Fund administrators must get busy or die trying, according to a panel of experts
How are you coping with downward price pressure from fund managers?
Keith Parker: I think that downward pricing pressure is out of step with industry realities when administrators are facing unprecedented cost increases due to regulatory demands.
Keith Hale: Asset managers’ margins have been significantly squeezed since the financial crisis, which has resulted in service providers being pressured to reduce their fees. Fund administrators, for example, are looking to increase their economies of scale and the efficiency of their operations, so that they can reduce their cost base. However, at the same time, they are dealing with the increased workload required to comply with the new regulations resulting from the financial crisis.
Multifonds is the core accounting and transfer agency engine for fund administrators (and sometimes asset managers who haven’t outsourced)—essentially like the CPU (central processing unit) at the heart of their operations and IT. That ‘CPU’ helps with the downward price pressure by reducing costs for our clients in three main ways: (i) having an as efficient as possible system means that operations staff can process more funds and accounts more efficiently; (ii) having a single global software platform across asset classes reduces the cost of ownership compared with the typical patchwork architecture of multiple core processing systems, interfaces and data warehouses; and (iii) reducing the need for numerous ancillary systems to support the core engine by continually improving and incorporating those elements into the core, such as tax calculations, trailer fees and operational reporting.
Roman Lewszyk: Atlantic Fund Services designed its service provision to be wholly reliant on straight through processing. This, in combination with operating within a low-cost environment, has meant that the organisation has been able to price very competitively.
Consequently, our experience has been that the pressure is more around requirements for additional functionality and not price. Probably the best description is more for the same as opposed to the same for less.
Which come out on top—independent administrators or those that are prime brokerage/bank-owned?
Parker: I think that is a function of what the fund manager in question is looking for. Typically, a bank-owned administrator offers a bundled service offering and so can be a useful one-stop-shop for managers looking for that type of service. With that said, some bank or broker-owned administrators will not take on fund managers that aren’t prepared to take all, or at least most of, the services they offer, eg, custody. Also, some bank-owned administrators will not take smaller or start-up funds.
An independent administrator by comparison usually offers a more limited suite of services, but will provide a more bespoke-type service that can be very attractive to smaller fund managers that look for a more personalised type of service.
Consequently, I don’t believe one type of offering is better than the other. They are different and cater for differing needs.
Lewszyk: There are obviously advantages and disadvantages to both models, but we are in the unusual position of having experienced both situations.
Clearly, big bank mentality brings cross-selling, bank infrastructure, lack of flexibility etc, but on the flip side, it also brings financial strength, global credibility, total service solution, etc.
Independent administrators generally have a much higher degree of flexibility and tailoring around their offering, each piece of business is judged on its own merits as opposed to arriving as part of a bundled bank deal. Additionally, independents can partner with any combination of parties to provide a bundled service, although generally they do not have the same financial clout.
In summary, there are pros and cons to both models, but our view is that independent administrators tend to be more focused on administration and client satisfaction to the exclusion of all else, which is obviously better for clients overall.
Hale: Traditionally, the fund administration market was polarised. On the one hand, we had large global custodian banks that were typically focused on efficiency via the economies of scale gained from a consistent operating model, often for long only funds. On the other hand, there were independent, typically alternative, fund administrators that had a focused, niche and flexible approach to servicing alternative managers.
However, the accelerating trend of convergence between traditional and alternative investment structures, caused by increased institutional investment into hedge funds and liquid alternatives, has manifested in the consolidation of the fund administration market. Many independent administrators have been acquired by the large custodian banks, for example, Bank of Bermuda by HSBC, Bisys by Citi, Goldman Sachs Administration Services by State Street, and Bank of Ireland Security Services and Omnium by Northern Trust.
In our view, given the trend towards bundling custody and fund administration services, combined with the pressure on costs and alignment with banks’ focus on efficiency and economies of scale, independent administrators are likely to get squeezed and there will be many more acquisitions. The challenge will then be to effectively combine the services, operating models and ultimately systems infrastructures of the large-scale efficiency-focused bank operations with the flexibility and customised approach of the independent administrators.
Considering the latest regulatory constraints and multi-prime approach that most hedge funds now typically take, we expect it will be the traditional custodian banks, rather than prime brokers, which will be the likely acquirers of independent administrators.
What are likely to be the most promising areas of new business generation for fund administrators in the next 12 months?
Melvin Jayawardana: We believe fund administrators have a tremendous opportunity to begin developing service offerings that address the new regulatory requirements fund managers face. The Alternative Investment Fund Managers Directive (AIFMD), European Market Infrastructure Regime (EMIR) and Foreign Account Tax Compliance Act (FATCA) will significantly affect current business practices, changing the way fund managers collect, validate and report on fund and investor data. The fact that funds must address all three in the same year amplifies that challenge.
Administrators will need to productise and innovate if they are to address these growing concerns from asset managers that are actively managing their profit margins. Those administrators that fail to realise the value of the data they hold will give away data elements in the form of free data extracts with no costs or large revenue implications, and will see their profits erode over time.
Hale: Liquid alternatives and exchange-traded funds offer a big opportunity for administrators. The key challenge for the administrators is to maintain efficiency in these structures in order to keep costs competitive and retain margin. Automation and technology are key to overcoming that challenge. For example, Multifonds has and continues to strategically invest in delivering the flexibility required for alternatives aligned with the control and efficiency for traditional structures.
Another area of growth is the combining of middle office portfolio accounting with back office fund accounting on a common platform. We are also opportunistically following our clients into new countries, and as a result, we now support funds in more than 30 fund domiciles globally.
Lewszyk: As the complexity of deploying funds into multiple geographies eases over time, we are experiencing growth from our clients expanding into non-traditional markets. So far this year, we have gained new business in Czech Republic, Slovakia, Liechtenstein, Poland and Austria. Unsurprisingly, many of our European clients are actively looking at distributing their funds in other European markets.
Our focus, therefore, is to continue supporting our current client base as it moves into new markets in combination with gaining new clients in key European fund management centres. We believe that this can be done most effectively by physically establishing ourselves in these locations. Our first step in this strategy was to open an office in London in May and we will follow this with more offices in other key European locations.
Parker: There is a growing demand for services that sit on the periphery of core fund administration, such as regulatory reporting, investor reporting and interfaces with other platforms. Fund administrators are being asked to do more that represents the potential for increased revenue on the proviso that they are properly compensated to do so. I say this as there is the issue, prevalent already, where fund managers expect the administrator to do more but within the scope of existing commercial arrangements.
Which tools and areas are becoming more imperative to the outstanding provider?
Parker: It is important to have regulatory reporting integrated into the core transfer agency and fund accounting systems, otherwise assembling the reporting data will become an enormous task—one which cannot be done without a huge increase in high-end human resources.
Outsourcing regulatory reporting to a specialist reporting provider or having the manager do it will not significantly reduce the administrator’s burden as it is likely it will still be expected to assemble the required data from its financial and transfer agency records.
Lewszyk: There is a continuing and increasing interest in the source and destination of funds and ensuring that financial organisations have industrial strength anti-money laundering and know-your-customer processes in place. Meeting the needs of our clients’ compliance functions has become increasingly complex as fully automated solutions now need to incorporate investor eligibility, sanction lists, market timing and frequent trading.
Another area of increasing importance is the interaction with investors, distributors and asset managers, and the conflicting needs of each party. In recent years, there has been a shift in investors’ expectations regarding data retrieval. They now expected to be able to manage their bank accounts and investments instantaneously on a range of platforms. Distributors and independent fund administrators need access to their clients’ investments together with the ability to understand their income stream. As asset managers expand their geographical reach, there is greater interest in investors’ demographics and investment trends.
At Atlantic, we have developed a range of solutions to meet these needs, which range from online solutions running on differing platforms to fully managed straight-through processing.
Hale: What we’ve seen in the market is that fund accounting, and to a certain extent transfer agency, have become increasingly commoditised. As a result, there is an ongoing pressure within those functions to standardise processes and provide efficient platforms that are as automated as possible.
Middle-office outsourcing, however, lags behind back-office fund accounting by at least 10 years and the market is now only at the point where firms are considering it as a commodity—so it is not yet ubiquitous across the industry.
The real challenge for administrators moving into the middle office is that they need to expand beyond the fund accounting view of the business—the Accounting Book of Record (ABOR). The view of the world presented to the client by the fund manager, the Investment Book of Record (IBOR), is usually calculated on a different system, often by different people and at different times.
However, both of these views of the same portfolio originate from the same data, just with different criteria and timing. Reconciliation between two systems to provide the ABOR and IBOR views is inherently inefficient. One system, with one database that can supply both views of the portfolio, means that the operational costs of calculating and verifying them are vastly reduced and the need for reconciliation is removed.
Jayawardana: Outsourcing continues to prevail, with much of the operational work undertaken by administrators and third party agents. But, while fund managers increasingly seek outsourced solutions to new operational and technology requirements, it is important to note that they will be unable to outsource responsibility. Managers will remain answerable to both investors and regulators for understanding the delegated party’s business model and operational process.
That said, managers are actively seeking solutions that can help them streamline their global operating models. We increasingly see managers looking for a managed cloud or SaaS-enabled service that can scrub, harmonise and manage data from both the administrator and other data providers, as well as store it in a centralised location. Fund managers are looking for the ability to consolidate and repurpose a single set of cleansed and augmented data across myriad platforms and business functions.
Building a solution in-house that can provide real-time, validated data for risk, regulatory, investor and management reporting can be very costly, so we see this as one of the primary outsourcing drivers in the months ahead.
There’s tremendous value in being able to leverage data in this way, and it goes beyond reporting obligations. Managers can also begin to identify fund flow trends that allow them to focus their sales teams in the right markets and to offer the most efficient products to attract investors.
What specific regulations are you attending to currently, and which will affect you in the next year?
Lewszyk: We face a number of challenges at the moment from multiple regulatory regimes. We are currently working on tailoring FATCA and AIFMD functionality in our systems to ensure that they continue to meet our clients’ and regulators’ needs.
In addition, we see the changes announced by UK chancellor George Osbourne that take effect in July around NISAs and junior ISAs as significant opportunities in the UK market. We watch with significant interest to see how the UK investment landscape adapts to the pension rule changes, which will take effect in 2015.
Parker: We have built a comprehensive solution for both Form PF and FATCA into our core PFS-PAXUS product, which has been very well received by our clients.
The current focus is on AIFMD reporting. In talking to our clients, the consensus seems to be that a typical administrator will hold approximately 70 percent of the information that a fund manager will need to report on under AIFMD. Consequently, we are enhancing PFS-PAXUS, our share registry/fund accounting platform, to generate automated AIMFD Annex IV reporting in the required xml format.
Jayawardana: With AIFMD coming into effect this year and the July 22 European deadline approaching, our focus has been to educate both our fund administration and manager clients on the full ramifications of the directive and the scope of work it will require of fund managers’ middle- and back-office operations.
Prior to AIFMD’s stringent reporting requirements, many alternative investment fund managers’ processes for collecting and validating fund regulatory reporting data were very much manual, reliant on disparate systems and multiple teams. Far too many people were touching disconnected data sets, and they lacked shop-wide data visibility.
Managing fund data manually across multiple in-house systems was challenging before AIFMD, but it will be nearly impossible within the short reporting window. Updating back-office processes to manage these new requirements efficiently will be a top priority for the Europe, Middle East and Africa fund industry, and we have seen fund administrators and managers mobilising to enact solutions that can support the complete AIFMD reporting requirement from beginning to end.
Hale: The two regulations impacting our clients most urgently are AIFMD and FATCA.
In terms of AIFMD, over the years our platform has already had to cater for a wider range of asset types and derivatives. We’ve extended our capabilities to service both long-only requirements as well as alternatives functionality such as asset class coverage, performance fees, equalisation, series of shares and partnership accounting. Three years ago, the alternative fund assets on our investor servicing platform totalled less than $1 billion, but this has now risen to well over $100 billion as our clients have leveraged the platform for long-only and hybrid structures, as well as for pure hedge funds.
In terms of FATCA, we have worked with our clients since 2011 to design, develop and test the requirements. They are now in production with the necessary capabilities for the categorisation, documentation and reporting requirements of the directive. It will also put our clients in good stead for the Auto-Exchange of Information proposed by the Organisation for Economic Co-operation and Development and the other copies of FATCA proposed globally.
Mark Jennis: The repercussions of OTC derivatives reform on collateral access and mobility is high on the agenda of market participants and therefore high on our own agenda.
The new global clearing mandates will significantly increase the number of margin calls by a factor of five to 10 according to latest estimates. Most of these will still be bilateral calls between clearing firms and their customers made in response to clearinghouse margin requirements for customer trades. There will also be a significant increase in the amount of collateral required for a number of reasons, including the fact that clearinghouses require initial margin, which had generally not been the case for most bilateral trades.
Moreover, collateral processing, whether in the context of collateralised trading or financing transactions, is becoming more complex due to financial reform and the need for collateral is expected to increase significantly under the new rules. The market safety and soundness benefits intended by the new rules, whether the Basel III agreement, Dodd-Frank, EMIR or similar legislation in Japan, Singapore and other major jurisdictions, will simply be lost if the global operational infrastructure cannot keep up.
To address this, DTCC and Euroclear, two of the largest industry infrastructures, recently announced an effort to create a joint venture to bring about a major improvement in global securities and settlement processing—in this case collateral processing. The joint venture will initially focus on launching a Margin Transit Utility (MTU) that will provide straight through processing for the settlement of margin obligations, and on piloting a collateral management utility (CMU) to address the pressing problem of sub-optimal collateral mobility and allocation at a global level.
What are your predictions for the evolution of fund industry back offices?
Hale: The industry in the past has been typified by separate organisations, operational teams, architectures and applications servicing traditional or alternative funds across different asset classes. As mentioned above, we see significantly more consolidation across the market, in particular the consolidation of administrators. We believe the top 40 leading significant administrators will consolidate down the top 20 in the next decade, leveraging on common efficient operations processes and systems.
Lewszyk: We are seeing an increasing standardisation around funds, reporting and regulations across the globe. Asset managers are now seeing that they are able to launch their funds in new geographical territories more easily than before. This has a significant knock-on effect to the underlying administrators that will be required to follow their clients around the globe. Regulatory support will become more complex as more markets are handled together with the associated compliance requirements.
Historically, asset managers wanted to focus on maximising their returns for investors and the growth of independent administrators has allowed them to buy this service as a commodity. It has also allowed for smaller asset managers to operate cost-effectively without significant overheads. As asset managers move into new markets, they will become more reliant on administrators to help launch and administer their funds.
Currently, asset managers need to interact with a number of parties within a new geography to get a fund registered, launched, distributed and administered. Investors will require a localised version of everything from documentation to online access. Atlantic is already working with clients that are introducing funds into new markets and we expect that the scope of the work that we undertake to only increase in the coming years.
Jayawardana: The fund industry back-office of tomorrow will be much more advanced and on a par with some of the advances the front office has made in the last 10 years. Our clients are increasingly looking to leverage systems that automate workflows that have been traditionally handled manually.
Two driving factors are behind this change. First is the increased scrutiny fund managers are under and the resulting need to ensure the certainty and accessibility of data held in the back office. The second, and longer-term, factor is a desire to achieve some of the operations efficiencies in the back office that fund managers have achieved in the front office through the use of sophisticated technology.
Administrators and asset managers will need to bring their ‘A games’ to the table if they are serious about addressing the lack of automation in the industry. I predict more scrutiny in the fund expense side of the business with automation playing a key role in managers being able ensure that expenses are distributed accurately and fairly across share classes.
Additionally, the ability to leverage a living document concept will help managers save time and resources while helping them ensure their fact sheets, key investor information documents, prospectuses and financial statements are aligned and fit for purpose before they are distributed globally.
Lastly, I cannot stress enough the importance in investing in a regulatory data platform that will help mitigate the cumulative cost of regulation. There is a need to invest in solutions now. The business and revenue opportunity that the era of ‘big data’ promises will not be realised without a deliberate and diligent management strategy to turn tactical solutions into more long-term strategic data driven initiatives.
I think the common view among fund managers is that return on investments that make the back office operate more efficiently will be felt in two ways: operational costs coming down over time, and new opportunities to win capital allocation by being able to demonstrate to investors a smarter, more robust operating model. That second benefit has the potential to contribute meaningfully to fund growth in the new environment.
Parker: The regulatory demands on the fund industry back-office have become extreme as a result of FATCA, Form PF, AIMFD and tighter anti-money laundering requirements. In addition, there is a risk that local regulators in other jurisdictions will try to compete with the US and European regulators to produce equivalent reporting demands. Meeting these highly complex regulatory requirements will be a major focus of fund administrators over the next few years and managers need to be sympathetic to the inherent cost increases that these regulations impose.
Indeed, the compliance department may become the largest department in a fund administrator, exceeding the resources that are devoted to the fund accounting and transfer agency departments. Administrators that do not have efficient systems for regulatory reporting and compliance will struggle to survive.
Jennis: Some firms already have back-office departments that leverage sophisticated and flexible technology across asset classes. For those firms, it will be important that they review their processes to ensure that they can handle all changes brought about by regulatory reform.
However, other firms do not have the operational or technical expertise or systems to properly support back-office processes—these firms will need to find suitable solutions that can process and manage trades according to the new requirements. In either case, firms must consider the impact on their operations—people, processes and systems—as well as review vendor solutions and industry infrastructure offerings when implementing solutions to address these new requirements.
If we take the derivatives market as an example, a report by Celent cited that half of respondents (48 percent) have not completed operational preparations to address the regulatory requirements for derivatives clearing and collateralisation. And, even among those firms that have made some preparations, 38 percent cited limitations with existing systems as a significant challenge. This situation will need to be addressed since an inability to efficiently manage and process collateral in the new clearing environment is likely to have repercussions on the ability to act on investment decisions.
Ultimately, we will see a growing number of firms adopt STP as well as an increase in the trend towards industry collaboration and community-based solutions as a cost-effective alternative to replacing legacy processes and systems at an individual firm level.
