Jul 24 2012
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Navigating in a rising tide
The global financial crisis has been a catalyst to regulatory change and fee pressures that are adding to the business burden of fund administrators. MENA Fund Review spoke to representatives from four leading firms about the challenges faced by the industry across the Middle East and North Africa and how it is rising to meet them
The fund administration business is becoming a complicated field to navigate, with increasing levels of regulation and growing demands from clients leading to a rising tide of compliance. A plethora of regulation is planned in the near future that will continue to impact the business, notably AIFMD and FACTA. This will further add to reporting requirements as institutional investors demand greater levels of transparency.
In conjunction with this, there are pressures on fees as a result of the difficult global financial conditions and resulting issues faced by asset managers. Despite these pressures fund administrators have reported a rise in business across the MENA region. MENA Fund Review spoke to Peter Dickinson, director, Sanne Group (Luxembourg), Dermot Butler, chairman, Custom House Global Fund Services, Arindam Das, regional head of the Middle East and Africa, HSBC Securities Services and Patricia White, managing director, Legis Fund Services about the issues faced by the fund administration business across the Middle East and North Africa.
What challenges does the fund administration industry face over the next 12 months?
Dermot Butler: The main challenge is compliance with the continued increase in regulation, both on behalf of the Administrator and in providing data and services to the client funds. Although Administrators will be doing a lot more work and should be able to charge more for their services, there will be fee pressure because of reduced returns.
Revenues are under pressure considering a fall in Assets under management (AUM) owing to increased cases of fund liquidation, winding up and a general lull in the market. This is specifically true for GCC or MENA investing funds, while the stock index within some markets within GCC have gone up the tendency of fund managers is to book profits by selling stock and either sit on cash balances or fund for redemptions in the fund. The lack of an "alternate" asset class of investment has also dampened investors sentiments (ie lack of a vibrant and liquid debt market) the minimum fees in most funds are indeed the sole revenue source for fund administration at any given point, while at the same time the cost of servicing a fund has increased with enhanced reporting requirements demanded by fund managers and their back office alike.
In the current economic environment the regulators have also re-looked at the regulations and are either in the process of a revamp or have already introduced this with a view to increase unit holders protection and transparency in the fund activities, which essentially then means that service providers are now expected to provide additional reports and disclosures New features within the fund like attribution analysis, performance analytics further means that systems and processes need to be constantly re-looked in an effort to keep pace with the changing demands of the funds industry.
Patricia White: While the debt crisis continues to plague the eurozone there is a constant fear of the continuing impact in the wider global economy. Concerns remain that the eurozone is in recession after GDP fell 0.3% in the final three months of 2011, with a further contraction anticipated in the first quarter of 2012. Manufacturing downturn is greater than expected and unemployment in the 17 countries adopting the euro has hit its highest since the currency began in 1999. The UK slipped back into recession with the economy contracting by 0.2 per cent in the first three months of the year following a 0.3% decline in the last quarter of 2011. While the Guernsey funds industry is faring well given the financial climate, new fund launches continue to take longer to get to market as fund raising and borrowing remains difficult. Investors are taking an extremely cautious approach to investment while economic uncertainty continues, and markets remain sensitive to any negative data emanating from the eurozone.
How do you see transparency and risk reporting developing? What factors might influence the development of reports?
Peter Dickinson: There will be a requirement to provide increased investor transparency reporting and more detailed operational risk reporting. This is already being driven by regulatory changes, the AIFMD being a prime example. Aside from regulation, investors are increasingly keen to receive detailed operational risk reporting from funds as well as more transparency into their operations. This represents an opportunity as well as a challenge for fund administrators.
Dermot Butler: There is increased pressure from institutional investors for full transparency including both operating procedures and the portfolio. This also includes full risk reporting. From the Administrator's point of view this does not present any major problems once they are able to develop the systems to produce the individual reports required by individual clients. Many Administrators have a concern over risk reporting because they are reluctant to develop or operate in-house systems. They are happy to provide the data and operate third party systems (RiskMetrix for example) but they do not want to assume the risk inherent in providing their own in-house risk reporting service.
Arindam Das: Over the last 12 months regulators in various jurisdictions within the ME have taken concrete steps in this regard, Bahrain has already finalised the new CIU regulations and they are expected to come into force in April/May 2012 which focusses on greater transparency and risk reporting both from the fund managers as also service providers like custodians and administrators, similarly UAE is in the process of revamping the funds regulations focussing on these two factors.
Patricia White: The trend in increasing levels of transparency and risk reporting shows no signs of abating, with changes in capital adequacy and liquidity reporting - and more recently the requirement to provide assurance statements on the Code of Corporate Governance -being examples emanating from Guernsey.
The cost and implementation of changes in compliance and regulation can act as obstacles to new business flows, topical issues currently being AIFMD, FATCA, and Dodd Frank. The UK Bribery Act also came into force in July 2011 with unknown extraterritorial reach and severe penalties for non-compliance. As reporting becomes more detailed, complicated and voluminous, there is increasing pressure to ensure that adequate IT and other systems are in place to meet the growing information demands.
Is the number of clients you have from the Middle East increasing or shrinking and what do you believe is driving this?
Peter Dickinson: It is increasing, with our main focus of work being outbound investments for large corporates and Sovereign Wealth Funds. Our presence on the ground in Dubai is enabling us to gain traction with a number of significant clients and we are seeing a notable increase in inquiries for Cayman, Luxembourg, Jersey and DIFC structures.
Dermot Butler: We believe the number of clients is increasing but cannot be sure as many invest through banks and third party nominees and so it is not always possible to identify whether they are actually Middle Eastern investors. There is nervousness both from the investor point of view and the Manager/Administrator point of view because of the Arab Spring and the inherent risk in the region - this despite some very bullish reports which seem to many to just be unbridled optimism.
Arindam Das: The client base is neutral. There are funds which are non performing, and have been burnt out in the increased competition of a "single asset class, GCC equity fund race", however there are new funds that are coming up which are unique in their investment pattern, we see an increased focus on single country funds (investment in asset classes within the country of domicile or investment) and looking to invest into debt and money market instruments.
Patricia White: Our experience in the MENA region includes the administration of limited partnerships and companies with Middle Eastern investors and investments in broad asset classes from Lebanese real estate to European property funds. We have longstanding client relationships with significant Middle Eastern banks, including Arab Bank and National Bank of Abu Dhabi which structures its open-ended global equity funds, and fund of funds, through protected cell companies with some listed on the Channel Islands Stock Exchange. We also have proven experience of working with promoters and Shariah advisers in the structuring of both funds and fund of funds, which comply with the fundamental principles of Islamic finance, and we understand the values of maintaining the Shariah-compliant status of funds.
The MENA region is not immune to the global financial crisis and when combined with the impact of the Arab Spring, volumes of new business are not at the levels previously seen. That said we have seen the re-launching and restructuring of existing funds where opportunities have been identified.
What factor is cost in clients choosing a fund administrator?
Peter Dickinson: The fund administration market remains very competitive but, given our experiences over the past few years, quality of service remains the most important factor when selecting the right administrator.
Dermot Butler: Obviously cost is a major factor, but this more important for small and start-up funds. Larger funds are more concerned about the quality of the work they receive rather than the cost because retaining a bad but cheap Administrator can be a very expensive error. The "pay for quality" approach is becoming more prevalent as is demonstrated by the increased demand for shadow accounting - another pair of independent eyes reviewing the NAV.
Arindam Das: Cost is certainly a big factor in choosing administrators, the other two being product and servicing expertise and a slick operating model. The importance of attracting new investment is massive, and fees - be it management fees or fees to service providers including administrators - is competitive at these times, every fund house is looking for the cheapest deal and pricing discounts, likewise its increasingly turning out that administrators are also looking at pricing very closely and are not shying away from letting the fund down because of thin pricing.
Patricia White: There are a number of considerations to take into account when selecting a fund administrator. Ideally the fund promoter should meet the prospective service providers to establish if a good working partnership can be achieved and their priorities should primarily be focused on the client services offering. Fund promoters should question the reputation of prospective administrators and seek evidence of this by requesting client references and identifying recognition of achievements through industry awards. By adopting this approach a comprehensive cost-benefit analysis can be ascertained to make the correct decision. Unfortunately the reality is that, particularly during these austere times, cost proves to be a significant, and occasionally the only, factor in choosing an administrator.
What are the biggest legal risks faced by fund administrators?
Peter Dickinson: Portfolio performance is the main driver of potential claims within a fund structure and, while the administrator is not responsible for underlying performance, dissatisfied investors are more likely to make a claim against a fund.
Dermot Butler: Errors resulting in substantial losses, but these should be covered by insurance. The biggest risk comes about when a Fund suffers major losses as a result of fraud or wilful negligence by the Manager that has not been picked up by the Administrator. Investors will follow the American pattern of suing everybody and particularly if they see deep pockets - and that is a major risk to Administrators.
Arindam Das: The biggest legal risk still remains the liability of an administrator with regards incorrect NAV declaration and the consequent subscriptions and redemptions, while the industry norm is to cap the loss on "direct loss" arising from the error, the ME as a region has not experienced losses arising out of NAV errors on a large scale and hence as the industry grows so will this risk.
Patricia White: The publication of the Finance Sector Code of Corporate Governance by the GFSC, containing principles and guidance for adherence to good corporate governance, and requiring submission of an annual assurance statement to confirm the same, is welcome and provides assurance that Guernsey does not underestimate the importance of these principles, which are underpinned in the aftermath of the Weavering scandal emanating from the Cayman Islands.
The Weavering case is a stark example of the risk associated with the lack of regard for good corporate governance, and was the first time that a Cayman court held directors personally liable for losses of a fund, specifically because they had wilfully failed to discharge their duties of skill, care and diligence to the fund.
Also the recent case of the Australian Securities and Investments Commission v Healey calls into question the extent to which directors can rely on the reports and conclusions of management and third party professionals, including auditors. In this case the annual financial statements failed to disclose $1.5 billion of short-term liabilities by classifying them as non-current liabilities. In the judge's view the directors did not make a careful consideration of the financial statements, the basic concepts and financial literacy required by the directors to be in a position to properly question the apparent errors in the financial statements were not complicated.
Directors and fund administrators providing the services of a personal or corporate director as part of their service offering should ensure that they have adequate directors' and officers' insurance arrangements in place and take stock of the number of directorships they hold.
With a growing number of conflicting cross-jurisdictional and cross-functional regulatory requirements, businesses need to take a more universal approach to compliance and risk management, and be aware of the detrimental impact of non-compliance.
What impact might regulations have on fund administration in the next 12 months?
Peter Dickinson: Far reaching regulatory change will be impacting the fund industry most notably the AIFMD and FACTA. Such regulation will have a significant bearing on reporting requirements as institutional investors demand greater transparency. Notably the AIFMD may lead to a greater demand for EU-domiciled funds particularly from managers who have Cayman funds or funds in other offshore jurisdictions.
Dermot Butler: There is a plethora of regulation that has been introduced with regard to funds, initially in Europe and then in the US and now all over the World. Even Switzerland has entered the game. The impact this will have on the whole industry - not just fund administration is immense and it will have a knock-on effect in fund administration, as funds and their Managers seek to comply. Compliance will often be entirely dependent upon data that the Administrator is best positioned to supply. This is going to mean a lot more work and probably substantial fee increases, if the Administrator can get away with it.
Arindam Das: Refer to my responses for question two. In addition we expect that making the appointment of independent administrators for funds will be the norm within the region.
Patricia White: Concerns regarding AIFMD, which initially threatened to significantly impact the offshore fund industry, have been significantly allayed since the first draft of the directive. November's level 11 regulations, concerning rules relating to third countries and de minimis calculations, resolved many of these concerns and Guernsey is well-positioned for the final outcome by offering an equivalent regime. Opportunities may also present themselves for Guernsey in terms of providing an alternative form of regulatory regime for those products which have no EU connections, bearing in mind that the industry cost of implementing the requirements of the AIFMD should not be underestimated. We have seen a positioning of fund managers setting up their operations and funds (particularly private equity vehicles) in Guernsey in an endeavour to avoid any negative aspects of the final outcome of the legislation.
Similarly, the draft FATCA regulations were released by the IRS in February this year and represent a complex set of rules designed with the objective of limiting tax evasion by US persons. Impacted organisations may need to adjust their existing operating model in order to avoid a punitive withholding tax of 30% on US investments and become compliant, as well as review their new business take-on procedures. To further exacerbate the challenge, the regulations will remain fluid up until and beyond the first deadline in June 2013.
The Dodd Frank Act further prompts changes to the ways hedge funds must operate to better protect investors, affecting investment advisers with a place of business in the US and certain custodians. Those affected should have registered with the SEC by the February 2012 deadline and consideration must be given to technology, operations and infrastructure to meet the new regulatory requirements, which among other things requires the appointment of a compliance chief for each fund.
The increasing challenges and costs of implementing the requirements of new regulations will result in further consolidation of service providers in the market.
How do you ensure consistency of service standards and find quality staff?
Peter Dickinson: Sanne Group undertakes a rolling programme of internal and external quality assurance initiatives to ensure that both the management structure and procedural environment which is in place to deliver client services continues to develop in step with industry requirements. This includes external accreditation for key processes across the business under the ISAE standard, as well as strategic business reviews.
We recruit and retain experienced staff through a well-defined vetting and take-on process involving senior directors, a programme of continual professional development and a clearly defined process for career progression. We also invest in a professional training programme which recruits high quality graduates and school leavers providing them with full financial and study support towards qualification with a number of professional bodies, including ACCA, ICAEW and ICSA.
Dermot Butler: Fund administration is increasingly becoming an IT processing business as opposed to a labour intensive largely manual accounting business and the more that you are automated the more consistent will be the service.
Finding quality staff remains a problem as it always has been, however the additional problem is that today you are looking for more technically oriented staff rather than accounting. It all comes down to management and how you look after the staff once you have employed them - giving them a career path and all the other clichés.
Arindam Das: Considering we are a large multinational bank our service offering across the globe is largely standardised. However, we make sure to tweak our proposition in such a manner to comply with regulations, local market practice, customised reporting, our global systems are both robust yet flexible and the operating model in line with what clients want , attracting talent is slightly easier for us in this niche field since we leverage on our global presence and select staff internally within our talent pool as also look externally to get the best person for the job.
Patricia White: There are two components that combine to impact on the ability to provide a consistent service standard; IT systems deployed and human resources. The use of market leading and flexible systems facilitates the efficiencies and bespoke reporting requested by fund managers and is versatile to meet the constantly increasing requirements in regulatory reporting. Quality staff are engaged and nurtured through offering on-going professional training, mentoring programs and career progression.
It is important to have a structured approach to recruitment, requiring a proactive on-going assessment of resourcing issues and managing future requirements. Careful planning allows a considered approach to candidate selection to ensure the best individuals.
Establishing a reputation as an employer of choice often attracts enquiries from the higher calibre professionals.
What impact have the global financial crisis and Arab Spring had on fund administration in the MENA region? Do you expect lasting or permanent changes as a result?
Peter Dickinson: Global economic issues continue to impact on all major finance centres. As a result opportunities for new fund launches remain sporadic and market specific. While regional unrest may impact negatively on short term investment appetite, this is counterbalanced by a refocusing of activity in well established, stable jurisdictions such as the UAE.
The fact that the Dubai Financial Services Authority has recently reported a significant increase in license applications, reaching levels not seen since 2008, would seem to indicate a growing confidence in region.
Dermot Butler: The financial crisis and the Arab Spring had two different effects. Those funds that had problems or closed during the financial crisis were different to those Managers and funds that retreated from the Arab Spring. The financial crisis was always deemed to be something that would eventually pass whereas the Arab Spring is something that nobody knows (and few are prepared to predict) when it will be resolved. My personal belief is that people who wish to invest in the MENA region will want to do it from outside and those investors in the MENA region who want to invest elsewhere will also invest through outside entities. As such I think that funds and Fund Administrators based in Malta and/or Singapore will be able to pick up business that would otherwise have gone to the Gulf. Before the Arab Spring, Bahrain was probably considered the most stable and perhaps boring of the Gulf countries, but that stability has been severely shaken. I think there will be permanent changes but eventually people forget and some "normality will return".
Arindam Das: The fund administration space has certainly undergone a change due to the Arab Spring and investor confidence is quite low which means lesser number of funds are launched however even during the height of the crisis we did not see a slew of redemptions from institutional investors, at the same time we didn't see new subscriptions either, we have seen volumes and activities in funds pick up in 2012 across the region and therefore we believe its a matter of time that things will bounce back. That said, a vibrant debt market will certainly help a faster recovery.
Patricia White: The global economy continues to face challenges and the volatility and unrest in the Middle East undoubtedly impacts on inward investment in those regions. The possibility is that investors based in the MENA region look for products and investments elsewhere, including a well-established jurisdiction such as Guernsey, particularly given our long-standing experience in this region and the breadth and versatility of product types on offer and quality service providers. S&P highlighted Guernsey's "success in attracting foreign financial institutions, its prosperity and its very strong government balance sheet". In time the political and economic structures will adapt to the changing environment and investors may recognise renewed opportunities for inward investment.
© MENA Fund Review 2012
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