What threat legacy systems pose to financial institutions

In Singapore, the investment management industry and related financial institutions often face the issue of legacy IT systems built in the 1980s or 90s.

Factors such as increased regulation, client demand for transparency, real-time reporting, and the ability to support and take advantage of new growth opportunities have all put increased pressure on IT infrastructure that was never designed to cope with such challenges.

The consequences are real: for investment management firms and their decision makers, corporate and career viabilities are impacted by the restrictions imposed by legacy systems, making the issue one that requires maximum attention.

What defines a ‘legacy’ system?

In a nutshell, a legacy system is an investment management system that is:

• Infrequently updated
• Often running on outdated, poorly documented, or obscure technologies
• Has difficulty in automating or adapting to business processes
• No real-time consolidated overview of the business

Reports have shown that one in four firms are running their core business operations on legacy systems. Given that the top 2,000 firms collectively manage upwards of US$80 trillion in assets, it is easy to see that several trillion dollars are at the mercy of legacy systems.

Losing the rat race

With the market pace and technological change at unprecedented levels, relentless pressure on operational costs, and relentless competition for client mandates, a tipping point could be near. According to Gartner, spending on information technology products and services in the Asia Pacific region is forecast to grow 5.5 percent in 2014 to reach US$767 billion, up from US$727 billion in 2013, and reach US$933 billion in 2017[¹].

The wide use of legacy systems that were designed to meet the needs of the previous century may ultimately precipitate a wave that could have the potential to wipe out much of the recovery made since 2008.

The potential consequences include loss of confidence in the industry, reputational risk implications for boards and managements of affected firms, and diverse operational issues that collectively could pose a level of systematic risk to the stability of financial markets as a whole.

Legacy system owners that fail to acknowledge they are on a platform that can no longer keep up with the pace of change might consider assessing their situation and understand the threats from various perspectives.

The risk perspective

Since legacy systems are unable to automate many standard processes, manual processes are put into place to compensate. The bulk of these processes involve spreadsheet analysis, which inevitably leads to errors. Spreadsheet errors were said to be the main cause when J.P. Morgan lost US$6.2 billion in the ‘London Whale’ incident in 2012.

Inadequate or faulty systems can also create severe reputational risk and, in the worse case, destroy a business. The collapse of MF Global, where company executives ‘could not find’ several billion dollars in client assets, was attributed by bankruptcy trustee and ex-FBI Director Louis Freeh to the company’s failure to decommission their ‘hodgepodge’ of legacy systems and adopt more modern systems.

The cost perspective

Legacy systems have more significant cost implications the longer they are used. In most cases, the increased IT spend on legacy systems is earmarked toward simply keeping up as opposed to innovating.

Regulation, asset class coverage, electronic trading, real-time reporting, and other factors that were not envisaged at the time the legacy systems were built have all caused costs to spiral upwards.

Additional costs are incurred as a result of the manual processes, workarounds, and ancillary systems put in place to address evolving market conditions and business processes that the legacy systems lack the flexibility and adaptability to cope with.

Eventually the cost of maintaining and augmenting legacy systems will be greater than the cost involved in replacing them.

The growth perspective

There is a need for IT infrastructure to support a firm’s growth initiatives. The investment manager who is able to get an accurate overview of assets under management within minutes with a click of his mouse will be able to react in a much more timely manner than one who waits hours or even days for the team of spreadsheet analysts and overnight batch jobs to provide the same result.

In an era where seconds can mean the difference between profit and loss, having the right IT infrastructure is imperative.

In Singapore, for example, the Monetary Authority of Singapore (MAS) proposed a two-phased approach in implementation of trade reporting, which was delayed due to MAS’s concerns regarding industry readiness, availability of trade reporting infrastructure, and international developments[²].

Typically, legacy systems were not built to handle the unique needs of emerging markets, and to a wide extent, they did not make provisions for the likes of Dodd-Frank, EMIR, Solvency II, and much more.

Conclusion

Legacy system owners are putting their corporate viability in jeopardy the longer they rely on systems infrastructure that was not designed to meet current market conditions. Legacy systems were designed for simpler processes in an era where the amount of data and knowledge was much lower than it is today.

As the financial crisis showed, no investment management firm is too big to fail. Investment management firms must decide if their current IT infrastructure has the capabilities to meet their needs right now, let alone in the future.