How has the financial crisis affected the market in Dublin?
There is no doubt that the market environment in the financial services sector over the last few years has taken its toll, and the fund sector is not immune to it. That said, the impact has not been as significant as with some other sectors. We see the Irish fund industry growing both in terms of assets managed and number of funds serviced. That’s testament to the way the industry in Ireland has positioned itself over the last twenty years and the body of experience that has been developed. HSBC Securities Services in Ireland has some major ongoing projects in migrating new business to our Dublin office, which will establish us as the hub for alternative fund services globally. This is a strategic decision that enables us to continue to invest the significant sums we need to invest in our product, in an ever-changing regulatory environment where demands on service providers will increase exponentially.
In my view, Ireland will continue to have a reputation for being the European domicile of choice. This is especially true for alternative fund managers, for a number of reasons. Firms are now operating in a tougher financial environment and the previous challenges we had in Ireland around staff turnover and cost base control have eased considerably. The knock-on benefit is that it has enabled firms here to become more competitive in the global fund industry. This is supported by the fact that managers continue to gravitate to a jurisdiction where the regulator is considered efficient and the service providers understand their product. The absence of a language barrier also helps. If you look at things from an investor perspective, managers that are targeting an institutional European investor base require regulated or listed products. This leads to the final point, which is related to the regulations coming downstream, and which plays nicely into the product set on offer in Ireland.
The statistics would appear to reinforce the above view. According to Irish Funds Industry Association figures, Ireland is the number one centre globally for the servicing of hedge funds, serving some 40 percent by assets of the world’s hedge funds. In fact, Ireland attracted nearly twice as much as all the other jurisdictions put together during 2011.
What’s your opinion on AIFMD and its effect on the industry?
At HSBC, we are pressing ahead with our preparations for implementation because our clients will need to know our response. We have until 22 July 2013 to put AIFMD into practice across our European network.
As a large universal bank with a substantial network of sub-custodians, we are well placed to deal with the liability requirements as many of our own HSBC entities are acting as sub-custodians, and the operational complexity and oversight responsibilities that will be thrust on the depositary. Oversight, look-through, reconciliations and cash monitoring are all functions that the traditional administrator has not had to focus on too deeply because the board of the fund had responsibility.
The relationship between the depositary and the prime brokers has not yet been fully defined and so there will be grey areas where people will be guessing for some time. The legislation promises complete investor protection but it comes at a cost, a cost which the industry has not yet fully surfaced. Whether investors wish to have this level of protection remains to be seen. Proportionality and relevance has been largely ignored.
There will undoubtedly be managers who choose not to market to European investors due to the additional cost of these regulatory requirements. At the same time, there will also undoubtedly be managers who re-domicile funds into Europe to attract investors who demand they are AIFMD compliant. Although fund re-domiciliation is not a requirement of AIFMD, it is a trend that is gathering pace.
What additional services are asset managers looking for?
The hedge fund industry continues to move towards the institutional model, driven in many cases by regulation, risk management and investor demand. Correspondingly, there is an increased focus on managers seeking to maximise their variable cost base and minimise their fixed cost base.
We have witnessed an increased appetite for our alternative middle-office offering, an area where we are making significant investment. Managing the changes to the OTC derivative model on the back of the US Dodd-Frank Act and the EU’s EMIR provisions will be key. Similarly, FATCA requires significant attention for managers and service providers alike and will require additional support with investor classification, withholding and annual reporting requirements.
An ability to fully service managed accounts is now a basic requirement for any hedge fund administrator, enabling our clients to respond to the increasing investor demands for transparency. In such cases, a cost effective operating model is key and an ability to leverage global talent pools represents an increasingly important component of the offering.
Are asset servicing firms becoming more specialised?
Most of the bigger servicing firms are broadening their offering rather than becoming more specialised. As managers are focusing on producing alpha and managing tail risk, they are looking for their administrator to provide a broader offering (the build-out of middle office and collateral management services being a typical example).
Outsourcing from the big providers are more driven by the aim to create efficiencies in the processes, for example, by using offshore locations for processing, vendors for distribution of investor statements and annual reports. To reduce valuation risk and provide truly independent pricing, there is probably also an increased use of external pricing vendors, along with the development of internal pricing capabilities, which only the top-tier providers can accommodate (and at that, only those with a global markets division can claim to be leveraging an existing infrastructure/knowledge base).
How do you cope with very illiquid assets in terms of valuation?
HSBC has significant experience in this area, with a dedicated OTC valuation function, headquartered in Dublin since 2005.
This function works with our expanding complex client base to ensure that the valuation of illiquid assets is undertaken in a manner that meets the increasing needs of regulators, auditors and ultimately investor requirements for valuation transparency and increased independence.
Are administrators developing their own independent pricing models?
Only the top-tier providers have the ability to attract the intellectual property and technology to enable them to put in place pricing models for complex instruments.
Even then, only a select few can claim to leverage off of the pricing models in place in their global markets divisions. At HSBC, our dedicated valuation function leverages complex instrument valuation expertise and knowledge from our quantitative risk and valuation group, within our global banking and markets division. This includes independent model review and development of analytic solutions.
Clients require service providers that can assist with the need for increased price transparency and have the ability to calculate independent internal valuations, as opposed to relying solely on external vendors.
Significant investment has been made in our operating model, implementing Calypso (a cross asset class platform) that allows us to handle large volumes of OTC instruments. It allows multiple valuation points intra-day and growing scale without large increases in headcount. Some fund administrators have attempted to address instrument complexity by building spreadsheet solutions rather than addressing the technology gaps. At HSBC, we are moving onto a fully STP technology platform, which improves turnaround time for responses that go back to our NAV accountants and verify complex instrument valuations, both for net asset values and collateral management purposes.
Previously, supplying the mark to market of an instrument would satisfy client and auditor requirements. In exceptional circumstances, additional assumptive data behind that price would be required. Much more data is now the standard requirement.
How much value can a third-party administrator add?
The last couple of years have been very challenging for managers, in terms of market conditions, compliance burden and regulation. A fund or money manager needs to be able to focus on what they are doing best—to generate alpha and value for their investors.
This is where a third party administrator can add value to your business. Firstly, consider counterparty risk. We continue to see increased scrutiny of administrators including more due diligence of their processes, controls and reporting. A strong brand is crucial. It gives investors a level of comfort that the organisation they are dealing with is a reputable organisation with an appropriate risk governance and compliance culture, that ultimately removes a headache for investment managers when it comes to investor due diligence. Brand and reputation remains key for hedge fund managers hoping to raise additional or new capital from investors, especially managers targeting experienced institutional investors.
Secondly, consider an administrator with a full service offering—core administration topped up with a full middle-office solution, so that clients can outsource partial or full back- and middle-office functions. The investment manager maintains the oversight function, but is able to leverage off the strength and scale of what the fund administrator can offer. Many of the top-tier administrators can offer end-to-end services similar to what we provide ourselves.
Thirdly, is the administration solely a product offering or can it be extended to a broader suit? Many managers find it valuable to partner with a provider that can offer access to global markets (for execution, financing and prime), corporate bank account and treasury services, wealth management solutions for the managers’ partners, and so on.
Will fund administrators have become 24-hour providers?
It depends on what client base the administrator is targeting. The number of hedge and absolute return funds requiring daily NAVs have increased and the pressure to deliver a flash NAV as early as 7 to 8am, makes it necessary to provide extended hours. Many providers, including us, leverage off offshore centres of excellence to support the NAV process overnight. At HSBC, we also have staff on early and late shifts on the ground in Dublin, in order to deal with the extended time coverage that is demanded by our client base.
Do you think consolidation will improve or reduce competition?
From a service provider’s perspective, I think the competition will intensify. The smaller independent players have been able to offer a nimble, often cheaper and more flexible product offering that has been attractive to alternative managers. They have built up a worthy client base over the years that is now appealing to the larger banks. By acquisition, the banks can get a better product, increase their asset base further and the economy of scale will drive down costs.
In summary, the fund service providers can expect to face a more competitive market with broader and better products that are offered at a reduced price. In contrast, for funds captured by AIFMD, it is generally expected that costs will rise to reflect the increased liabilities being sought by regulators. From a fund manager’s perspective, they may have fewer service providers to choose from in the future due to new capital requirements.
What’s the outlook for the hedge fund administration business?
The increased burden of fund manager compliance represents a challenge for the hedge fund industry, and in some cases an opportunity for the administration business.
The burden is such that it is likely to drive consolidation of hedge fund managers and service providers. Service providers that already have scale in their operations and infrastructure alongside highly developed compliance and risk capabilities will be particularly well placed.
The increasing requirement for service providers to demonstrate very strong capital credentials will also drive the service provider model toward the large global banks.
Generally, the cost of compliance across the value chain is going to raise the barriers to entry for smaller managers, and perhaps drive the market towards fewer, but larger, hedge funds.
← Previous interview
Brown Brothers Harriman
Jeffrey Holland
Next interview →
Moore Stephens Fund Administration
Nick Solt
Image: Shutterstock 
