Strengthening the middle office

THE middle child syndrome is a psychological condition among children born in the middle who feel left out. The first-born received privileges and the youngest received indulgence. The middle child is burdened with a feeling of exclusion and this results in misbehavior in order to catch the parent’s attention.
A similar situation occurs in many firms. While the front office is equipped with latest and greatest technologies to keep them generating income, the back office receives regular tune-ups to ensure operations is running smoothly. How about the middle office? Often, it is usually an underfunded or worst, neglected office. Alarming as it sounds, the vital elements happens there — pricing, valuation, collateral management, market risk — yet time and again they are left alone to fall into disrepair.
The middle office is the part of a financial firm that sits between the trading desk and the clearance and settlement units. The middle office manages risk, calculate profits and losses and is often in charge of information technology. It has historically been taken for granted by financial firms. It is often classified as a cost center and receives the least attention and funding. Middle office specialists often gripe that they are the forgotten middle.
There are perils of failed middle office operations. One such example is in reconciliation — an everyday process in varying institutions. Consider Merill Lynch in the United States whose errors elicited unwarranted attention from regulators that led to a $1.2-million fine — a result of bad management of reconciliation and client billing of fees. While the real story inside the 2014 incident is left unpublished, the case showed that the middle office cannot be neglected.
Regardless of how minor any errors might seem, clients could take their business elsewhere if they have been overcharged. In a market with thin margins, financial firms cannot afford to lose even a portion of its business. Moreover, regulators are getting strict on operational shortcomings as seen in the case just cited.
There is a tendency to blame all the errors in the middle office on untrained and mismanaged staff. But could it be possible that unfortunately the middle office received lower priority in technology spending? Most of such investments are focused on front-end analytics designed to haul in the business revenues. Technology spending on the middle and back office needs scaling up. Incentives too will naturally favor the front office but management needs to find ways to provide commensurate and proportionate rewards as well as training on improved job competencies.
Middle office and back office jobs are generally non-revenue producing. There was a time, according to Investopedia, that unlike the pedigreed MBAs required of the front office, the middle/back-office personnel were only required to have a high school diploma. Of course, the technical and skill requirements have changed as transactions and technology have become more complex. However, this vignette points to the lack of attention the middle and back officers used to get.
While middle office is now gaining the attention it needs, firms must realize the value of the data they hold and find ways to include it into systems across the enterprise to improve the quality of insight generated. Not paying attention to the middle office can have a debilitating effect on the enterprise. It is also an eye opener to those who only focus in the front offices that if they want to get their houses in order, then they should pay attention to and include their “middle children.”
The views expressed herein are his own and do not necessarily reflect the opinion of his office as well as FINEX.)
 
Benel D. Lagua is Executive Vice President at the Development Bank of the Philippines. He is an active FINEX member and a long time advocate of risk-based lending for SMEs.