on how Limina might be able to aid your automation efforts.
Concrete examples of exception-based workflows in Limina:
- Getting data in and out (custody, admin, reporting, etc)
- Validating that instrument parameters are set (e.g. unique parameters we need to compliance or reporting)
- Warning on stale prices or large movements (you define what “large” is)
Middle Office Trends
- Middle Office Outsourcing
Some investment firms decide to narrow down internal functions and outsource what is not their “secret sauce”. - Experiments with AI
Adoption of Artificial Intelligence (AI) in daily investment workflows has been slow. AI isn’t a great fit for automation since it’s not precise. It does well in pattern recognition and generating text from data. At Limina, we’re therefore looking at use cases like:- Suggesting the likely cause of a fund reconciliation break based on past patterns
- From a recon break, drafting an email to external partners with the information in the break and asking them to help look into it.
