States of change
18 Oct 2023
As the US fund administration landscape shifts, market participants share their thoughts on the SEC’s actions, the state of the market, and where they think fund administration will go next
Image: andriy_blokhin/stock.adobe.com
New rules
In August of this year, the U.S. Securities and Exchange Commission (SEC) adopted new rules for the regulation of private fund advisers, alongside amendments to existing rules, with the intention of improving transparency, competition and efficiency across the market.
“Improved transparency will benefit both investors and regulators,” says Timothée Raymond, head of innovation at Linedata. With increased access to information on the funds they are invested in, investors are able to make more informed decisions and can better understand a fund’s strategies, risks and fees, potentially improving trust in fund advisors.
“From a regulatory perspective, increased transparency allows regulators like the SEC to have better oversight of private funds,” he continues. Regulatory compliance is easier to keep track of, and fair treatment of investors can be monitored more effectively. “This, in turn, can contribute to the overall stability and integrity of the financial markets.”
Alongside that stability should come increased investor and market confidence, enhanced investor protection, improved market efficiency and capital allocation and greater accountability for fiduciaries, according to Sonia Bhasin, general counsel at MUFG Investor Services. “The increased cost of compliance is on everyone’s mind, however one hopes that the benefits to the industry as a whole will outweigh the costs,” she says.
Following the announcement, private fund investors registered with the SEC must provide quarterly statements to investors including information on fund fees, expenses and performance, in addition to annual financial statement audits on each of the private funds they advise and a fairness or valuation opinion.
Sean Wilke, senior managing director at IQ-EQ, suggests that this element of the new requirements could prove “burdensome” for fund advisers, administrators and other service providers alike. “Much of the new private fund rules is simply a codification of existing informal requirements, particularly with regard to disclosure obligations,” he explains, but these reports could “materially impact fund sponsors’ operations”.
Rich Clark, managing director of regulatory solutions at SS&C Technologies, affirms that “managers need to be prepared”, making decisions now in order to strengthen their compliance operations and minimise disruption later down the line.
Rules around preferential treatment have tightened, with any such behaviour banned if it could have a negative impact on other investors. Investor protection has also been bolstered with the restriction of private fund adviser activity that acts against the public interest and investor protection. Advisers cannot charge or allocate certain investigation costs to a private fund if a sanction for a violation of the Investment Advisers Act of 1940 and its associated rules is in play. However, these rules are not set in stone. Certain preferential treatment will be permitted on an disclosure-based exception, so long as current and prospective investors are made aware of preferential terms, and certain restricted activities are permissible following specific disclosures and, in some cases, investor consent.
The SEC has adopted legacy status provisions for certain restricted activities and preferential treatment provisions in order to avoid renegotiations around existing funds’ governing agreements, covering such agreements entered into in writing before the new rules go live.
“For now, the primary impact of these changes is on the investor-adviser relationship,” says Linedata’s Raymond. “These initial changes are just the beginning of what appears to be a broader regulatory focus on private funds,” however “if this trend continues and begins to resemble the regulatory oversight experienced by retail mutual funds, it could indeed have a more profound impact on our operations and the private fund industry as a whole,” he adds.
While there are certainly benefits to be reaped from the changes the SEC has laid out, some, like IQ-EQ’s Wilke, are not certain about their “staying power”. Due to legal issues around the implementation of the rules — namely a potential breach of the Administrative Procedure Act — a number of private fund industry groups and political organisations have taken action, he explains. A petition has been established to instigate a judicial review of the commission’s actions and potentially invalidate the regulation.
As such, “the outcome of the new regulations are in peril,” Wilke states. “Until we have greater clarity, the industry will be paralysed on what steps will be necessary to bolster their compliance programmes.”
Goodwin Law’s Larkin and Peltz state that “we will be watching to see whether the rules are adopted substantially as proposed, tempered in minor ways, or revised in material ways”.
They reflect that, during Gary Gensler’s tenure as chair, the SEC has released an “incredible number of rule proposals” that are notably “aggressive”, and suggest that the approach taken with the adoptions of these rules “could give an indication” of how other proposals will be implemented.
There have already been a number of changes between the private fund adviser rules outlined in the February 2022 proposal and the August 2023 go-live, with the actual changes less harsh than their original counterparts. Wilke agrees: “Anticipate potential revisions. The SEC may consider a more tempered version to address any ambiguities and concerns.”
Compliance is crucial
Beyond the SEC’s actions in this case, compliance and pressure to keep up with regulatory change are inevitable issues in the financial service world, with a number of firms finding it difficult to keep up with their obligations.
Things are made even more complicated by the fact that “in the US, fund administration is not a regulated activity,” Frederick Shaw, US country head at Apex Group, explains. “Financial regulations such as the SEC and the Financial Regulatory Industry Authority (FINRA) do not have direct oversight over our activities.”
As a result, fund service providers like Apex are taking an individualised approach, “adapting to accommodate the varying needs of the clients we serve.”
Although regulations around transparency and communications may be particularly difficult to keep up with, as Linedata’s Raymond suggests, transparency is nevertheless “the hallmark of an efficient market”, according to IQ-EQ’s Wilke. It also provides “an inherent check and balance on the historically opaque private funds industry,” and can help limited partners to both better understand how a fund operates and to ensure their alignment with expectations without the confusion of manipulated fee, expense and performance calculations, he adds.
In the face of new requirements, private fund advisers must ensure that their reporting is timely, accurate and comprehensive; “maintaining a clear and auditable record of compliance is crucial,” Raymond states. There could be serious consequences if this isn’t achieved, with firms risking increased regulatory scrutiny and potential penalties as a result of their shortcomings. With any rule passage, the true ramifications are realised long after the initial passage,” Raymond continues; there will doubtless be headaches and gripes as new regulations are accommodated.
“It takes time for industry practice to coalesce,” Bhasin says, adding that ”in the current climate, compliance and legal teams are facing regulatory fatigue” exacerbated by increasing volumes of legal and regulatory changes. This latest batch of rules — the adopting release of which consisted of 656 pages, she notes — represent a great deal of work. “Compliance departments will need to prove they are maximising spend.”
Technology remains key
“Technology is undoubtedly the route to gain competitive advantage,” Raymond asserts, expecting to see reduced labour and increased automation in the space as time goes on. “A simple increase in labour is likely to be unaffordable and more limited in impact” he explains, a reality that much of the industry is preparing to accept.
“Innovation needs to be embedded throughout a business,” Apex’s Shaw states. Although investing in new technology is a risk, requiring “significant time, resource and capital investment from service providers”, not engaging with emerging technology use cases can leave firms lagging behind their peers. These “new and changing” technologies include more sophisticated AI, advanced machine learning and accounting reconciliation systems, Shaw says, all of which contribute to better-supported markets through improved transparency and better price discovery mechanisms.
Kin Lai, CEO of Amicorp, advocates for the use of Microsoft’s Copilot in fund administration processes. “It’s an amazing tool,” he says, and one that can “help us to deal with some of the questions we’re facing on a daily basis”. Incorporating this technology into operations can remove the need for a real person to be engaging in repetitive, low value-add tasks, freeing employees up to complete higher-level work and potentially increasing efficiency. Copilot is “an exceptional new feature” for the industry, Lai affirms.
Linedata’s Raymond highlights advanced workflow automation tools as notable additions to the private fund industry’s technology kit. These allow for many compliance-related tasks, including reporting, documentation and audit trail management, to be scaled and the chance of errors reduced.
This also helps firms to achieve the heightened transparency that new regulations demand, producing a digital record of compliance efforts.
In addition to this, Raymond reports that transparency initiatives are being strengthened by investor portals and reporting platforms. “Ultimately, fund managers are looking for real-time, comprehensible, and accurate tools to help them continue delivering for their clients irrespective of regulatory changes,” he says — something that these systems can grant.
Wilke believes that “as with everything, technology will lag behind automation” when it comes to the new SEC rule; “but it will eventually catch up”.
In agreement with Raymond, IQ-EQ’s Wilke anticipates fund administrators and service providers will streamline their processes and optimise efficiencies, but emphasises the need for more detailed, revised rules to be issued before the architecture of software solutions can be envisaged in more detail.
Educating investors
As the new SEC rules will necessitate quarterly and annual statements to be issued to clients, the way in which private fund advisers communicate with their clients may require a few tweaks. An influx of information can be less than useless if individuals are not equipped with the knowledge to understand it.
With the new SEC rules, this could be a particular issue for high-net-worth individuals, Wilke comments.
“Institutional and professional investors tend to be well-versed in fund operations,” but other clients may not have access to the same knowledge; “investor education will become more important” as their involvement with the funds they are invested in deepens.
“Investors will need to grasp the significance of the reports and disclosures provided to them,” Raymond comments, “particularly in cases where advisers seek their consent for specific actions.” Fund advisors may therefore need to provide “more comprehensive explanations and clarifications as part of their communication efforts,” ensuring that investors fully understand the increased frequency and transparency of information they are receiving.
Consolidate or go it alone?
In the US and beyond, recent years have seen changing ownership, mergers and acquisitions of fund administration companies. Apex Group has acquired a number of fund administrators in the past two years, including MJ Hudson, Mainspring and Sanne, while Waystone Group has continued to expand its reach — most recently with the addition of Link Fund Solutions in April 2023.
Explaining why this trend is so prominent, Shaw explains that “consolidation is a natural by-product of the maturity and evolution of an industry”. New market entrants join the industry boasting a differentiated offering and critical mass, and are left to decide whether to “go it alone or join a larger, more established organisation.”
The latter option is often appealing, allowing smaller, independent companies to benefit from process orientation, scale and technology, Wilke adds. “At some point, smaller fund administrators reach an inflection point where capital improvements are necessary to grow beyond boutique status,” he says.
“In order to penetrate the upper echelon, it is necessary to search for ways to both expand coverage areas and increase efficiency,” and these are more easily accessible with the investment, technology integration and experience of larger firms’ global management teams.
From the perspective of one of these firms, Apex’s Shaw notes that acquisitions must either improve the company’s capabilities and solutions offerings or allow them to expand their global footprint. “Whilst flexible enough to accommodate opportunistic situations, our acquisition strategy remains focused on only acquiring quality businesses which add a specific product, technology or geography for our clients,” he affirms.
The future of fund administration
“Fund administration, and the role of a fund services provider in general, is constantly evolving,” Shaw states. He predicts a continued focus on technology as the industry moves forward, along with an expansion in the range of services that clients expect from their service providers. “ESG reporting and regulatory services are becoming more important to our clients as the requirements of investors and regulators evolve,” he adds.
IQ-EQ’s Wilke draws attention to the SEC’s recently “increased vigour in terms of examinations, enforcement and rulemaking”, particularly around fast-moving topics such as AI and crypto.
Shaw adds that changing regulation that encompasses new products and industry growth is “critical” in a constantly evolving market. In order for “compliant and market-forward platforms” to run successfully, industry players must ensure alignment with regulations and have access to effective regulatory support, he says, allowing for the benefits of technology enhancements and developments to be maximised.
The SEC’s new rules have been embraced by some and met with scepticism by others, but as the industry evolves and becomes more complex, one thing’s for sure: the fund administration sector must prepare itself for change.
In August of this year, the U.S. Securities and Exchange Commission (SEC) adopted new rules for the regulation of private fund advisers, alongside amendments to existing rules, with the intention of improving transparency, competition and efficiency across the market.
“Improved transparency will benefit both investors and regulators,” says Timothée Raymond, head of innovation at Linedata. With increased access to information on the funds they are invested in, investors are able to make more informed decisions and can better understand a fund’s strategies, risks and fees, potentially improving trust in fund advisors.
“From a regulatory perspective, increased transparency allows regulators like the SEC to have better oversight of private funds,” he continues. Regulatory compliance is easier to keep track of, and fair treatment of investors can be monitored more effectively. “This, in turn, can contribute to the overall stability and integrity of the financial markets.”
Alongside that stability should come increased investor and market confidence, enhanced investor protection, improved market efficiency and capital allocation and greater accountability for fiduciaries, according to Sonia Bhasin, general counsel at MUFG Investor Services. “The increased cost of compliance is on everyone’s mind, however one hopes that the benefits to the industry as a whole will outweigh the costs,” she says.
Following the announcement, private fund investors registered with the SEC must provide quarterly statements to investors including information on fund fees, expenses and performance, in addition to annual financial statement audits on each of the private funds they advise and a fairness or valuation opinion.
Sean Wilke, senior managing director at IQ-EQ, suggests that this element of the new requirements could prove “burdensome” for fund advisers, administrators and other service providers alike. “Much of the new private fund rules is simply a codification of existing informal requirements, particularly with regard to disclosure obligations,” he explains, but these reports could “materially impact fund sponsors’ operations”.
Rich Clark, managing director of regulatory solutions at SS&C Technologies, affirms that “managers need to be prepared”, making decisions now in order to strengthen their compliance operations and minimise disruption later down the line.
Rules around preferential treatment have tightened, with any such behaviour banned if it could have a negative impact on other investors. Investor protection has also been bolstered with the restriction of private fund adviser activity that acts against the public interest and investor protection. Advisers cannot charge or allocate certain investigation costs to a private fund if a sanction for a violation of the Investment Advisers Act of 1940 and its associated rules is in play. However, these rules are not set in stone. Certain preferential treatment will be permitted on an disclosure-based exception, so long as current and prospective investors are made aware of preferential terms, and certain restricted activities are permissible following specific disclosures and, in some cases, investor consent.
The SEC has adopted legacy status provisions for certain restricted activities and preferential treatment provisions in order to avoid renegotiations around existing funds’ governing agreements, covering such agreements entered into in writing before the new rules go live.
“For now, the primary impact of these changes is on the investor-adviser relationship,” says Linedata’s Raymond. “These initial changes are just the beginning of what appears to be a broader regulatory focus on private funds,” however “if this trend continues and begins to resemble the regulatory oversight experienced by retail mutual funds, it could indeed have a more profound impact on our operations and the private fund industry as a whole,” he adds.
While there are certainly benefits to be reaped from the changes the SEC has laid out, some, like IQ-EQ’s Wilke, are not certain about their “staying power”. Due to legal issues around the implementation of the rules — namely a potential breach of the Administrative Procedure Act — a number of private fund industry groups and political organisations have taken action, he explains. A petition has been established to instigate a judicial review of the commission’s actions and potentially invalidate the regulation.
As such, “the outcome of the new regulations are in peril,” Wilke states. “Until we have greater clarity, the industry will be paralysed on what steps will be necessary to bolster their compliance programmes.”
Goodwin Law’s Larkin and Peltz state that “we will be watching to see whether the rules are adopted substantially as proposed, tempered in minor ways, or revised in material ways”.
They reflect that, during Gary Gensler’s tenure as chair, the SEC has released an “incredible number of rule proposals” that are notably “aggressive”, and suggest that the approach taken with the adoptions of these rules “could give an indication” of how other proposals will be implemented.
There have already been a number of changes between the private fund adviser rules outlined in the February 2022 proposal and the August 2023 go-live, with the actual changes less harsh than their original counterparts. Wilke agrees: “Anticipate potential revisions. The SEC may consider a more tempered version to address any ambiguities and concerns.”
Compliance is crucial
Beyond the SEC’s actions in this case, compliance and pressure to keep up with regulatory change are inevitable issues in the financial service world, with a number of firms finding it difficult to keep up with their obligations.
Things are made even more complicated by the fact that “in the US, fund administration is not a regulated activity,” Frederick Shaw, US country head at Apex Group, explains. “Financial regulations such as the SEC and the Financial Regulatory Industry Authority (FINRA) do not have direct oversight over our activities.”
As a result, fund service providers like Apex are taking an individualised approach, “adapting to accommodate the varying needs of the clients we serve.”
Although regulations around transparency and communications may be particularly difficult to keep up with, as Linedata’s Raymond suggests, transparency is nevertheless “the hallmark of an efficient market”, according to IQ-EQ’s Wilke. It also provides “an inherent check and balance on the historically opaque private funds industry,” and can help limited partners to both better understand how a fund operates and to ensure their alignment with expectations without the confusion of manipulated fee, expense and performance calculations, he adds.
In the face of new requirements, private fund advisers must ensure that their reporting is timely, accurate and comprehensive; “maintaining a clear and auditable record of compliance is crucial,” Raymond states. There could be serious consequences if this isn’t achieved, with firms risking increased regulatory scrutiny and potential penalties as a result of their shortcomings. With any rule passage, the true ramifications are realised long after the initial passage,” Raymond continues; there will doubtless be headaches and gripes as new regulations are accommodated.
“It takes time for industry practice to coalesce,” Bhasin says, adding that ”in the current climate, compliance and legal teams are facing regulatory fatigue” exacerbated by increasing volumes of legal and regulatory changes. This latest batch of rules — the adopting release of which consisted of 656 pages, she notes — represent a great deal of work. “Compliance departments will need to prove they are maximising spend.”
Technology remains key
“Technology is undoubtedly the route to gain competitive advantage,” Raymond asserts, expecting to see reduced labour and increased automation in the space as time goes on. “A simple increase in labour is likely to be unaffordable and more limited in impact” he explains, a reality that much of the industry is preparing to accept.
“Innovation needs to be embedded throughout a business,” Apex’s Shaw states. Although investing in new technology is a risk, requiring “significant time, resource and capital investment from service providers”, not engaging with emerging technology use cases can leave firms lagging behind their peers. These “new and changing” technologies include more sophisticated AI, advanced machine learning and accounting reconciliation systems, Shaw says, all of which contribute to better-supported markets through improved transparency and better price discovery mechanisms.
Kin Lai, CEO of Amicorp, advocates for the use of Microsoft’s Copilot in fund administration processes. “It’s an amazing tool,” he says, and one that can “help us to deal with some of the questions we’re facing on a daily basis”. Incorporating this technology into operations can remove the need for a real person to be engaging in repetitive, low value-add tasks, freeing employees up to complete higher-level work and potentially increasing efficiency. Copilot is “an exceptional new feature” for the industry, Lai affirms.
Linedata’s Raymond highlights advanced workflow automation tools as notable additions to the private fund industry’s technology kit. These allow for many compliance-related tasks, including reporting, documentation and audit trail management, to be scaled and the chance of errors reduced.
This also helps firms to achieve the heightened transparency that new regulations demand, producing a digital record of compliance efforts.
In addition to this, Raymond reports that transparency initiatives are being strengthened by investor portals and reporting platforms. “Ultimately, fund managers are looking for real-time, comprehensible, and accurate tools to help them continue delivering for their clients irrespective of regulatory changes,” he says — something that these systems can grant.
Wilke believes that “as with everything, technology will lag behind automation” when it comes to the new SEC rule; “but it will eventually catch up”.
In agreement with Raymond, IQ-EQ’s Wilke anticipates fund administrators and service providers will streamline their processes and optimise efficiencies, but emphasises the need for more detailed, revised rules to be issued before the architecture of software solutions can be envisaged in more detail.
Educating investors
As the new SEC rules will necessitate quarterly and annual statements to be issued to clients, the way in which private fund advisers communicate with their clients may require a few tweaks. An influx of information can be less than useless if individuals are not equipped with the knowledge to understand it.
With the new SEC rules, this could be a particular issue for high-net-worth individuals, Wilke comments.
“Institutional and professional investors tend to be well-versed in fund operations,” but other clients may not have access to the same knowledge; “investor education will become more important” as their involvement with the funds they are invested in deepens.
“Investors will need to grasp the significance of the reports and disclosures provided to them,” Raymond comments, “particularly in cases where advisers seek their consent for specific actions.” Fund advisors may therefore need to provide “more comprehensive explanations and clarifications as part of their communication efforts,” ensuring that investors fully understand the increased frequency and transparency of information they are receiving.
Consolidate or go it alone?
In the US and beyond, recent years have seen changing ownership, mergers and acquisitions of fund administration companies. Apex Group has acquired a number of fund administrators in the past two years, including MJ Hudson, Mainspring and Sanne, while Waystone Group has continued to expand its reach — most recently with the addition of Link Fund Solutions in April 2023.
Explaining why this trend is so prominent, Shaw explains that “consolidation is a natural by-product of the maturity and evolution of an industry”. New market entrants join the industry boasting a differentiated offering and critical mass, and are left to decide whether to “go it alone or join a larger, more established organisation.”
The latter option is often appealing, allowing smaller, independent companies to benefit from process orientation, scale and technology, Wilke adds. “At some point, smaller fund administrators reach an inflection point where capital improvements are necessary to grow beyond boutique status,” he says.
“In order to penetrate the upper echelon, it is necessary to search for ways to both expand coverage areas and increase efficiency,” and these are more easily accessible with the investment, technology integration and experience of larger firms’ global management teams.
From the perspective of one of these firms, Apex’s Shaw notes that acquisitions must either improve the company’s capabilities and solutions offerings or allow them to expand their global footprint. “Whilst flexible enough to accommodate opportunistic situations, our acquisition strategy remains focused on only acquiring quality businesses which add a specific product, technology or geography for our clients,” he affirms.
The future of fund administration
“Fund administration, and the role of a fund services provider in general, is constantly evolving,” Shaw states. He predicts a continued focus on technology as the industry moves forward, along with an expansion in the range of services that clients expect from their service providers. “ESG reporting and regulatory services are becoming more important to our clients as the requirements of investors and regulators evolve,” he adds.
IQ-EQ’s Wilke draws attention to the SEC’s recently “increased vigour in terms of examinations, enforcement and rulemaking”, particularly around fast-moving topics such as AI and crypto.
Shaw adds that changing regulation that encompasses new products and industry growth is “critical” in a constantly evolving market. In order for “compliant and market-forward platforms” to run successfully, industry players must ensure alignment with regulations and have access to effective regulatory support, he says, allowing for the benefits of technology enhancements and developments to be maximised.
The SEC’s new rules have been embraced by some and met with scepticism by others, but as the industry evolves and becomes more complex, one thing’s for sure: the fund administration sector must prepare itself for change.
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