Gavin Tobin, global head of private equity fund administration at Deutsche Bank, is sympathetic to the plight of fund CFOs.
He notes that there are more regulations than ever before, constant new threats and customers’ requirements are ever more varied – reflecting the increasing diversity of the private equity investor base.
“In recent years the number of regulations has been relentless,” says Tobin. “As a result, the burden of reporting to various regulators is much greater than it was five or six years ago.”
However, Tobin makes clear that for CFOs wanting to shoulder this load within the firm, there are no easy answers; only questions. Should they take on new people? How much will that cost? Can the fund manager’s small personnel function cope with this? “It’s hard for CFOs to hire, maintain and deal with large teams of back-office staff in-house, and all the HR issues that go with it,” he says.
Tobin’s answer is not to outsource everything indiscriminately to a third-party fund administrator, but to look at what should go out and what should stay in-house because it is what a private equity fund does. “I want managers to be able to focus on being managers,” he says. “That’s what they’re good at.”
Top of the list of the regulations which private equity fund managers have recently had to deal with for the first time are the Alternative Investment Fund Managers Directive (AIFMD) in the EU and the Dodd-Frank Act in the US which brings the burden of transparency reporting to regulators for managers, says Tobin.
Asked for an example of why these rules make life more complex for fund managers, he cites the requirement under AIFMD that non- EU managers marketing into Europe could have 28 different variants for their Annex IV reporting.
Unfortunately, however, the directive does not remove the time-consuming idiosyncrasies of different national rules, Tobin points out. For example, a non-EU fund marketed in Germany needs a depository lite solution – but this is not the case in other markets in Europe.
Asked about new threats, Tobin mentions cybersecurity. Many fund managers have taken much greater notice of this over the past couple of years, after high-profile incidents such as the theft of the names, contact details and credit card information of tens of millions of customers of Target, the US retailer, and the leaking by hackers of sensitive emails written by executives at Sony Corporation, the Japanese conglomerate.
“Cybersecurity is a real hot topic, particularly with regulators,” says Tobin – citing recent notices from the SEC and European regulators. Regulators are expecting managers to have a strategy to prevent, detect and respond to cyber security threats. “Fund managers have to deal with the more sophisticated type of hacker, who might want to steal data on investors, or acquire information on funds’ investments.”
Poor cybersecurity could, he warns, lead to disaster: “Managers should be very concerned about the reputational risks of any data leaks as well as the legal and regulatory implications.”
Moving on to the issue of the customer requirements of investors in private equity, Tobin has noticed a growing desire for customised reporting. For example, “investors might want quarterly, year-to-date or even inception-to-date reporting. It’s quite different from client to client”.
How should fund managers decide what to outsource and what to keep in-house? “Where a third-party administrator can add value is in the low to medium complexity tasks,” says Tobin.
He gives several examples of such functions that can be outsourced, across the range of a fund manager’s activities. On the accounting side, partnership accounting and financial reporting these include audit co-ordination and the generation of the annual statutory accounts. Day-to-day fund operations that can be done by an expert fund administrator include the cash management, vendor payments and performance reporting. Third parties can also take over much of the administrative interaction with investors, including their requirements for customised reporting, as well as processing investor capital calls and distributions.
The functions that should be left in-house are, says Tobin, “the real high risk items”, such as fund structuring, asset valuations, financing and hedging.
The rationale for outsourcing is based largely on what Tobin calls “scalability”. He notes that even relatively simple issues can be labour-intensive for fund managers whose small scale means they do not have specialists with intimate knowledge of each task. However, for a large third-party administrator such as Deutsche Bank, the scale of the teams dedicated to a particular issue means that each task can be done very efficiently.
He gives financial reporting to investors as an example. “We have specialist report writers who can provide customised reporting,” says Tobin. “If a fund manager only has three or four people in the administrative team, it won’t have a specialist in-house.”
Tobin argues that for low and mid-complexity tasks, the huge spend and skill base of a firm like Deutsche Bank means that clients should not just be thinking about cost efficiency – an outsourced expert can do things more cheaply – they should also be thinking about performance; they can do things better.
A good example of this is cybersecurity. “Banks have very strong and well-defined processes for cybersecurity, given that their industry is highly regulated,” says Tobin. “For example, Deutsche Bank has leading edge solutions in data protection, and specialist departments whose sole function is to protect bank and customer data.”
Clients can shelter under the strong and large protective wing of an outsourced cybersecurity platform and the control functions that surround it..
The scale of the operations also means expertise in the new swathe of regulations. By contrast, for fund managers, “if you have a small team it’s hard to keep abreast of ever-changing regulations”, says Tobin.
As a large third-party administrator, Deutsche Bank can guarantee a constant, unvarying level of expertise in each regulation or function, adds Tobin, who warns fund managers against making any such cosy assumptions about their own back offices. “If somebody leaves a fund manager’s small team, the chances are that this is a key person,” he says.
In theory a fund manager can make life attractive enough to retain back-office staff. However, in practice, “it’s difficult for fund managers to offer the career path in back-office work that a big administrator like Deutsche Bank can provide”.
Sceptics might argue that in many industries, clients do not want outsourcing. However, Tobin points out that in private equity, they tend to be keen on it. “For some functions, a degree of independence gives investors comfort,” says Tobin. “They’re not totally reliant on that manager to make the best decision and also report on it.”
In other words, there are things that an investor would probably be shocked to find outsourced: the core issues where private equity fund managers have special skills. On the other hand, there are some things that an investor might well be disappointed to find done in-house, by back-office teams that don’t have the scalability or the controls framework.
Finally, Tobin emphasises that once the fund manager has decided to outsource functions, the quality of the relationship between fund manager and service provider is key. “If fund manager CFOs use a third-party administrator, it’s important for them to view it as an extension of their own team,” he says. “They really need to work together, and the fund manager should give feedback on whether a particular service is good, bad or indifferent so that the administrator can deal with any perceived shortcomings.
“Open and honest dialogue is the best way forward.”
This article is sponsored by Deutsche Bank and first appeared in PEI's Fund Administration supplement, published in June 2016.