What is the story behind GlobeOp Financial Services?
GlobeOp Financial Services was founded by five entrepreneurs who spotted a niche in the market and an enormous commercial opportunity to service a segment of the financial services industry that showed substantial promise and reward. Four out of the five founders were alumni at Long Term Capital Management (LTCM), a hedge fund that had endured a high-profile restructuring. In its heyday, LTCM was an industry-leading money manager with $7 billion in assets under management (AuM).
Supporting a fund with such complex and multi-faceted strategies and assets, ranging from sovereign to emerging market debt, plus vanilla equities, and over-the-counter derivatives, required a robust and cohesive infrastructure, replete with a best-of-breed middle and back office, and surrounded with the expertise to back it up. The veracity of this infrastructure was severely tested with the LTCM collapse. A typical byproduct of a major credit event or insolvency is the administrative chaos that follows. Not so at LTCM, its infrastructure proved solid.
This allowed the fund’s restructuring and wind-down to be undertaken in a precisely controlled, carefully considered manner. LTCM’s processes and procedures had proven robust, while the personnel had demonstrated mettle in the face of adversity. We felt that a service provider offering similar middle- and back-office services would resonate with the growing hedge fund industry. The concept of an outsourced middle office was not a service being offered elsewhere in financial services.
What abetted GlobeOp Financial Services’s success in its early days?
LTCM lost a large percentage of its AuM in a very short period of time, but one positive that stood out was the resilience of its middle and back office. During the crisis, LTCM never missed a cash payment or collateral movement. It remained entirely consistent in its valuation policies and never restated or suspended a net asset value (NAV). LTCM’s annual audits remained on schedule and communications with investors were transparent and efficient. The firm had invested heavily in its middle- and back-office people, procedures and technology. It built a bullet proof system. This is ultimately what gave us the original GlobeOp concept. We set out to create the gold standard in middle- and back-office systems, deploying best-of-breed people, processes and online technology for our clients.
GlobeOp’s early success was also abetted by US law changes. The 1997 Taxpayer Relief Act allowed US hedge funds to either self-administer onshore or delegate administration to onshore alternatives. This was a major game-changer as hedge funds had been required for the previous 30 years to undertake 10 administrative functions. Known as the 10 commandments, these included shareholder communication, accepting subscriptions and redemptions, and maintaining corporate books and records, all in offshore locations.
One of our strengths at GlobeOp has always been around OTC derivatives. We were, and still are, industry leaders in the OTC space. Being able to locate our business in major financial centres such as New York and London, as opposed to in offshore centres, meant we had access to a much larger talent pool to grow our business. The decision to enter hedge fund administration to complement middle- and back-office outsourcing happened by good fortune. Our first client asked us whether we could do their administration as well. The client pointed out that we already provided a fully reconciled daily profit and loss (P&L) report, which meant we had produced the necessary data to offer fund administration along with our core services.
How did you navigate the financial crisis?
As hedge fund assets grew, so did GlobeOp as a business, and 2007 marked a high point for hedge funds. As the crisis unfolded, the hedge fund industry underwent enormous structural change. Initial outflows following the 2008 credit crunch resulted in global hedge fund industry AuM declining to just $1.4 trillion.
GlobeOp, being at the forefront of the industry, faced increased workloads and cemented its reputation as an organisation that could manage frenetic scenarios with calm and composure. In 2008, a lot of money left the hedge fund industry. However, GlobeOp was not hurt as badly as some of our competitors, mainly due to our focus on OTC instruments and fixed income. The relative-value and macro fund investors were not as adversely affected as equities. There were fewer redemptions in those asset classes due to their low correlation to the equity markets and comparatively low volatility. Inflows into hedge funds returned at a rapid rate—beginning in 2009—pushing the industry at one stage past a record $3 trillion as investors sought to move away from traditional stocks and bonds that displayed high degrees of market correlation.
What are the biggest investor trends you have seen in the hedge fund industry post-crisis?
Start-up hedge funds in the pre-crisis era routinely highlighted that their business operations comprised of minimal infrastructure with a few key personnel, an office, a Bloomberg terminal, and very little else. The crisis has changed this markedly, as investors’ operational due diligence ramped up, forcing structural and operational improvements at hedge funds. A hedge fund today will typically be asked about its operational processes and technology in immense detail, and will be expected to have well-documented, robust business continuity plans and cyber-security measures in check.
Pre-crisis, the hedge fund industry had been dominated by private investors such as high-net-worth-individuals (HNWIs) and family offices. This changed and the industry gradually became more institutional as pension schemes upped their allocations, hoping to accrue returns to plug sizeable deficits, while insurers too moved towards hedge funds amid the low-interest rate environment.
The post-crisis environment also saw major changes for GlobeOp, following its acquisition in 2012 by SS&C Technologies, which enabled the combined business, through its various synergies, to service a more diverse range of institutional clients and asset management products in this fast evolving landscape.
How has regulation affected hedge fund industries?
Hedge funds may not have caused the financial crisis, but the asset class was never going to escape the regulatory fall-out that followed. In the US, through the Dodd-Frank Act, reporting requirements forced private funds to supply Form ADV and Form PF. Dodd-Frank also introduced mandatory clearing for vanilla derivatives, effectively forcing hedge funds to appoint clearing brokers and manage their collateral more efficiently.
In the EU, the Alternative Investment Fund Managers Directive (AIFMD) introduced additional reporting requirements via Annex IV for EU hedge funds and private equity managers, or those marketing into the EU above a certain AuM threshold. AIFMs were also obliged to appoint a depositary or depositary-lite in charge of ensuring assets are held safely in the custody chain. Affected fund managers also faced AIFMD asset stripping restrictions (for private equity), remuneration curbs, and rules demanding they appoint an independent valuer. Other rules, such as the European Market Infrastructure Regulation (EMIR) and Solvency II, have also increased hedge funds’ reporting obligations. Additional requirements under EMIR include mandatory OTC clearing obligations and reporting on OTC data while Solvency II requires hedge funds supply intricate data to insurance clients.
Private sector initiatives such as the Open Protocol Enabling Risk Aggregation, pushed by consultancy Albourne Partners have also ramped up reporting obligations around risk. These additional requirements cause a real strain on the compliance and legal teams at fund management firms. The consequences of failing to report properly and on time can be serious, and include regulatory censure and reputational damage.
How can outsourcing help firms to navigate these challenges?
Outsourcing this work can save costs and time. Service providers such as ourselves sensed an opportunity with regulatory reporting. SS&C GlobeOp creates and retains huge volumes of client data in a central, reconciled database. The client’s data can then be consolidated into regulatory reports. We have a holistic view over all of the source data and our staff has the regulatory and practical knowledge to ensure transparency and create these intricate reports on behalf of clients.
We are diversifying our own client base beyond hedge funds and more toward banks, private equity, traditional asset managers and insurers. This diversification became a strong focus following the acquisition. Our service offering can be deployed as separate modules and applied to nearly any financial services institution. This is a major growth area for us. Typically, it is similar to the work we do for hedge funds around OTC derivatives but utilised by insurers, for example.
Moving forward, what trends are you seeing emerge in the hedge fund industry, and how well positioned is SS&C GlobeOp to assist?
Hedge funds are also evolving by migrating into other asset classes that share more characteristics with direct lending and private equity. There is a trend of hedge funds moving towards illiquid assets such as corporate debt, corporate distressed debt and loans.
We are the premier service provider for supporting operations on direct lending portfolios. SS&C GlobeOp’s support of loans delivered organically within our platform puts us, we believe, well ahead of the competition. SS&C GlobeOp’s ability to service level-three assets is also a major advantage as hedge fund strategies evolve. However, with this move towards illiquid assets comes increased risk to the industry. In 2007 and 2008, a number of hedge funds had to suspend redemptions due to liquidity mismatches whereby they granted liquidity terms that were not consistent with the underlying liquidity profile of the portfolio assets. The hedge fund industry has mostly learned from those mistakes, and managers provide the appropriate liquidity profiles for the underlying assets they may hold.
Hedge funds are facing challenges and, in today’s market, these are only going to grow. The introduction of Basel III will certainly ramp up the costs of financing and prime brokerage, and this is just one potential problem. Running a fund management firm is a tough business. The operational challenges, such as the reporting, are difficult and time-consuming. Finding investors and raising assets is hard to say the least. But these can be managed in a cost effective way. Keeping in-house operations costs to the minimum can be achieved through sensible outsourcing to high-quality providers. Having a streamlined middle and back office, supported by a best of breed outsourced provider, will help enable hedge funds to flourish in this tough regulatory and low-return environment.