STP Institute


First and Second Generation Middle-Office Outsourcing

June 2024

First and Second Generation Middle-Office Outsourcing

By:  Dan Houlihan

I write and speak often about the strategic value of middle-office outsourcing. I’ve been in this business for more than 25 years, and here’s what I’ve noticed. At a high-level, it’s a crucial component that allows investment managers to execute their business strategies more effectively. Whether firms are entering new asset classes, launching products faster, or expanding geographically, an outsourced middle-office facilitates faster and more efficient execution compared to an insourced platform.

There are generally two “generations” of outsourcing. Understanding the differences between each can lead to better outcomes for both the manager and the provider.

First Generation Middle-Office Outsourcing

The first generation of outsourcing involves start-up or established managers transitioning from an internal technology and staffing platform to an outsourced provider for the first time. This transition is unique and requires careful handling. The good news is that both parties usually have well-documented operating and technology requirements, which sets the stage for better outcomes.

However, first-generation firms face several challenges. They need to develop a human capital plan to redeploy or displace resources post-conversion. They often lack experience with the critical governance framework required for proper oversight of the relationship. From my experience, strong post-conversion governance, including executive sponsorship, is critical to the long-term success of the partnership.

Another significant challenge is recognizing and accepting that the implementation is a transformation, not just a project. This change – often a venomous experience to human nature – can provoke resistance, necessitating an active change management plan with proper executive sponsorship from both the manager and provider.

First-generation firms tend to focus more on how things are done rather than the final outcomes. Understanding this mindset and factoring it into implementation and change management plans is critical. Both the manager and provider should aim for the desired end-state outcomes, not just the methods to achieve them.

Second Generation Middle-Office Outsourcing

Second-generation outsourcing, on the other hand, involves firms that are switching from one outsourced provider to another. This scenario brings its own set of challenges. Most second-generation firms have lost much, if not most, of the institutional knowledge about how their operations work. While they may have developed a strong governance framework, the process knowledge often resides with the existing provider. Therefore, these firms must focus on desired outcomes to define their requirements, often in the form of reports, interface files, and data sets from their existing provider. Most firms switch providers due to service or pricing issues, so it is incumbent on the provider to thoroughly understand any existing service deficiencies in addition to standard requirements gathering.

Implementation in second-generation outsourcing also requires a different approach. Many firms no longer have the resource capacity required for a major transformation, placing the burden on the provider to ensure a robust and rigorous methodology for defining and validating requirements through third-party outputs. There is a significant focus on “recreating” outputs, such as internal reporting, client reporting, invoicing, or interface files. This process requires a strong feedback loop of testing and validation by both the provider and the client.


Achieving the desired strategic and day-to-day outcomes in an outsourced relationship requires rigorous and thorough due diligence based on real-world requirements. It also needs a provider that truly understands how to deliver their capabilities in the context of those requirements, along with a proven methodology tailored to the unique needs of each firm. Strong governance post-conversion is also critical to the ongoing evolution and success of the partnership. As one of my clients once said, “you date your fund administrator, but you marry your middle-office outsource provider.”

By understanding and adjusting to the unique characteristics of first- and second-generation outsourcing, managers and providers can tailor their approach to due diligence and implementation. This ensures the right steps are taken to achieve the desired outcomes and fosters a successful long-term strategic partnership.

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