All change

What are the main challenges facing fund administrators over the next 12–18 months?

A wide variety of challenges face fund administrators over the short term. Regulation, valuation, transparency, inflows of capital and increasingly complex legal structures are all cited as causing concern in the industry. Real concern over what laws will emerge from both the EU and the US appears to be top of the list of fund administrators’ concerns for this year and into 2011.

 “The main challenges will be trying to predict how the new regulatory framework will look in Europe and the US,” says Peter Hughes at Apex Fund Services. He believes administrators need to be “evolving their business models to be ready for the new landscape.”

According to Hughes the industry should be “used more as the ‘eyes and ears’ of regulation to protect investors and the business model.” As a result of this changing legal landscape, he proposes as an example that administrators will need to adapt their business models to counter the effect of Cayman funds redomiciling to European centres.

Richard Ernesti at Citi believes fund administrators need to respond quickly to a host of “new and varied client and regulatory requirements”. As competition for investments increases, he sees fund managers exploring alternative distribution channels.

“Fund administrators are also facing demands for transparency from investors. They need to respond to client demands for more frequent and timely valuations while providing a high level of compliance and controls,” notes Ernesti.

In Europe, the Middle East and Africa he sees fund managers considering new structures and distribution vehicles including Ucits, EU domiciliation and retail channels, “making it necessary for the administrator to provide a broader breath of services and expertise”.

Paul Stillabower at HSBC Securities Services agrees that increased regulatory pressure on a global basis is the main challenge for administrators. “This is manifesting itself as an increase in capital requirements stemming from the ‘strict liability’ clause which is currently in draft form in the alternative investment fund managers (AIFM) directive in Europe and further calls for more transparency and independence in the valuation process,” he notes.

However, Stillabower sees an opportunity for administrators to increase the services offered to customers and believes legislation could drive more funds to outsource their valuation validation. He warns this could result in capacity problems for the most successful administrators, including those with the “best fit” business model for the new world order.

He expects the industry to continue to focus on independent pricing and valuation of assets.

At Legis Fund Services Martin Tolcher agrees the AIFM directive and increased corporate governance responsibilities will drive the industry. He also believes the “ongoing economic situation” means there will be fewer fund launches than before, and those that do start up are taking longer to launch, often with lower assets than previously.

David Morrissey at SEI also sees regulation coupled with risk management as the key challenges. “We are focused on helping our clients prepare by understanding the requirements and what it means, as well as making sure our systems and processes can facilitate regulatory requirements,” he notes. 

Another focus will be the evolving needs of investors together with helping clients proactively address those needs. Morrissey says: “Recent research we did in collaboration with Greenwich shows there’s a shifting mindset in what we’ve coined as ‘the era of the investor.’ Managers are under pressure from institutional investors to provide greater transparency and enhanced reporting in a much more timely and ultimately useful manner.”

Being able to provide back- and middle-office services across multiple strategies, asset classes, product structures and jurisdictions will also be key. “This gives managers the flexibility to distribute their products in many different ways and channels without needing new outsourcing partners or running the risk of being the first manager to blaze that trail,” concludes Morrissey.

“Increasing profitability in an environment where our investment manager clients are very price sensitive and where new fund launches are fewer and smaller” will drive fund administrators, according to Akshaya Bhargava at Butterfield Fulcrum.

He believes monitoring legal and regulatory developments in the financial markets and quickly adjusting procedures and reporting to ensure compliance with regulations will be a key challenge for the industry, along with an ever-increasing need for more frequent and transparent reporting and robust controls to mitigate operational risks.

Hans Hufschmid at GlobeOp sees four main challenges. One is an increasing demand by regulators, investors and clients for greater transparency and access to information about fund valuations and risk reporting. “Data is being demanded more frequently, in more detail and in customised configuration,” he says. “This requires integrated, scalable data management as well as valuation and risk analytics expertise.” Demand for independent valuation and verification that assets exist, positions are true and that cash reported is real are increasing.

“Sophisticated investors are requiring more frequent and detailed risk reporting, calculated using the same independently reconciled trade and position data used to calculate net asset value (NAV). Administrators will need to avoid the risk of errors and security master differences which can be created by transferring data between systems,” notes Hufschmid.

With complex trading strategies like distressed assets continuing to remain popular, he believes administrators will need the skills, analytic capability and scalable systems required for daily valuation, collateral management and risk analytics and reporting.

For David Aldrich at BNY Mellon, continued volatility in markets will “present real challenges to service providers who will need to adopt flexible cost structures to remain competitive. Managing growth of the flight to quality will be a welcome challenge for the fully integrated, global securities servicing.”

Oliver Scully at Citco Fund Services says one challenge is maintaining control of increasingly complex fund legal structures, in particular following the re-organisation of many funds during the financial crisis.

Being able to expand product offerings to meet both investment manager and investor expectations, managing industry consolidation brought about by the required investment in expertise and technology, and adapting to the evolving regulatory and legislative environment are also on the list, concludes Scully.

Kleinwort Benson’s Joseph Truelove explains that many fund administrators “are going through a process of upheaval. Institutional fund administrators have publicly listed parent companies which are deriving support from governments and going through mergers, splits and acquisitions.”

He points out that some independent fund administrators have recently been sold to larger competitors or private equity backers. “Some of the smaller fund administrators have gone out of business entirely having suddenly realised that they have not or cannot achieve the scale to serve a demanding client base in difficult times,” he notes.

“Significant challenges will be faced by administrators who operate without institutional technology, infrastructure and investor base as investors and managers seek institutional quality service solutions,” comments Stephen Castree at Equinoxe Alternative Investment Services. “These solutions may be found in large or boutique organisations and we believe that operational risk concerns will outweigh counterparty risk concerns in 2010 and 2011,” he adds.

Stuart Feffer at Lacrosse Global Fund Services says providing newly launched funds with lower assets under administration (AUA) with quality service at a price they can afford is a real challenge. “Sooner or later we believe that larger administrators will once again resume cutting their tails, terminating managers that have not grown sufficiently. Before the financial crisis, this was occurring with managers with up to $200 million in assets under management,” he concludes.

“The main challenges facing fund administrators is responding to the evolving demands of investors around asset control, liquidity management, transparency and counterparty exposure,” declares Ian Headon at Northern Trust.

“Although institutional investors are likely to retain their hedge fund exposures, they are structuring them differently and demanding more regulated fund products as well as greater control via separately managed accounts. Consequently, fund administrators need to be able to support these growing trends by investing in their people and technology, enabling their fund manager clients to compete successfully,” he notes.

John Buckley at Omnium believes the focus is on capital raising. “Hedge fund launch activity has begun to pick up but fund sizes have been smaller than in past years. Administrators must leverage scalable technology in order to sustain and develop customer service levels and increased reporting requirements despite reduced asset growth,” he says.

 “As investors demand more timely information about their fund investments, fund administrators will need to step up their capabilities in a 24/7/365 operating environment,” comments Deborah Yamin at State Street Alternative Investment Solutions.

“Another key challenge for administrators can be summed up in one word: adaptability. As interest in Ucits, managed accounts and hybrid funds grows, administrators will need to ensure their product set and operating model can respond swiftly to shifts in servicing requirements from fund managers. Finally administrators need to stay close to regulatory developments, understand the operational impact of new regulations and proactively support fund managers to respond to an increased regulatory and compliance burden,” concludes Yamin.

Extended traditional back-office services is the main concern of Liam McNiffe at Bank of Ireland Securities Services. These services include middle office with trade capture, trade matching and daily P&L reporting. “This has become much more important as funds move away from single prime brokerage and investment managers seek to outsource all but the investment decision,” says McNiffe.

Another concern for McNiffe is competition from lower-cost jurisdictions such as Malta. “Ireland is no longer the lower-cost jurisdiction it once was but has developed its infrastructure and expertise to be a significant competitive advantage,” he admits.

Like others he sees regulatory reform as a challenge.  “It is still unclear what shape new reforms currently being debated in Europe and the US will take but it is certain that such reforms will require more transparency and, therefore, more reporting. The administrator will be best placed to support the investment manager in meeting these reporting requirements,” McNiffe says.

Finally, he sees data capture becoming much more important as funds appoint multiple brokers and custodians. “Administrators’ systems will have to have the flexibility to be able to interface data in and out with other third parties including investment managers, brokers/custodians and regulatory bodies,” he concludes.

Jonathan White at Viteos Fund Services believes the market has matured and become “saturated with a larger number of service providers offering fund administration. With so many offerings in the market there is a tendency to compete on price alone, which will ultimately lead to significant changes and consolidation in this space. In reality, fund administrators need to find ways to be more innovative with the services they offer, creating real differentiators from competitors.

“Now that the $50 million start-up hedge fund has become the ‘new’ $1 billion start-up, even when the number of start-up managers reaches the peak of three years ago, fund administrators will find it challenging to experience significant growth based on legacy business models. Only those fund administrators that are agile enough to adapt to the changing needs of clients will flourish in the next 12–18 months,” he believes.

Trinity Fund Administration’s John McCann says there will be a widening and deepening of products and investment strategies used and the instruments created to achieve them, as well as the need to keep up with the pricing, valuation and accounting issues of the strategies and instruments. “There will be a need for a more frequent valuation cycle, moving towards daily pricing. I think the industry as a whole, including institutional investors and the regulators, will force hedge fund managers and their funds to have an external seal of approval across many more areas, well beyond the historic core reporting services such as NAV calculation, financial reporting and others and ‘disclose, disclose, disclose!’ will be their mantra,” declares McCann,

“There is no doubt that compliance and good corporate governance practices will be another focal point as new business models are established in response to recent events. Given the many regulatory/policy changes that are in the pipeline, all directors/managers must ensure a sound and robust compliance framework is in place to meet regulators’ expectations,” he adds.

“Trinity believes administrators must provide comprehensive, proactive corporate secretarial services to many of the funds/corporate entities to which it also acts as administrator,” concludes McCann.

At Custom House Global Fund Services, Dermot Butler agrees with others that aside from the “vexing question of new regulation”, the main challenges are unlikely to change from those that administrators have faced over the past 12–18 months. He sees these as independent verification of valuations of assets that comprise the NAV.

“The only real difference will be that, post-Madoff, there will be pressure on verifying the actual existence of some assets of the fund. The verification of the existence of assets has not been one of the main requirements of hedge fund administrators in the past and this may present some problems,” he points out.

“It is not that the actual verification is difficult, just that the verification must be consistent and is likely to be a post-NAV event, unless the manager is prepared to delay the publication of NAVs,” adds Butler.

“The verification that certain complex over-the-counter assets actually exist may be a relatively quick and simple procedure, or it may be complex. The most problematic is likely to be proving the existence of assets purported to be held by a prime broker or custodian on behalf of the fund, where there is a very close, indeed possibly unhealthy, relationship between the manager and the custodian. All this takes time and requires a different group of resources to be applied than is necessary for normal asset valuation and administration of hedge funds,” declares Butler.