Auditors find recovery slow in Ireland

The hedge fund audit sector suffered during the financial crisis but a resurgent interest in launches, particularly of regulated products, bodes well for the future.

Among hedge fund service providers in Ireland, the group that has seen the slowest return to growth following the financial crisis has been the auditors.

All four of the main audit providers – Deloitte, Ernst & Young (E&Y), KPMG and PricewaterhouseCoopers (PwC) – have substantial operations in Ireland. The companies report the same activity pattern for the past year: a slow start followed by steady recovery.

“We have certainly seen that the latter half of 2008 and the start of 2009 were very bad from an industry perspective. The latter half of 2009 and this year so far have been good,” says PwC’s Ken Owens, a partner in the asset management group.

Eoin MacManus, a partner at E&Y and assurance leader for UK and Ireland asset management, agrees with Owens’s diagnosis. He says the crisis brought hedge fund auditors in Ireland a “whole lot of challenges” which have settled down since the end of 2009.

MacManus says December 31, 2009 marked the real turning point as funds that had been forced to close down during the crisis no longer needed auditing and issues such as side-pocketing and gating ceased to be an issue. “From a financial reporting perspective there was a lot more normality. We’re not quite back to business as usual but we’re heading in that direction,” says MacManus.

He points to a steady increase in assets under management as a sign that business is returning to the hedge fund sector. Currently that increase is largely due to performance-based growth as inflows start to revive.

Many audit firms in Dublin are reporting the same interest and similar patterns in new launches as other service providers. Killian Buckley, who heads Kinetic Partners’ Dublin office, says: “From our point of view as a business, Ucits is the name of the game at the moment.”

The auditors attribute the rise in Ucits product launches to a mixture of manager concern about proposed regulation and investor demand for extra transparency and liquidity, qualities often attached to the Ucits brand. Buckley warns that Ucits is not necessarily the solution to all the issues that have plagued the hedge fund industry in the past few years but admits the brand is ticking investor boxes.

Meanwhile enquiries about more exotic or risky strategies have dropped off. The auditors point to sectors such as asset-backed lending as being quiet. MacManus also says there has been less interest in distressed debt than was predicted.

Deloitte audit partner Christian McManus says he is seeing more enquiries about qualifying investor fund (QIF) products than Ucits funds. The QIF is now well established in Ireland as being a viable and respected regulated product. McManus says it is a good option for hedge funds.

“It can take the full hedge or alternative strategy. You don’t need to tinker with it or tailor it, it just slots in very nicely. It has the bonus of being a recognised brand,” says McManus.

Moving questions
The audit companies are also seeing enquiries about fund redomiciling following the introduction of Ireland’s legislation through the Companies Act in December 2009. However, there is little actual work following through at present.

“At the moment people are opening up the regulated product but still retaining their Cayman product. They’re not going to move away from that all of a sudden,” McManus says.

“It’s kind of like the opposite of protectionism. In my view free trade generally is a good thing and this is in the direction of free trade,” believes PwC partner Garrett O’Neill. He adds the Irish approach to redomiciling is a good idea as it allows a streamlined, simple process that maintains a fund’s performance record.

Exchange traded funds (ETFs) also continue to be of interest for fund managers looking at Ireland. O’Neill says investment in ETFs can help investors and managers manage their risk more easily. They also meet the current demand from investors for liquidity and transparency.

Another issue impacting the funds audit sector at present is the introduction of the US financial reporting requirement FIN 48. This was originally introduced by the US Financial Accounting Standards Board (FASB) in 2006 but will now apply to investment funds.

FIN 48 requires companies to disclose any uncertain tax positions they may have and prescribes a recognition threshold for the measurement of a position expected to be taken in a tax return.

Owens says funds domiciled in countries with extensive tax agreement networks, such as Ireland, would find it easier to comply with the new requirement. But it is likely to mean extra work for the auditors of funds using US GAAP. “It’s just something else to bear in mind,” Owens notes.

All four of the big audit firms also report an increase in due diligence enquiries from would-be investors wanting to avoid Madoff-like situations while looking at where to allocate capital.

“The level of enquiry that’s coming through has picked up markedly compared to what was there 12 months ago,” says Owens. “People are investing again and clients are telling us that money’s coming back. The evidence you can see is guys ringing up to get some level of due diligence done on the fund that they’re looking to invest in.”

“The crisis has shown that having that strong separate function is important,” adds McManus.

The crisis has also had an effect on audit fees. Until 2007 Ireland’s booming economy as well as the growth in assets for hedge funds led to the costs of hiring an auditor rising considerably.

Cost conscious
“We became uncompetitive because of the pricing,” says McManus. “That’s now been reined in.”

Owens says clients used the crisis as an opportunity to discuss the issue of fees. He believes the industry lost between two and three years’ worth of fee increases in a single year and this will not be regained quickly.

“It’s hard to ask for a fee increase when you have deflation generally in the economy. The level of increase that people might be looking for in the near future will be low,” he says.

Any future increase in audit fees is likely to come from new work generated by additional regulatory or reporting requirements imposed on hedge funds. The particular set of accounting standards being used also affects the amount of work, as does the location of the hedge fund being audited.

Auditors also find they have a slightly larger role in a Ucits-compliant fund than in offshore funds or QIFs, thanks to the extra regulatory reporting and oversight integral to the structure.

“I think we have a little more interaction with the board of directors in Ucits simply because there are more regulatory issues that they deal with that impact us,” says Deloitte’s McManus.

The increased interest in regulated products like Ucits and QIFs is a good thing for auditors. “We’re an advisory firm and, from a very selfish perspective, regulation brings opportunity,” McManus admits.

From a client’s perspective, selecting an auditor in Ireland might not be an obvious decision. The Big Four will give a potential investor the comfort of having a known name on the fund’s prospectus. All offer a full service with links to offices across the globe.

The companies themselves see significant differences in their culture and what they can give to clients.

McManus says he can offer clients a coordinated approach across multiple products, issues and jurisdictions.

O’Neill believes KPMG focuses on ensuring people doing the audit work are experts and take no shortcuts. Work, he says, “should be tailored to the particular business circumstances.”

At E&Y, MacManus thinks his company can offer a larger range of services than its competitors and it has been a market leader in the hedge fund business for a long time. “The regulated fund environment is becoming more complex. From our perspective we feel we’re very well positioned to avail ourselves of that and capitalise on it,” he says.

Owens says PwC has tried to differentiate itself through specialisation within the group. He thinks the company’s “very significant market share” across different countries helps it connect with clients.

“The feedback we get from our clients is that our guys know the industry better,” Owens adds.

While there is healthy competition between the audit firms, they believe the Irish industry is working well as a group to promote the jurisdiction. “With the changes it’s very important that we sell ourselves as an industry and then we can all fight between ourselves to win that business,” says MacManus of E&Y.

“There’s a very trusting attitude to sharing information on trends about managers considering Ireland,” adds Kinetic’s Buckley. “That collegiate approach has benefited the industry both in terms of the innovation that we’ve created around ETF products and so on, and with the relationship with the regulator.”

E&Y partner Aidan Tiernan says Ireland’s experience with both regulated and non-regulated products as well as its English-speaking culture will serve it well in this regard.

The fund industry as a whole has survived the turmoil of the past year and will continue to survive because the underlying fundamental of the sector has not changed, notes O’Neill.

“The funds industry is driven by global demographics. The number of people is still the same. The future in the medium-term sense is positive for funds. Funds are required because people will have to save more and for longer,” he explains.

From that perspective the outlook for Ireland is looking good and the audit firms believe they are well positioned to take advantage as the industry slowly returns to health.