With an ever-increasing emphasis on transparency and timeliness of information flows, the issues of balancing outsourcing with substance are now top of the agenda for most CFOs and COOs. Existing operating models are under pressure, and maximising efficiency has become critical. At our Client Forum in London we identified the key challenges and the steps being taken to meet these challenges.
The increasingly time-consuming task of responding to complex and detailed data is driving a move towards greater outsourcing, particularly in areas such as reporting activities and data driven requirements. However, while decision-makers are trying to free up time to focus on value-added work, a big concern is how to find the right balance between outsourcing and substance. And, as substance is very much in the spotlight with authorities clamping down on any perceived weakness in the area, it is a question that needs careful consideration.
Substance is now less about people and more about responsibilities and corporate governance: what is the process, and are the right people in place to demonstrate genuine local decision-making powers? What we are seeing today is that increasingly fund controllers are sitting in local jurisdictions with the bulk of back office activities delivered by service providers.
The AIFM licensing requirements are seeing the emergence of two new operating models: funds are either creating their own in-house AIFMD-authorised management company or seeking a third-party manager. The in-house model allows fund managers with an operational presence in the EU to establish a licensed AIFM entity in their home jurisdiction, where the portfolio and risk management is actually carried out, or in the jurisdiction where the investment vehicles are domiciled.
The need to hold fund board meetings to discuss all investment decisions can create a ‘fly in, fly out’ situation. That can work when investments are low, but for debt funds, where there is a lot of investment activity, it presents a practical problem. While both models focus on substance, being licensed in your ‘vehicle’ jurisdiction with the right people in place strengthens the substance argument, whereas entities licensed in their home jurisdiction will struggle to demonstrate substance.
QUESTIONS OF TRUST
Following the introduction of the AIFMD, fund boards have a very different role to play, including new risk management responsibilities and the need to demonstrate genuine independence. Inevitably this has changed the relationship between portfolio managers and fund boards. Where once fund boards could be seen to take a relatively ‘hands-off’ approach, today they must examine investment decisions in greater depth and be confident that fund managers are making the right choices. This shift in responsibility can raise questions of trust as investment managers may wonder if fund boards are demonstrating independence or caution.
It also generates considerable data requests as boards seek clarity and understanding at every level of the decision-making process. This presents a huge educational challenge with more steps and processes for portfolio managers to follow. However, investment teams must be made aware of just how significant the role of the fund board is, where responsibility lies and what they must do to ensure they are getting it right. While it can put additional pressure on their time, it is essential to establish a clear and simple process to ensure investment teams do not become choked by administration.
In addition to the challenges of choosing the appropriate operating model, pressure is also building significantly from investors. On one hand, they are seeking higher returns through increased diversification between asset classes and geographical regions. At the same time, they are demanding broader and more detailed information about the fund’s investment decisions. This growth in the ‘informed investor’ can be seen at every stage of the investment process. The level of detail they require can be overwhelming as they seek maximum transparency and absolute clarity.
Both developments, with investors seeking greater diversification and detail, have a substantial impact on operating models. The information flow is substantial, and relentless, eating into time and resources. But it is an essential and integral part of today’s investment world and managers must implement processes and procedures to ensure it runs as smoothly as possible. However, while the right processes may be in place, it also takes the right people to be in place together with a flexible platform. Without this the risk is that so much time and effort is spent on meeting investor demands that there is little capacity to service bolt-on investments or capture new opportunities in an efficient and effective way.
As managers and back office teams struggle to meet increasing investor demand, including the expectation of more face-to-face time at every level, one clear trend is emerging: an increase in separately-managed accounts for large investors, typically replicating the fund but perhaps also exploring areas and opportunities that the fund’s investment parameters do not allow. This brings a whole new set of operational challenges for the fund manager.
At least for now, the dream of being able to push a single button to bring together layers of data from multiple jurisdictions, systems and sources into one coherent report is just that – a dream. While the need for more, smarter, faster technology is evident it must be balanced with the costs involved and CFOs and COOs are debating whether to invest in technology and transactional systems or to partner with a service provider, leveraging an existing relationship.
While technology is the means by which information flows, the biggest challenge comes from integrating the wide variety of systems in use as investment structures span many jurisdictions. Factoring in multiple service providers, in multiple jurisdictions, for fund managers with a range of different systems, the true extent of the technology challenge becomes clear.
As an initial response to this challenge, and in the absence of a single button, companies are looking to build ‘global data libraries’, cataloguing in detail the reporting requirements, deadlines, processes and multiple systems of jurisdictions, investors, stakeholders and authorities around the world. While it is a comprehensive approach to a fragmented and ever-changing regulatory and fiscal environment, the scope and frequency of ad hoc requests continues to challenge traditional operating models.
Against this background decision-makers must weigh up the balance between opportunity and operational ability. Opportunities may be everywhere, but if the platform and infrastructure does not have the flexibility to cope with a new or different process, it can lead to operational problems.
FINDING THE RIGHT BALANCE
Outsourcing is no longer a question of ‘should we, shouldn’t we?’ it is now a question of defining what aspects can be outsourced in order to deliver an efficient and compliant service. Typically, regular reporting activity is outsourced freeing up time for more value-added work.
The sheer demand for data drawn from multiple layers of fund structures and frequently a range of jurisdictions for regulatory purposes is overwhelming – on top of the detailed information investors require. As operating models adapt to optimise efficiency in the face of these challenges, service providers too are evolving to meet the complex needs of their clients.
• New opportunities must be balanced with operational ability
• Asset managers are turning increasingly to ‘home’ licensing
• Global data dictionaries are being developed to manage reporting
• Do fund boards demonstrate real independence, or caution?
Alter Domus is a leading provider of fund and corporate services, dedicated to international private equity and infrastructure houses, real estate firms, private debt managers, multinationals, capital markets issuers and private clients. The vertically integrated approach offers tailor-made administration solutions across the entire value chain of investment structures, from fund level down to local Special Purpose Vehicles.
Founded in Luxembourg in 2003, Alter Domus has continually expanded its global service offer and today counts 31 offices and desks across five continents. This international network enables clients to benefit globally from the expertise of more than 900 experienced professionals active in fund administration, corporate secretarial, accounting, consolidation, tax and legal compliance, depositary services and debt administration services. Alter Domus serves nine of the 10 largest private equity houses, six of the 10 largest real estate firms and three of the 10 largest private debt managers in the world.
This article is sponsored by Alter Domus. It appeared in the Operational Excellence Special published with Private Equity International in October 2016.