LONDON -- The number of investment accounts in Europe is projected to double over the next five years, placing a huge strain on money managers' back offices.
Already stretched by the introduction of the euro next year and year 2000 compliance issues, back offices will be further burdened by an expected huge increase of accounts to service.
"There is a very real risk that the back-office infrastructure as it stands at the moment will quite simply be unable to cope," said a report on the subject by London-based Latchly Management Ltd., a provider of third-party accounting and administration services for investment managers.
The risk is that managers will be unable to monitor transactions, resulting in a Barings-type disaster or in portfolios exceeding exposure limits, such as the large stakes in unlisted investments taken by Peter Young, formerly of Deutsche Morgan Grenfell, which cost parent company Deutsche Bank about L450 million ($738 million).
A recent survey conducted by information technology specialist Cap Gemini UK plc, London, found 75% of traders knew of colleagues who regularly exceed their limits, the Latchly report said.
Errors will creep in from manual entry and transference of data, resulting in failed trades. Losses could be much higher than experienced previously, given the higher amount of assets, according to the report.
"Undoubtedly, there will be casualties and a very real risk to the reputation of some financial institutions and, at worst, even a danger of collapse for some of them," the report added.
The problem is managers often are reluctant to invest capital in their back-office operations, the report said.
"If you put L5 million into infrastructure, it brings in no new revenue," said John Campbell, Latchly's managing director.
While much back-office work has been centralized in the United States, the issue is "pretty new in Europe," Mr. Campbell said.
The need to address these strains on the back office is mounting for a variety of reasons, according to the report:
* European nations are starting to shift the retirement burden to private pension funds and away from the state. What's more, funds are moving toward equity investments and away from government bonds. Demand for equity funds in Europe has jumped 89% in the past two years, according to Lipper Analytical Services.
* The shift toward defined contribution plans, often involving individual investment discretion, requires creation of individual accounts.
* Thirst for more sophisticated alternative investments, such as hedge funds, by retail and institutional investors also is on the rise, again increasing the overall number of portfolios.
* European pension funds are becoming more sophisticated investors, adopting core/satellite approaches, which also tend to increase the number of portfolios.
* Growth in cross-border investment not only results in a greater number of portfolios but also in more complex reporting and back-office demands.
* Investors are demanding more customized reports, many requiring specialized benchmark comparisons and differing currency scenarios, performance measurement and performance attribution, risk analysis and custody information.
What makes the situation untenable is that many managers are working with old and unintegrated systems, Mr. Campbell said. That requires additional legwork to input and reconcile data, increasing the chances of mistakes being made. It also takes weeks to produce client reports.
"Legacy systems tend to be extremely inflexible and client-specific reporting requirements can only be accommodated by exporting data to spread sheets and other processing applications. This takes time and is prone to error," the report said.
While a survey by the United Kingdom's Institutional Fund Managers Association shows back-office staff has grown at a 13% annual clip since 1992, people problems often are overlooked.
Administrative staff are paid much less well than portfolio managers, generating morale problems, the report said. What's more, temporary staff -- who may lack strong commitments to their jobs -- account for 13% to 15% of back-office staff in London, the report said.
Two-year-old Latchly -- which just raised L2.26 million in new capital from private investors -- is offering third-party administrative systems to managers. Using modern systems, Latchly offers an automated approach for managers.
Michael Bauer, managing director of Pall Mall Partners, a new London-based money manager that has just won regulatory approval, said he outsourced fund administration to Latchly.
"I could not see, as a small asset manager, that we could be in the position of having a high-quality back office," he said.