1 Fund admin 2.0
Private equity fund administration has been slow to embrace the deluge of new technology on offer compared with adjacent industries. Until recently, it was not uncommon to find some relying on Excel spreadsheets and basic general ledger software packages.
But as pricing models shifted from billable hours to fixed transaction fees post-financial crisis, a need to maintain margins has led to a drive for efficiency and administrators are now embroiled in a technology arms race.
“If it takes twice as long to perform an action that means you are half as productive,” says Neil MacDougall of Silverfleet Capital, former owner of Ipes. “That is why technology is becoming so important.”
The approach to technology is twofold. Fund administrators are increasingly automating tasks such as cash movements and reconciliations to meet growing demands without costly team expansion. Second, in response to growing LP pressure, they are investing in data analytics.
2 LP pressure
Limited partners are becoming increasingly sophisticated — and demanding. They are no longer just interested in IRRs. They require a broader range of data points and greater level of detail, as well as the ability to manipulate data according to parameters such as vintage year, geography or sector.
“A significant change that we have seen over the past two years is administrators’ willingness to build data feeds straight into our systems,” says Michael Robertson of Aberdeen Standard Investments.
And while LP pressure has provoked fund administrators into belated action when it comes to harnessing data, it is also helping drive demand for third-party fund administration services in general.
LPs are placing a growing emphasis on operational due diligence. They are not only concerned with fund performance but with underlying governance and process and this extends to external providers. Indeed, there are increasingly instances of investors insisting that managers outsource fund administration as a condition of commitment.
“I can think of five occasions in the past year where firms have made the decision to outsource because an investor said they wouldn’t come in unless they did so,” says Melanie Cohen of Apex Fund Services.
3 Increased standardisation
The private equity industry’s ability to increase automation and deepen its data analytic capabilities has historically been thwarted by a lack of standardisation in the data available.
However, initiatives such as ILPA’s guidelines and templates are beginning to formalise market best practice around managing non-homogenous data in a consistent manner, meaning the potential for further automation is now significant. Some administrators believe as much as 70 percent of labour involved in manual processes can be reduced.
4 The advent of AI
Despite some improvements in standardisation, the use of emerging technologies such as AI is still extremely nascent in the illiquid part of the fund admin industry. Blockchain is in a similar position. An independent record which can be seen by all authorised parties would make sense, but questions remain around who would store that record independently and securely.
However, according to Sam Metland of Citco Fund Services, there have been some strong use-cases of machine learning. “In the AML area, large administrators receive hundreds of scanned passports every day, for example,” he says. “There is a tool being shown to the market that learns the standard features and layouts of the variety of passports around the world and then can alert humans to any that seem odd. It can also extract the required data from the scan more efficiently and accurately than humans.”
With more and more data now available – and critically in the cloud rather than on-premises storage facilities – the onus is on fund administrators to ensure the highest standards of cybersecurity. Both managers and the investors that sit behind them are increasingly scrutinising the security credentials of service providers and having basic accreditation in place is the minimum standard expected.
A comprehensive audit trail around data management, password management, multifactor authentication and single sign-on solutions is critical. “We get asked about how data will be held in terms of hosted services, for example, as well as who has access to that data,” says Iain Robertson of eFront. “Clients are doing much more stringent due diligence with a view to understanding the security models. Having ISO 27001 is an absolute prerequisite.”
6 Fresh faces
The advent of new technology in the fund administration space has the potential to radically alter the proposition that administrators offer. With more of the mundane being automated, the industry must carve out a new value-added role for itself and this means that staffing requirements are changing. Fund administrators are hiring fewer accountants and are, instead, recruiting risk and compliance experts, as well as data analysts. “In a nutshell, we are hiring more technologists,” says Justin Partington of IQ-EQ.
Scott Kraemer at Vistra adds: “There has been a change in the types of people we are hiring. We are looking for broader skill sets. Being a great accountant is one thing, but it is just as important that you understand where the inputs are coming from and what the outputs are going to be used for. People have to be technology-focused, for sure.”
In addition to the impact of new technology, a proliferation of complex regulation has also led to administrators staffing up their specialist teams in this area, as well as increasing investment in training to maintain accreditations.
7 M&A mayhem
High cash conversion, margins and growth rates have lured investors into the fund administration space for years. As some administrators, such as JTC, successfully make the leap on to public markets, the appeal is only growing. But acquisition activity amongst administrators themselves has really hotted up over the past 24 months.
Recent deals of note include Vistra’s acquisition of Radius; IQ-EQ’s acquisition of Augentius and Apex’s acquisition of IPES.
In addition to jostling for jurisdictional access, fund administrators are chasing scale to facilitate technology investment; to lower overheads, while maintaining margins, and, in some cases, to attract buyers.
For managers and their underlying investors, mergers and integrations can sometimes mean disruption, with both LPs and GPs warning that administrators must work hard to maintain service levels during this period.
Consolidation has also resulted in a pronounced polarisation. “The biggest players are mopping up the market, while a handful of boutiques remain,” says Simon Gordon at JTC. “The danger is that the industry giants focus their attentions on mega-cap managers, while the smaller players only have the resources to service the smallest funds. Mid-market firms could find themselves under-served.”
8 Regulation, regulation, regulation
Staying one step ahead of the latest regulatory changes is, of course, paramount and the industry is certainly being kept on its toes. The tangled web of single jurisdiction, regional and global regulation is becoming increasingly hard to navigate and this is whipping up demand for fund admin outsourcing.
The base erosion and profit shifting initiative; Common Reporting Standards; rising anti-money laundering standards; GDPR; FATCA; AIFMD II and any number of other ominous anacronyms are all driving GPs into fund administrators’ arms.
9 Domiciling decisions
The percentage of private fund managers who plan to use Luxembourg for their next launch has risen, according to PEI’s fund manager survey.
One of the most significant impacts of the changing regulatory environment has been the relative dominance of domiciling destinations. Ongoing uncertainty surrounding third country passporting rights — initiated by AIFMD but exacerbated by Brexit indecision — has led to some managers considering relocation. While many are happy to sidestep onerous regulatory overheads by making use of the national private placement regimes offered by offshore jurisdictions, a growing number are heading onshore to secure AIFMD compliance and hedge against Brexit.
Pressure from some LPs to move away from offshore locations for reputational reasons has deepened the trend and Luxembourg has been the overwhelming beneficiary. For fund administrators, it has meant agility in the pursuit of appropriate licences and flexibility of resource. Access to the explosive Luxembourg market has also been a key driver of M&A.
10 Outsourcing soars
Each of these key trends — access to costly technology, rising investor demands, as well as complex regulation — are driving private equity firms to outsource their fund administration in growing numbers.
Indeed, while European uptake of third-party administration has been pervasive for some time, a lower regulatory burden means the US market has historically lagged. This is now changing as US managers wake up to the raft of direct and indirect regulation they are exposed to.
“Europe is at the forefront but it is a global trend,” says Emmanuel Raffner at Alter Domus. “Managers are facing regulatory pressure, technology pressure and reporting pressure. They want someone else to take on this pain so they can focus on what they are paid to do — invest and divest.”