Much like the private equity industry itself, the fund administrators that serve it are in clear growth mode. Where once, the majority of private equity firms kept all their operations in-house, a recent survey of private equity CFOs conducted by EY and PEI found that 61 percent of firms now outsource their fund accounting functions, with more planning to do so in the future. And while middle office outsourcing rates remain low, the survey highlighted a clear trend towards further use of third parties for areas such as portfolio company analytics. We spoke to Srikumar T.E., deputy CEO of Apex Fund Services, to gain his perspective on some of the key changes – past, present and future – to the industry and to discuss why regional nuances count when it comes to providing outsourced services.
Outsourced private equity fund administration services have long been a feature of the market, so why are firms now looking beyond their in-house teams?
My perspective is that much of this has to do with the make-up of the fund administration business. Until recently, many players were geared largely towards hedge funds – outsourcing rates have historically been much higher there because of the nature of their investments and the need for custody services. As a result, there were very few specialist private equity administrators who had the skills and technology to service the unique characteristics of a private equity fund.
The landscape has changed, with more services now tailored specifically towards private equity, so there’s a pull factor. Yet there are also a couple of major push factors. One of the biggest drivers is the increased reporting requirements of limited partners today. They need more detailed information in specific formats and they are seeking the comfort of a layer of independence in reporting. Regulatory change is also pushing firms towards outsourcing as items such as FATCA and CRS compliance require upgraded IT, which can be expensive to build and maintain.
Where are you seeing most demand?
There is clearly a greater percentage of smaller and medium-sized houses looking to outsource, although demand is actually across the board. Some larger houses are also looking at this because, even if they do have the firepower to build big, in-house teams and invest in IT, they are facing continued pressure on fees, which can make the need for constant technology updates prohibitively expensive.
With the smaller and medium-sized players, there’s a move to outsource all fund administration services, while at the larger end, many firms are choosing from a menu of options and will often have in-house teams and infrastructure plus external providers and these act as a buffer for each other.
So what are the reporting requirements of LPs now? In what ways are their needs changing?
They are seeking more granular information from their GPs. So, that might be deal-by-deal IRR, transparency in allocation of fees or more information on investment holding structures. The point is they need it in a timely fashion and in a format that they can use. This means that GPs are having to report according to ILPA templates, in some instances, or according to whatever other format an LP may require. That takes either much more sophisticated technology than many GPs have access to or it requires an awful lot of manual work, much of which will have to be duplicated several times over.
THE TECHNOLOGY DIMENSION
New software is providing LPs with greater transparency on valuations, says Srikumar T.E.
LP demands and the need for regulatory compliance are increasing the need for powerful solutions. The rise of automation is enabling GPs to produce data according to many different templates and to synchronise data at increasingly granular levels, while also consolidating information at a higher level. Yet it’s not just automation that’s proving powerful. Technology is starting to emerge that will enable increased customisation so that individual GP and LP information needs can be met.
The next big development will be on asset valuations. Most GPs still conduct these in-house, but there is now scope for them to outsource this to a fund administrator via a platform that can not only update asset valuations efficiently, but also provide LPs with greater transparency – they can understand better which valuation models are being used and tell from which stage the reports they are receiving have been drawn.
While GPs can source many of these technology solutions and run them in-house, the need for constant upgrades (not to mention the initial implementation) makes this an expensive undertaking. At the same time, while the technology is already here, the skills and talent required to test these solutions is in short supply – many GPs are weighing up whether they can recruit the right people and whether they really want additional staff to manage.
With these greater demands are you seeing private equity GPs increase the requirements they have for fund administrators?
Absolutely. And that’s where private equity specialist knowledge really comes in. Fund administration in PE is fundamentally different from what is needed by hedge funds. You can’t take a cookie-cutter approach. There needs to be a level of flexibility in the way you service private equity clients – it’s not a commoditised business where you have, say, 5,000 people based in India or China doing the work. You need to be capable of producing bespoke reporting across a variety of private equity fund strategies to offer a real value proposition for private equity. You also need to take account of the different regional nuances if you are to build a business of scale.
What do you mean by regional nuances?
The private equity market is not uniform globally. Different regional markets have different dynamics, characteristics and investment preferences. In the Middle East, for example, there is a high affinity to investing in real estate through private equity funds and, more recently, REITs that have launched over the last 12 months.
There is complexity in the level of detail and granularity that needs to be recorded in this type of investment. It requires collecting data and reporting it right down to the property level, including rent collection. Firms based in the Middle East have traditionally therefore been open to the idea of outsourcing. They also value the independence a fund administrator can bring as this provides a level of comfort and reassurance to their global investor base.Asian GPs have historically also been very open to outsourcing, although for slightly different reasons.
So what are the nuances with Asian GPs?
The Asian private equity market is different. A lot of capital has flowed there from local LPs, unlike with open-ended funds and hedge funds in Asia, and so it’s not necessarily the comfort factor that comes into play here. However, many of these firms run small funds, yet make investments across a number of different jurisdictions with different tax regimes and local compliance requirements. This makes administration complex.
There are also a lot of new GPs in Asia – and it’s often the case that newer fund managers tend to opt for outsourcing so they can hit the ground running. Singapore and China, for example, have many new GPs, including large numbers of venture capital funds as well as buyout houses.
So if both of these markets have been very open to outsourcing, what are you seeing in some of the more traditional private equity markets?
We’re seeing a big uptick in outsourcing in the Americas, a region that has been slower to use third-party services. Canadian investors, for example, have largely concentrated on local real estate, but that is now changing as they are looking internationally. In the US, many mid-market houses are now outsourcing to upgrade their operating environment through improved technology. They want to ensure they are adhering to best practices, managing their internal teams effectively and are more nimble.
European managers, meanwhile, are the most regulated of all with the implementation of the AIFMD. This has had some taxation implications because of the substance requirements in the jurisdictions in which their funds operate. Many firms are now trying to outsource as much as is legally possible and, as a result, the European Union is where we see the greatest trend of larger private equity houses moving towards third-party administration.
Given all these nuances, how can fund administrators service the different needs of private equity clients globally?
First, you really need on the ground presence to appreciate the nuances locally. Yet the fact is that private equity is also a global industry today, with investors committing from different regions and investments being made across different jurisdictions, so it’s hard to be a single-region fund administration player. At Apex we have a network of offices worldwide to service clients’ needs seamlessly – you have to be able to follow a fund that may be established in one jurisdiction, with investors in a different jurisdiction and the assets in yet another.
What do you think will be the most significant trends in private equity fund administration in the coming few years?
Private equity has had a dream run over the last few years. The industry has performed well and this has resulted in increased allocations from pension funds, endowments and other institutions. At the same time, many new investors have emerged over the last 10 to 20 years in regions such as Asia. There is $327 billion of money set to come towards the industry over the next few years from Greater China alone. The pace of change in the industry may well be much faster in the years to come.
Yet the flip side to this success is that regulatory pressure is likely to increase significantly, too. Unlike hedge funds, private equity has largely been left to its own devices in markets outside the US and Europe. The fact is that the industry is now much more dispersed than it used to be as it has reached all the corners of the globe, so it’s inevitable that compliance will upgrade too.
Where do you think increased regulation is likely to bite most?
I think we’ll see moves to engender greater accountability from the private equity industry worldwide, but particularly in emerging and newer markets where there are currently fewer rules and guidelines than in more established markets such as North America and Europe. The capital call default process has never been tested in the Chinese market, for example, so there is no legal precedent set there. Regulations will inevitably develop and tighten and the industry will need to grapple with these, coupled with more data protection issues, greater calls for transparency as well as more frequent valuations that are independently conducted.
This article is sponsored by Apex Fund Services and appeared in the Perspectives 2018 supplement in the December 2017/January 2018 edition of Private Equity International.