India carves outsourcing niche

Mindspace handles deals for world banks where the Investment bank model has grown to a $4.4bn industry.

Mumbai // A sparse hedge is all that separates hectares of reeds and mangroves from the Mindspace corporate park. Malad, one of Mumbai's youngest north-west suburbs, is a long trek from India's financial centre at Nariman Point, let alone New York or London. But it is here, and in parks just like it in Indian cities such as Bangalore, Hyderabad and Chennai, that deals left stranded by Lehman Brothers's action in filing for bankruptcy protection must be unravelled.

It is a vast job, and together with a host of other shock waves from this year's financial crisis, it is putting banks' outsourced operations to the test as never before. "I don't think we have had a scenario where an office of 3,000 or more people has shut its door on a Monday morning and not allowed anyone to work," said Chitra Baskar, the chief operating officer of Viteos Capital Market Services, which handles fund administration services for hedge funds and back-office operations for Credit Suisse and alternative investment firms from its bases in Bangalore and Mumbai.

"This is the only time a big broker dealer has gone down. That's a big impact," he said. Mindspace is home to the Indian back-office operations of some of the world's largest banks. In the Prism Tower, bright young Indian MBAs and accountancy graduates settle trades from across JP Morgan Chase's operations. One floor below, Merrill Lynch puts together its trading rooms' IT systems. In the Athena building next door, thousands of employees are doing the same for Morgan Stanley. Lehman itself has a vast campus not too far away in the suburb of Powai, which is now for sale as part of the firm's liquidation. Marc Vollenweider, the founder of Evalueserve, one of the first companies to do outsourced work from investment banks, says the industry has grown from nothing in 1999 to $4.4bn today, with most companies launching only in the past three or four years.

The ripple effect of events in New York are instantly felt in Mumbai. A smart young graduate at JP Morgan Chase who was approached in Prism's lobby said she and her colleagues were now working 12-hour days instead of nine to cope with the erratic trading volumes they had seen. For now, she said, JP Morgan Chase had left all the trades involving Lehman frozen until Barclays Bank and Nomura, which have bought Lehman's US and European businesses, fully open its trading operations. Lehman's New York floor traders began trading under the Barclays name on Thursday.

Ms Baskar said it would still be weeks before the team that Viteos had put together to deal with Lehman gained a proper grasp of the scale of the task, and months before everything was unwound. "It's getting there," she said. "It will be another few weeks before we have clarity. How much will be recoverable will not be something we know overnight. It won't just take a month." She runs through the challenges that the Lehman bankruptcy brings to outsourced operations.

"If you're having counterparty positions where you've taken risk against them, you have a problem - you don't know how much is going to get paid out against those positions. Stocks in custody, in trust, those can be moved out. "But if you've taken a counterparty risk with them or you have a derivative contract with them, it all depends on whether they are able to pay up." Even shifting those stocks in custody is a knotty job: the counterparty in each trade needs to be contacted and agree to reroute it through another bank. And this is already showing up the shortcomings of some banks' outsourced operations.

"Deutsche Bank are a pain in the neck from my point of view because they've outsourced everything to India," said a source in the London back office of a major US bank. "They have to do all the settling of trades, all the interfacing with clients from India. I get phone calls from Deutsche in India on a daily basis. "They have quite a bad reputation from our point of view. Very few banks have outsourced the way Deutsche have."

But picking up on how other banks are valuing the frozen trades where Lehman is a counterparty - which is essential if back offices are to know how to value them themselves - is even more of a challenge for banks who have outsourced heavily. "If you're not in the thick of what's happening, if you're exclusively out in India, then it's quite possible that you're not picking up on everything," Ms Baskar said. "We strongly believe that you need to be present in the market place you are serving."

The US bank source said that his bank had been careful not to outsource any activities that could lose the bank money to India. "The only functions that have been outsourced are functions that are repetitive and boring. All of the activities which involve us evaluating risk and other non-standard activities are still in the UK and other parts of Europe." It was the UK and European offices, for example, that ran the risk exercise that tested the bank's clients' links with Lehman.

Another challenge has been the sheer volatility. On the Monday when Lehman closed its doors, there were record trading volumes. "When the markets are going crazy there are a lot more problems setting risk, or when trades don't settle there's a lot more financial risk," the London source said. Not all the challenges faced by the banks' Indian outsourcing operations are unwelcome. A lot of work has gone into absorbing business lost by Lehman and Bear Stearns, and migrating hedge funds and other clients from banks they no longer trust to manage their deals for them as prime brokers.

"We see this flight of business from the boutique investment banks," Ms Baskar said. "And we seem to be servicing some of the banks who are getting the business." But the extra volume of work also means operations are stretched. "There's a lot of business which is not in the normal course of what you've scaled up and provided for," she said. "If you've built for 'X' and you get '5X' coming in, it puts to test any infrastructure that you've built."

Most of the work unravelling the web of Lehman's deals is still to come, so it is still possible that the outsourcing of bank back offices will create a more serious upset. But Ms Baskar thinks that is unlikely. The chances are the model will pass this test, and the additional hurdles created by having the back office thousands of kilometres away in a different time zone will continue to be justified by the cost savings. Critical back-office data can be simultaneously available in New York and Malad, so outsourcing does not mean the US or European operations are cut out of the picture.

"The world is becoming flat," Ms Baskar said. "The global office will take the decisions, and the Indian offices will deliver." In the medium term, she thinks companies like hers can benefit. "Costs are going to be under pressure. So if we make the partnerships with the right entities, there's a lot of opportunities for growth." Sam Chopra, who heads the Business Process Industry Association of India, agrees that the economic hangover the US will be left with may bring benefits. "There's going to more business for us in the long run. Everything the US government is doing is going to increase inflation in their economy, which means they will need reduced price products. They will go to China for goods, but they will go to us for services." Mr Vollenweider said he still expected the business of outsourcing highly skilled specialist work - which he called "knowledge process outsourcing" - would triple in size by 2012, although he believed the present financial crisis would kill off the newer, smaller companies.

"We may see a blip, but the economic drivers are so strong, and in the back-office processing and settlements business I think that's similar, there is no way this can be turned back." Whether the bank outfits here thrive in the present crisis or merely survive, Mindspace looks unlikely to be reclaimed by the mangroves. [e-mail]