Alpha Financial Markets Consulting Group, recently supported Guardian Financial Services with the post-acquisition integration of a £5bn book of in-payment pension annuities from Phoenix Group. Guardian is a leading consolidator of closed assets in the European life insurance sector. Following the transaction Guardian has approximately £13bn of assets under management and administers over 600,000 policies.

Alpha was engaged to lead the transition of both custody and fund accounting services to Guardian’s chosen outsource provider. Given the time-critical and market-sensitive nature of the deal, timeframes were short – with the planning, preparation and execution of the transition being completed within three weeks of Alpha’s engagement.

Paul Dixon, Chief Investment Officer at Guardian said “Alpha’s breadth and depth of post-acquisition transition experience made it the perfect partner for us in this transaction.” “Alpha’s support during this critical period was invaluable, and allowed us to execute a very smooth transaction”.

The buy-side front office technology offering has seen significant change in the last ten years. It is one of the most diverse market places for financial vendor products with a vast array of providers and a multitude of deployment options. More than ever, the front office technology decision is turning into a challenge of organisational change rather than a decision focussed purely around technology and functionality. And with choice comes both opportunity and risk.

Current Market Place

The front office systems market place, covering all activities from decision making through to post execution, has never been so diverse. The last decade has seen an unprecedented number of changes including the emergence of new vendors, the consolidation and development of existing platforms and the demise and recovery of others. In addition, the growth of hedge fund strategies, fund of hedge funds, private equity and real estate has added to the diversification of the traditional buy-side business. This has resulted in the majority of changes visible in today’s offerings.

Ten to fifteen years ago the vast majority of front office technology was built around in-house solutions, often with a heavy emphasis on Excel with poor centralisation of data and disparate systems across asset classes. The increase in buy-side complexity has spurred an increase in the maturity of vendor products in a swiftly maturing market place. This rapid evolution has resulted in different challenges for the vendors including QA, release strategies, development timelines and new client requirements.

The background of vendors can typically be attributed to one of three camps:

• Systems with a background in a specific asset class/function (Equity, Fixed Income or Compliance) - which have often been part of “Best of Breed” implementations. These products continue to face the challenge of diversifying their offerings to include enhanced functionality outside of their historic ‘core competency’. Indeed, one of the biggest challenges encountered is when security-based systems implement cashflow-based products;
• Data providers - who have largely fixed the data quality dilemma within their front office offerings and have the opportunity to leverage in-house product experts to enhance their products further;
• In-house built systems - that have been augmented and subsequently offered to the wider market place. BlackRock’s Aladdin is certainly the largest player in this space and has moved to become a quasi-data vendor through their offering.

Deployment Options

Front office technology delivery mechanisms have become more varied. Today’s bandwidth and technology offer cost effective ASP (Application Service Provider) or “SaaS” (Software as a Service) delivery methods, which a number of front office vendors have embraced to reduce the immediate technology and headcount requirements associated with internally installed systems. ASP/SaaS delivery mechanisms provide a number of operating advantages over standard in-house located systems, reducing or completely eliminating upgrade and technology costs. This is a key consideration often overlooked during the evaluation process.

In addition, deployment methods of the applications have been enhanced through thinner clients and “hybrid” SaaS offerings. The hybrid offering is an interesting concept as it retains the IT controls in-house but leverages the vendor expertise in application maintenance, support and configuration, which can often represent an on-going headcount saving. There continues to be a perceived advantage from the systems borne out of an ASP offering; they run a singular version of the software, all clients upgrade at the same time and a “single” live code stream is maintained. Charles River, Fidessa, thinkFolio, Linedata and many others follow a different model, but this could change in the next five to ten years as contractually enforced upgrades continue to pose a challenge of cost and complexity.

The 'Best-of-Breed' Option

Best-of-breed applications have traditionally had strong open-API capabilities. These have been further developed through mature pre-canned adapters and interfaces which reduce implementation time/cost and further cement their position within the workflow. Most major vendors have been working hard to replicate this sort of capability.

A best of breed approach still merits serious consideration as a front office technology configuration option. Implementation approach is increasingly workflow-centric. As the offerings have evolved it is now possible to adopt a best of breed approach for OMS, EMS or Portfolio Construction with full instrument coverage across the workflow. The centralisation of technology across the workflow resolves many regulatory and compliance challenges. As an example, we are seeing commodity-based (non-alpha generating) workflows being deployed as a SaaS offering. Currently there are at least two pure compliance (pre- and post-trade) SaaS offerings. Although not suited for larger organisations, small managers and boutiques could consider commoditised compliance propositions as a lighter-touch implementation option.

However, during the selection and implementation process, it is critical for clients to evaluate and fully understand the implications of integrating all elements of such a solution. Experience demonstrates that the perceived benefits of a decoupled architecture have often been illusory, particularly where a change of front office technology is required.

The Emergence of Enterprise Level Solutions

The emergence of true Enterprise level solutions continues to gather market place strength. The ability to offer a full service from portfolio construction through to post execution, including data as well as attribution, performance and risk is a compelling offer, to which the success of solutions such as Aladdin testifies.

Clients adopting these solutions certainly accept a lack of customisation potential (possibly no bad thing given the organisational consolidation that such projects should entail to be successful). The challenge for all such enterprise platforms, and indeed all other global offerings, is to continue to meet local needs and expectations and challenge any dominant niche products in these spaces. Ensuring suitable product and workflow coverage, with the flexibility and speed to accommodate new requirements and regulatory demands, can be a key differentiating factor.

The Data Challenge

Perhaps the biggest challenge faced by organisations configuring their front office architecture is data quality. As organisations centralise data, the front office system has to become either a supplier or a consumer of data for the buy side. Different products offer different approaches and some attempt to cover both sides. On the surface, solutions that offer embedded data can often result in quick wins and ultimately shorter go-live timelines when compared to data consumers.

The front office is one of the key stakeholders in the data strategy of any asset manager. Data strategy should represent a fundamental component of any organisational technology design programme - and should never be underestimated in terms of its impact on both the programme and the effectiveness of the end-state operating model.

What's Next?

Many organisations are still grappling with the need to maintain a front-office investment book of records. Maintaining such a record – which allows managers to view current and historic information from the same interface – is operationally more complex in an environment where Fund Accounting is commonly outsourced. The vast majority of vendors currently do not support the maintenance of an investment book of records – a drawback which we expect many to address as a matter of priority.

Empowered By Options

All the above developments mean that organisations have never before been faced with such an array of architecture, operational and deployment options when it comes to determining their front office strategy. The good news is that, by comparison to even several years ago, there is now a range of highly mature, functionally rich solutions with efficient and effective deployment options. But with choice comes the added complexity of evaluating and choosing an optimal solution. It’s critical that organisations leverage the right expertise and capabilities when making these choices. And it’s equally critical to marry technology change with organisational change, to capture the full benefits of promising new solutions.

Avoiding the pitfalls can reap increasingly rich rewards.

To find out more about Alpha’s work in assisting clients define and implement their investment management architecture and IT solutions, please contact Greg Faragher-Thomas (greg.faragher-thomas@alphafmc.com) or Dave Nathan (dave.nathan@alphafmc.com)

As the outsourcing market for asset management back office functions has matured and the services provided by administrators become increasingly commoditised, the benchmarking of rate card fees has become a frequently used, and increasingly important, tool in the industry. However, there are a number of challenges that need to be overcome to ensure that benchmark comparisons are fair and valuable.

Because of the complexities involved, tariff benchmarking can never be an exact science, but with a flexible and robustly analytical approach it can provide a very compelling view of the relative attractiveness of a rate card.

The Challenge

Comparing the costs for outsourcing deals is not like comparing prices for a litre of milk between two supermarkets. The products (service scope and complexity) differ between deals and the way the services are billed can be structured using a wide range of cost drivers. Simply performing a line-by-line comparison of two rate cards next to will tell you very little about the comparative value they represent for the services covered, or how total costs compare against other deals.

The business profiles of asset managers and the effort required to service them can differ significantly. For example, providing Fund Accounting for a set of fixed income funds with high derivatives usage is more costly than for a set of equity funds with no derivatives holdings. Supporting trade processing for an emerging markets fund is more complex than for a fund that only trades domestic government bonds.

However, while differences in service scope and complexity should be recognised, it is also important not to let them overshadow the bigger picture. Whilst all deals have their quirks and complexities, there is significant commonality in the majority of activities performed in the back office for asset manager clients.

Dealing with differences in rate card structures can also be complex. With the exception of custody, where a standard charging model more or less already exists in the market, the way services are charged for does not follow a standard template. Rate cards are usually tailored to each individual deal with the objective to get to an agreed total cost - and the cost drivers use to get to this number can vary widely. The graph below shows the share of the total cost driven by the main cost drivers in a range of investment operations rate cards from Alpha clients:

Tariffs are only partially structured to reflect the effort involved in servicing a client. In particular, fluctuations in AUM have little impact on what goes on in the back office. However, it does of course drive the Asset Manager revenues and there is often a wish to ensure that outsourcing costs move in line with income.

Our Approach

The main objective of any tariff benchmarking should be to verify whether the fees charged are fair considering the efforts required to support the business. The differences in business profile combined with the variations in structure means that simply applying the volumes of a specific asset manager to a set of tariffs from other deals will not provide a robust answer. A manager with a low number of trades relative to AUM will attract high charges using a rate card with a high share of costs from asset fees, whilst a manager with a small number of funds but high levels of trading will attract a low fee from a tariff primarily driven by fund and portfolio fees.

To achieve a fair comparison, you need to find, for each function, the factor that best reflects the effort involved in providing the service and compare the cost per activity using the costs and volumes from each deal. For example, the most appropriate reflection of fund accounting effort will be the number of NAVs calculated, ideally weighted by fund complexity.

It is also important to consider that there are economies of scale built into outsourcing tariffs. Even if all TPA clients are supported on the same platform at the same marginal cost, overheads such as Relationship Management and Service Management teams will make up a higher share of the total costs when servicing a very small client compared to a very large one and the cost per NAV will be higher.

Based on our large library of detailed information from outsourcing deals, Alpha has been able to create scale curves that allow us to make these comparisons for core outsourced functions. The graph below shows an illustrative example for Fund Accounting, where Manager X is paying slightly more for Fund Accounting compared to the rest of the market than would be expected given its volumes:

It is important to note that tariff benchmarking should not have as its aim to reduce or increase costs to the lowest/highest levels in the market. A deal that is not profitable for the TPA, or where the asset manager is paying over the odds, is not beneficial for either party and is likely to end in tears.

However, used in the right spirit, rate card benchmarking can be an invaluable tool for both sides of a relationship, creating transparency, aligning fees to the market via sophisticated comparisons, and building a greater sense of partnership.

If you are interested in further information, please contact Bo Lantorp, Alpha’s Director of Benchmarking: bo.lantorp@alphafmc.com or +44 (0) 7958 304053.

Alpha recently authored the ‘Inside View’ contribution to Funds Europe magazine, examining the multitude of challenges facing today’s COOs.

For many a COO it can feel like the four horsemen of Vanishing Revenue, Regulatory Burden, Operational Risk and Operational Complexity are closing in fast. But these formidable adversaries also present opportunities, and for many back office organisations, change and evolution is more a necessity than a choice.

The list of major regulatory initiatives impacting asset manager operations is genuinely arm’s length. In many instances, perhaps most strikingly in the cases of FATCA and Dodd-Frank, the approach adopted throughout the industry varies in terms of structure and urgency, and is hampered by uncertainties (perceived and actual) over the final regulatory provisions.

These initiatives compete for time and money in an environment where both clients and regulation demand a sharp focus on operational risk. An independent operational risk function, commensurate with the size and complexity of a firm, must be developed and maintained. This requires robust risk identification and assessment processes, and informative and decision-oriented operational risk reporting (including analysis of external events) – all of which are necessary for the quantification of operational risk exposure and resulting capital requirements. The consequences of getting this wrong, both in measurable monetary terms, as well as in reputational terms, are high.

And of course, being a back office would not be the same if you were not constantly being asked to support new and more complex business and services, with increased transparency and accuracy, and more efficiently – regardless of whether your clients are internal or external.

All of which contributes to technology spend, (covering regulation, automation and efficiency, and support for new products and services), that can typically range from 15% - 25% of a firm’s total expense budget – often equating to hundreds of millions of dollars annually. It’s a situation in which those few global organisations with significant scale and resources are increasingly outspending smaller players, who lack the scope and budget to develop robust and scalable responses to every operational challenge.

What’s the response to all of this?

If you’re an in-house back office, never before has forensic scheduling and structuring of regulatory efforts been more important in developing a manageable and compliant programme portfolio. Such an approach will focus on those aspects of a programme which can and should proceed in advance of final regulatory detail – but which nevertheless schedules final implementation and roll-out for a timeframe consistent with regulatory timetables. There is no escaping the time and cost involved in staying on top of the competing demands on service – and only strong internal governance and a clear product strategy will produce a coherent operational response.

Of course, for third party administrators (TPAs), regulatory programmes, and a focus on risk, present opportunities to generate new revenue lines by assisting clients with compliance-related services. Those TPAs that are most effective at pre-emptively leading their clients through the regulatory jungle and developing a clear service offering are already confident of off-setting a significant proportion of their implementation costs – which they share across their client base in the first instance anyway.

Risk and data management services are major new areas for service and revenue growth. Indeed, with the recognition that several core areas of historically significant revenue (FX execution, securities lending etc.) have probably diminished for good, the current operational challenges provide a major impetus for extension and diversification of revenue that the TPA industry clearly needs.

Keeping all the plates spinning is tough balancing act for today’s back office chiefs. Budget discussions get no easier, and the change pipeline only grows. But in a world where transparency, efficiency and regulatory compliance enjoy renewed focus, and where front office margins are feeling the pressure, the back office increasingly finds itself on the front line.

By funds europe

Over the last 8 years, Alpha has either led or been closely involved in a large proportion of the outsourcing, business transition and post-merger integration activity in the industry. Our involvement has spanned the full business transition programme lifecycle, from RFI, through to RFP, contract negotiation, implementation, and post-transition support and oversight.

As a result, we have developed the most detailed and thorough end-to-end Outsourcing and Business Transition Best Practice Methodology in the asset management industry. It is this expertise and insight that enables us to deliver market-leading value to our clients at all stages of an operational outsourcing programme.

In this and subsequent newsletters, we will be running a 'Best Practice Insights' series for operational outsourcing programmes in the asset management sector. In each newsletter, we will summarise some of the key insights and best practice points from our Outsourcing and Business Transition Best Practice Methodology that we recommend to our clients during each of the 5 key phases of a business transition. This edition – The Contract Finalisation Phase."

Best Practice Insights - Contract Finalisation Process

1. Negotiating the detail of the contracts takes a considerable amount of time and effort. Use the heads of terms agreed in the RFP stage to produce an early draft of the contract which can be used to start the contract discussions. Plan a hard-stop for all work detailing operational requirements, after which senior management and legal teams can finalise the contract.

2. Interaction between the two organisations should continue to develop operating models and plans, build relationships and increase confidence. Continue with face-to-face workshops to perform gap analysis, estimate developments, develop operating models and the transition approach, and the SLAs and KPIs.

3. Early or inaccurate communications can increase risk of current in-house staff leaving or performing their responsibilities at a sub-standard level. Carefully plan communications to ensure the right people get the right message in the right way at the right time; we recommend that all staff are updated during this stage and that staff earmarked for being transitioned with the management are told first in person.

4. As the project gains momentum and size, it will be more difficult to manage, track progress and make centralised decisions. Implement a strong governance structure and mobilise a strong PMO team. Create a central document depository which all teams use and utilise PMO team to centrally monitor and manage depository.

5. Stakeholders will not be able to attend detailed workshops so decisions making will be delegated during this process even though the stakeholders are still ultimately responsible. Create a summary report for senior stakeholders to review and sign-off before finalising the contract. Distribute regular, clear and concise information to all stakeholders and ensure that all questions from stakeholders are investigated and answered in a timely manner.

6. A single stakeholder has to own the deal and take the intellectual lead. Ensure this stakeholder is updated regularly and is involved in all decision making, especially during the contract discussions.

7. Service and relationship with the TPA will deteriorate if the TPA is not making a profit and could result in huge penalties and costs if the TPA has to be changed as part of a second generation outsourcing deal. Understand that the deal has to be win-win for both organisations and seek to ensure through negotiations that the deal is commercially viable for the TPA.

8. Transition approach needs to be built into contact and not addressed for the first time during the transition stage. Jointly agree transition principles, high-level approach and timelines prior to contract signing.

9. Insisting on bespoke solutions creates inefficiencies, complexity and embedded ‘relationship friction’ for both parties – only a TPA’s standard operating model will provide scale-related economic and service benefits and deliver a high level of service against standard operating procedures. Adopt, to the greatest possible extent, the standard operating model of the TPA; where there is a necessity to deviate from the standard operating model, ensure that the model has been thoroughly thought through and documented.

10. Staff decisions are complex and involve a range of considerations. Define the HR plan only when sufficient information is available, i.e. general HR data (names, level, compensation etc.) with a clear distinction between contractual and non-contractual benefits.

To find out more about Alpha’s market-leading capabilities and credentials in outsourcing and business transition, please contact Stuart McNulty (stuart.mcnulty@alphafmc.com), Euan Fraser (euan.fraser@alphafmc.com) or Nick Fienberg (nick.fienberg@alphafmc.com).

The topic of Over-the-Counter (OTC) Clearing has been prevalent for some time. However, continuing uncertainty over requirements and timelines has meant that Asset Managers and Third Party Administrators have been reluctant to make the workflow changes required.

As regulatory requirements are refined and uncertainty is reduced, the ‘buy-side’ is now readying itself for significant change.

Certainty At Last?

To date, regulatory timelines have slipped on multiple occasions, but recent progress is bringing increased certainty.

Following the collapse of Lehmans and the ensuing events of 2008, the use of OTC derivatives has attracted significant scrutiny.

In the resulting post-mortem, a number of areas of weakness were identified relating to the transparency of the OTC process and the inability of market participants to calculate and report counterparty credit exposures on a timely basis.

In response, the dealer–to-dealer market was an early adopter of OTC derivative clearing; the size of counterparty exposures and related trade notionals being significantly reduced by the introduction of intermediaries to the existing process. However, the ‘buy-side’ market has been less quick in following suit.

In September 2009 a commitment was made by G20 member states to centrally clear all ‘standardised’ OTC instruments via Central Clearing Counterparties (CCPs). It was proposed that the member states would implement new regulations by 2012, with each country given the autonomy to decide on the detail of these regulations. The leading signatories to the agreement, and principal users of OTC derivatives, are the US (who enacted the Dodd-Frank Act) and Europe (who implemented the European Market Infrastructure Regulation (EMIR)).

The Dodd-Frank Act was passed in July 2010 and is currently undergoing a rule-writing process that is due to become effective in July 2012 (though at the time of writing this article there are rumours of further delays). The final implementation of these rules will most likely be phased, impacting clients between 3, 6 or 9 months from the effective date.

The European regulations have, to date, lagged behind those of the US; but due to a number of delays in drafting the detailed requirements, it is expected that there will be increasing convergence with Dodd-Frank in both detail and timelines

More Than Just CCP

The new regulatory requirements will be far reaching, with an end-to-end impact on the OTC processing workflow.

Despite often being described as the “CCP regulations”, neither act looks exclusively at the use of CCPs within the OTC process; the requirements are in fact more far-reaching. For example, the principal pillars of the Dodd-Frank Act are:

1. Clearing – use of CCPs to reduce counterparty exposures but with added complexities associated with initial margin;
2. Reporting – of trades to a registered central trade repository within tight time limits;
3. Swap Execution Facilities “SEFs” – use of automated, many-to-many trading platforms that are in development in the industry.

Although the final pillar is not currently a requirement of EMIR, it will likely be covered by MiFID 2 requirements. A significant advantage of the trend towards convergence of the regulations is that companies should be able to leverage a standard operating model on both sides of the Atlantic.

Ever Increasing Scope

Regulatory requirements will initially focus on a small group of instruments but this will expand over time.

The initial products in-scope of Dodd-Frank will include simple Credit and Rates instruments (e.g. IRS and CDS). Those instruments that are not supported by CCP clearing will be subject to higher capital requirements and will become more expensive to execute in the future landscape.

Whilst the roll-out of new regulations varies by underlying client type (with some clients offered exemptions), all clients trading OTC instruments will likely be impacted.

The Known Unknowns

There remains significant uncertainty around specific details but the industry is starting to get a grasp on what is required.

Industry associations (such as the Investment Management Associated (IMA)) have been working to define models to assist their members with understanding the impact of the new regulations.

However, uncertainty remains in a number of areas:

1. Eligibility – extra complexity arises from the different eligibility criteria issued by the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) who both govern different products.
2. Extraterritorial scope of legislation – legislators in the US are at pains to ensure that US banks are not put at a disadvantage to their European competitors which will be subject to the later provisions of EMIR.
3. SEFs – potential platforms are under development but there is currently no market leader.
4. CCPs – there is a small group of confirmed entities that will compete for clearing business, but more entrants may appear, each of whom may use different legal and operational frameworks.

A Pragmatic Approach

With the continued lack of clarity, ‘buy-side’ firms are often tempted to delay implementing change, but is this a high risk strategy?

Even as the G20 deadline approaches at the end of 2012, many industry participants still remain sceptical about whether the regulators will be able to adhere to the published timelines.

Support for this view has increased given the continued market turmoil, which is providing a distraction to politicians and regulators. Also, it is believed that events such as the collapse of MF Global will lead to further delays as the impact is reflected in the wording of new rules.

Whilst there is some validity in this argument, the amount of change required to meet the new legislation necessitates that action be taken now – the only question is how much early investment is reasonable?

Now Is The Time To Take Action

There are many areas where action can and should be taken now.

The key focus for all Asset Managers should be to understand how the regulatory requirements affect their business specifically. The impact on each business will obviously depend on the structure of OTC processing, the firm’s clearing members and selected CCPs. However, it should not be regarded as simply a Front or Middle Office problem; project engagement is required across the whole business, from Compliance, Risk and Legal to Operations, IT and Investment teams.

The first step should be to conduct a detailed impact gap analysis. Firms can use this to identify resourcing requirements and implementation lead times. Changes in the following areas should be initiated now:

1. Selection of Clearing Brokers and Clearing Houses;
2. Updating infrastructure and processing to cope with margin requirements;
3. New data capture and downstream processing (e.g. the capture of clearing house and clearing member trades);
4. Legal issues such as portability, margin segregation and clearing agreements, as well as negotiation and execution of the clearing agreements themselves.

The areas of less well defined change are also likely to necessitate amendments to many or all front-to-back processes, across a number of business areas. Therefore, at the very least broad discussion and scenario planning should be initiated across the board.

OTC Clearing is coming and firms should take a pragmatic approach; action is required now or the risk of missing regulatory deadlines, and being left behind by competitors, will soon become a reality.

To find out more about Alpha’s work in assisting clients prepare for and execute regulatory change initiatives, including CCP, please contact Stuart McNulty (stuart.mcnulty@alphafmc.com) or Rob Carter (rob.carter@alphafmc.com)

While offshoring is not a new concept, its principles – and its variants – remain at the forefront of the strategic agenda for both outsource providers and asset managers. This is perhaps as much, if not more, the case than it ever was, as organisations face the need to respond to continued cost pressures and to deliver against ever stronger commitments to locally support investment and client horizons that are increasingly multi-regional.

Moving towards target markets

This global outlook places increased emphasis on the importance of creating truly global operating models. Such models tend to focus on the cost and operational performance benefits of centralised operational hubs, where time-zone independent activities with significant scale economies are concentrated in operational centres of excellence that are typically located in ‘lower cost’ locations.

Such hubs are often supplemented with regional spokes providing localised support for investment teams and clients alike while also satisfying local regulatory requirements. Spokes facilitate pass-the-book models that enable ‘follow the sun’ advantages to be realised - enabling processes to be completed earlier and data available quicker than would otherwise be the case.

With traditional offshoring locations such as India, Asia and South Africa located right at the heart of target expansion markets, these geographies represent an opportunity for those looking to offshore to create global operational hubs in these locations while simultaneously establishing localised ‘spokes’ in important growth regions.

The increasing pull of ‘Near-Shoring’ and ’In-Shoring’

This traditional offshoring model is however increasingly being complimented, and in some cases replaced, with ‘near-shoring’ and ‘in-shoring’ strategies. Here operational hubs are located closer to home – either in the same region in the case of near-shoring or, in the case of in-shoring, in the same country but different location to the onshore investment centre.

Access to a skilled but lower cost workforce and lower cost infrastructure are again key drivers here, along with well-established infrastructure, political stability and workable employment laws.  From a European perspective, locations such as Warsaw, Bratislava, Glasgow and Lisbon have established themselves in this regard, with Malta also now emerging in this space.

While time-zone advantages and cost and scale efficiencies are perhaps reduced when compared to the traditional offshoring locations, the gap in terms of potential cost savings is rapidly closing as traditional offshore locations become more expensive and the challenges associated with language and culture differences, and lack of proximity, are to a certain extent mitigated.

Indeed even for higher skilled functions such as Fund Accounting, near-shore and in-shore locations can deliver significant cost savings when compared to the on-shore investment centres of London, Paris, Edinburgh and Geneva and so on, while standards with respect to quality and productivity are maintained.

In fact, aside from certain regulatory constraints and the need for at least residual local support for clients and investment teams, it is not typically operational constraints that restrict offshoring parameters  - particularly with the emergence of ever more sophisticated global workflow solutions.

Instead, it is often a reluctance to move ‘higher value add’ functions away from the proximity of the front office due to concerns around reduced client responsiveness and a lack of direct control. Client Reporting and Performance would be examples here. However these perceptions are being challenged, with asset managers and outsource providers increasingly and actively pursuing offshoring solutions across the investment operations landscape.

The gap between Near Shoring and Offshoring narrows….

If the potential benefits of offshoring are well understood, realising them can often prove more challenging than originally anticipated. For example, when initial offshoring business case expectations are compared to the actual cost savings, recent analysis indicates that while meaningful 20%+ savings are typically achieved, these tend to be significantly lower than the 30%+ savings originally anticipated.

There are a number of factors at play here. Firstly, implementation costs for offshoring initiatives are high, with payback periods often longer than typical thresholds. This can be as a result of a number of factors, including initial duplication of infrastructure and staff costs in on-shore and off-shore locations and the lead-time required for productivity levels offshore to meet/ exceed those in existing on-shore locations.

Managing and coordinating geographically dispersed teams is also challenging, and without strong workflow tools, processes and effective governance such models can represent a significant operational risk. It is also worth noting that global systems do not always cater well for localised requirements across regions, and so platforms can quickly become complex with bolt-ons and workarounds.

Furthermore, the offshoring of roles from an onshore to offshore location can be politically sensitive, morale sapping and steeped in regulatory constraints – all of which can be restrictive and expensive.

Indeed the cost of redundancies and redeployment of incumbent staff in the onshore locations can be high, although can be mitigated to a certain extent if the new roles in offshore locations are used for the support of growth rather than as direct replacements for resources supporting the existing business. Over time this onshore presence can be managed down and the offshore location ramped up as staff leave and are redeployed organically.

Conversely, identifying and recruiting staff with the right skill-sets in the offshore location can also prove challenging. As mentioned above, there is also typically a productivity lead-time before offshore resources meet the productivity levels of their on-shore colleagues.

Furthermore competitors - or at the very least competitors for staff and infrastructure - tend to follow quickly into the land of opportunity and first mover advantages can also quickly start to be eroded as, before too long, the battle for talent drive up both staff attrition levels and costs. As examples here, portfolio managers in India can now be more highly paid than their European counterparts, as indeed can back and middle office staff in Brazil compared to their peers in North America.

Alpha is currently working with a number of clients to assist with optimising their global operating models, in some cases through the business case assessment and implementation of offshoring options.

For more information on Alpha’s capabilities and credentials in developing and executing offshoring strategies, please contact Duncan Spencer: Duncan.spencer@alphafmc.com

The market meltdown of 2008 and the ensuing market volatility has led to increased pressure on both the revenue and cost base of Wealth Managers. This has required them to re-focus strategies from both a client and operational perspective to ensure effective client service and increased efficiency so that competitive positions are maintained.

From a client perspective, asset protection and wealth preservation are now key priorities; with less appetite for higher risk, more complex products, a significant reduction of fees is being realised. There is also more scepticism around the role of the Wealth Manager which has been exacerbated by both reduced client returns and continued adverse media press.  Strong client service and overall experience remain imperative for both attracting and retaining clients – and achieving this requires sufficient investment in both technology and infrastructure.

A much more stringent regulatory environment now governs investment support operations. New regulations such as FATCA and RDR create additional significant investment requirements in processes and compliance monitoring throughout the organisation.

Overlaying these cost pressures, the industry is becoming more competitive. Whilst there has been a move by some clients to more traditional establishments where wealth preservation and typical stockbroking are more prevalent, 'big banks' are leveraging retail and investment arms and investing significant sums to create market share.

With both squeezed margins and required investment spend, it has never been more important for managers to focus on opportunities for efficiency and rationalisation. Alpha FMC has this year launched the 2012 Wealth Management Operations Benchmarking Study. The study will provide invaluable insights for managers seeking to get an in depth view of their comparative operational cost base. It will clearly demonstrate to participants how they compare against their peers with respect to detailed operational costs, service capabilities, service levels and overall operating model to help identify potential opportunities for cost savings and increasing efficiency.

Alpha FMC is the global market leader in asset management benchmarking and runs comprehensive studies for all parts of the asset management value chain as well as for the different industry segments (alternatives, property, etc.). If you are interested in further information,  please contact Bo Lantorp, Alpha FMC’s Benchmarking Director, on bo.lantorp@alphafmc.com or +44 (0) 7958 304053; or Joe Docker, Senior Manager on joe.docker @alphafmc.com or +44 (0) 7968 209213; or Luc Baque, Director (France) on luc.baque@alphafmc.com or +33 6 62 78 27 80.

Alpha FMC is the leading supplier of consulting and implementation services to asset managers and the firms that support them across Europe. Over the last 8 years, we have either led or been closely involved in a large proportion of the outsourcing, business transition and post-merger integration activity in the industry. Our involvement has spanned the full business transition programme lifecycle, from RFI, through to RFP, contract negotiation, implementation, and post-transition support and oversight.

As a result, we have developed the most detailed and thorough end-to-end Outsourcing and Business Transition Best Practice Methodology in the asset management industry. It is this expertise and insight that enables us to deliver market-leading value to our clients at all stages of an operational outsourcing programme.

To find out more about Alpha’s market leading capabilities and credentials in outsourcing and business transition, please contact Stuart McNulty (stuart.mcnulty@alphafmc.com), Euan Fraser (euan.fraser@alphafmc.com) or Nick Fienberg (nick.fienberg@alphafmc.com). 

Following FBI investigations in 2008, a number of Swiss banks were accused of helping wealthy Americans evade US taxes via offshore accounts, by not applying required withholding taxes. One high profile case resulted in UBS agreeing a settlement of $780m in unpaid taxes and the release of the names of thousands of offshore account holders. This focused the attention of the US government on the prevalence of offshore tax abuse.

More generally, the behaviour of financial institutions is under unprecedented public scrutiny, exemplified by the recent Occupy Wall Street movement, which has now spread to other cities around the world. Tax avoidance and the ability of so-called elites to avoid their fair share of the tax burden have received much media attention in the post-2008 environment. Legislators around the world have started to look at ways to address this problem; partly to fill their hollow exchequers and partly to be seen to publicly tackle inequity and perception of regressive taxation regimes.

The Foreign Account Tax Compliance Act (“FATCA”) legislation is the US government’s attempt to address these issues by forcing foreign financial institutions to disclose the holdings and income of US citizens or face a 30% withholding charge on all US originating payments (e.g. dividends). The act is far reaching and will have a significant impact to the financial services industry globally. Many commentators have focused to date on the opaque nature of implementation and the confusion over how it will be interpreted. In addition, there is the intriguing prospect of financial institutions facing a catch-22 of either complying with FATCA, or the incompatible EU Data Protection law. Whilst such observations are interesting and important, they somewhat miss the point when it comes to addressing a key question for asset managers – what should I be doing right now?

Focussing on FATCA’s ambiguities and complexity induces fear in some organisations of the consequences and implementation requirements that FATCA will impose. This anxiety in some cases translates to intensive, up-front programme activity, an approach favoured by many consultants and advisors. In other cases, firms face organisational paralysis resulting from the need to digest uncertain, complex requirements.

We believe that neither predicament is correct approach to FATCA compliance. Whilst there is substantial work to be done, no major programme needs to be initiated within the next quarter. Rather, the existing sense of urgency should be channelled into a streamlined and limited ‘flash diagnosis’, which will help to clarify the known impacts and planning proposals for programmes to commence in Q1/Q2 2012.

‘Flash Diagnosis’ – not ‘Programme Rush’

An immediate ‘flash diagnosis’ would entail the following key elements, and would set the scene for a well-planned and controlled implementation programme in 2012/13:

• An up-front strategic decision on fund compliance vs. non compliance
• A detailed impact assessment to identify gaps in current processes and infrastructure, and ability to adhere to disclosure requirements
• Assignment of appropriate resources to drive through change; FATCA is an organisational change initiative and not just a Finance change
• Development of a coherent communications strategy to manage commercial tensions that may arise from increased investor requirements, particularly among investors based outside the US
• Maintenance of a close watching brief on lobbying and engagement efforts on-going with the IRS on behalf of the industry, which are aimed at clarifying points of contention and minimising the ultimate compliance burden

The critical outcome for asset managers is an early and clear identification of key plans and organisational impacts, and a sense throughout the organisation that FATCA compliance is a known and planned quantity. We believe that too much industry emphasis currently focuses on the (admittedly important) complexities and ambiguities of FATCA compliance. These will be clarified in time, and can be handled in a controlled fashion once contingent plans are in place based on the above steps.

Nevertheless, any such analysis will need to be cognisant of the key provisions, complexities and pitfalls that FATCA presents, a number of which are recapped below.

FATCA – the background

FATCA was passed into US law on 18th March 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, and is intended to counter US tax evasion through the use of offshore accounts and foreign management companies by US investors. The act requires Foreign Financial Institutions (FFIs) to identify whether or not investors are US persons; if they are US persons then FFIs will be required to submit certain information about the financial assets held by these persons with an aggregate value of $50,000 or more.

Who is impacted?

It is important to note that asset managers or promoters are not themselves FFIs – funds themselves are. Although it is the responsibility of the fund to report to IRS, they may delegate this to administrators, which means that the issue of FATCA compliance is a critical consideration for all administrators as well as their clients’ funds.

Custodians will also be FFIs, but Fund Accounting and Transfer Agency functions may not necessarily be. The large global custodians have therefore taken an industry lead in initiating programmes of change within their organisations to ensure they are best placed to meet FATCA requirement and also advising their clients on potential change.

What FATCA means in practice – and when

The deadline for FATCA compliance has been delayed from the original date of 1st January 2013 and will now be 1st January 2014. FFIs will need to identify new and pre-existing US account holders (including certain ‘high-risk’ accounts, typically those above $500,000, where more extensive due diligence requirements apply). As a first key interim deadline, each FFI must subsequently enter into an agreement with the IRS by 30th June 2013 to adhere to certain disclosures and provide ongoing reporting – this will result in a classification as a ‘Participating’ or ‘Good’ FFI.

If an FFI does not enter into an agreement with the IRS, it will be classified as a ‘Non-Participating’ or ‘Bad’ FFI, and will be subject to a 30% withholding tax on all US source income. Withholding on US source dividends and interest paid to Non-Participating FFIs will begin on 1st January 2014.

‘Participating’ FFI’s will be required to withhold 30% of any US source income and gross proceeds from the sale of assets generating US source income from all ‘recalcitrant’ investors – those who have failed to provide adequate information about their residency status. Whilst this sounds simple enough, this requirement has implications for both managers and investors:

In the above schematic, Client 1 consents to the residency disclosures required, and his FFI is registered as ‘participating’. He receives his full allocation of income from US-registered stock dividend. However, whilst Client 3 is similarly compliant, his FFI has not registered as ‘participating’, and therefore 30% of his US-sourced income, to which he is entitled, is collected by the IRS directly from the custodian. Clients finding themselves in this scenario could well represent the industry’s biggest headache following implementation.

Client 2 is recalcitrant, and has not provided the requisite disclosures. He forfeits 30% of all US-sourced income; and the collection point for the IRS depends on whether his FFI participates or not.

The basic premises of FATCA compliance are clear enough. Firms are highly incentivised to get their compliance strategies right – customer demand will see to that. But how easy is this to implement in practice? The fear of many firms is – not easy at all.

The first challenge lies in classifying customers as compliant or not. Identifying recalcitrant account holders should be no more than an administrative headache. But the 30% withholding also applies to foreign entities with ‘undeclared substantial US owners’; meaning that, for example, any offshore trust where ownership of the assets is not entirely declared must be treated as effectively a recalcitrant investor.

Secondly, participating FFIs must also be fully aware of which FFIs are non-participating, since any US-sourced income due to them (e.g. through fund-of-fund structures) will need to be similarly withheld.

It is therefore clear that the categorisation of investors and institutions, and the controls and procedures required to administer the correct withholding treatment, are going to be onerous in aggregate. And the burden imposed on the industry does not end there.

For example, under the current ‘Qualified Intermediary’ regime only accounts holding US securities need to be documented as to their US tax status; under FATCA all account holders will need to be documented regardless of whether or not they are a US citizen and hold US securities. This switch from negative to positive evidencing of tax status entails another major piece of administration.

A further important principle of FATCA is the calculation of a Payment Pass-through Percentage (PPP), which is based on an assessment of the proportion of US assets in a fund. The PPP will denote the degree of withholding of payments based on the proportion of US assets held by a particular fund, and this is where the current lack of clarity and resolution becomes a real headache for the industry. For example, will the PPP be calculated at a legal entity (SICAV) level or sub-fund level? The answer to this question will have significant implications; e.g. would investors in a Japanese sub-fund be impacted if US assets are held in a different sub-fund?

To make the situation yet more interesting (or confused), the FATCA reporting requirements are in contravention of the EU Data Protection law, which forbids the transmission of personal information to jurisdictions with lower standards than the EU’s own (which includes the US). Compliance will therefore break EU law as it stands, and clarification of this situation is urgently being sought.

What of UCITS funds?

Current FATCA compliance requirements do not provide any exemptions for UCITS funds. Controversially, this means that whilst UCITS funds are not allowed to sell to US citizens, under current FATCA interpretation they would still have to provide proof to the IRS that they do not have US investors.

The provisions above are examples of the features of FATCA which have infuriated the European Fund Industry. There are likely to be further debates and compromises reached before the final requirements become clear.

More onerous than complex

The implications of FATCA therefore extend right through from the new account due diligence processes and the information required to be captured at this point, to the maintenance and administration of withholding tax by entity category, to compliance disclosure and reporting requirements - all of which demands substantial operational, procedural and organisational change.

What is clear is that the changes and operational enhancements required will impact almost every participant in the asset management value chain, including asset managers themselves, transfer agents, custodians, administrators, clearing organisations, distributors and investors.

But crucially, we see this work as being more onerous than complex. Requirement ambiguities will be clarified in due course, and managers who have prepared early and thoroughly have no reason to fear the implementation ahead. 

Getting prepared should start with an assessment of the level of US exposure of their products and investors. This will lead to a range of critical decisions on whether particular entities can and should comply, which must be taken on a fund-by-fund basis and will be driven largely by the type of clients, and the degree of US exposure of each fund.

If you can keep your head whilst all around you are losing theirs…..

There is still a lack of complete clarity around the precise provisions of FATCA compliance and implications for implementation, which does create uncertainty for the industry. The deadline for compliance has shifted once already (no-one should count on it shifting again); and (by way of an example) the details of the new reporting requirements must be developed through treasury regulations that have not yet been issued - further guidance will be issued in 2012 which may clarify the situation.

Despite the extensive lobbying underway to try and protect the asset management industry, asset managers will receive no special exemptions under FATCA. It must also be a strong possibility that where the US legislature leads, the EU will follow; and FATCA might well precede similar regulations originating in Europe and/or the Far East.

FATCA compliance will entail far reaching impacts to all financial organisations, and all key participants in the asset management value chain. But volume of work should not be confused with complexity. As clarity emerges (and it surely will), asset managers need to be ready with clear strategies, impact assessments, communication plans, and implementation approaches. But what this means is that it’s now time to be ‘on your marks’, rather than for a headlong rush into a full-scale programme. Clear, streamlined up-front analysis will lay the groundwork for successful implementation in 2012/13.

It’s time to act now – but it’s time to act smart. Planning cannot wait. Implementation must.

For further advice on how best to manage the impact of FATCA on your business, and on Alpha’s implementation approach and capabilities, please contact Luc Baque: luc.baque@alphafmc.com or Matt Bacon: matt.bacon@alphafmc.com

During October, Alpha FMC hosted its inaugural Private Equity discussion forum. Attended by leading global GPs, LPs and Family Offices, as well as high profile administrators and software vendors, the forum focussed on current industry hot topics - notably outsourcing and technology.

Trends in Outsourcing

The panel and attendees were unanimous in their agreement that there is an increasing trend towards the outsourcing of ‘non-core’ functions within the Private Equity (PE) market. The key drivers of this trend are the topically urgent search for cost savings, a regulatory environment that is becoming more intrusive and onerous, and the pressure exerted on PE managers through increasing investor discretion.

These trends largely mirror those that drove, and continue to drive, outsourcing across the wider asset management industry - and they now provide the imperatives for PE managers to focus on core activities, whilst de-risking and driving efficiencies from non-core activities by leveraging the scale and expertise of third party administrators (TPAs).

The Development of PE Administrator Capability

Historically, bespoke PE administrators have struggled with the scale and breadth of service offering required for them to be seen as plausible partners for GPs. Conversely, larger traditional TPAs have been perceived as trying to deliver the administration of PE assets through their core service functions, without fully accounting for the inherent idiosyncrasies of complex asset classes or fund structures.

In recent years, however, the administrator landscape has evolved considerably. Bespoke administrators are reaching a level of maturity and scale that establishes them as genuine potential partners to the PE powerhouses - witness the numerous recent wins by such administrators of established PE brand names. Concurrently, global TPAs have understood that PE administration is fundamentally more complex than their traditional asset coverage, and that administration on hybrid long-only systems and processes will not suffice as a credible service offering.

Naturally those TPAs who developed a more bespoke capability earliest, (or who grew through acquisition into the alternatives space), have enjoyed a head start on their rivals, benefiting from the direct domain expertise of their targets whilst also leveraging their significant balance sheets and service offerings.

A Positive Sales Message

Like their traditional asset manager forerunners, GPs increasingly see the value of the positive marketing message associated with independent administration. Such an arrangement demonstrates transparency and rigorous asset servicing in an environment of increased scrutiny by investors and regulators, particularly on those organisations managing alternative asset classes. Indeed the use of an independent administrator is becoming a key checklist item for some investors when considering where to allocate their capital. As we move into 2012 and beyond, regulatory scrutiny and consequent investor pressure are only likely to become more acute – a challenge that outsourcing may prove the most effective means of addressing.

Technology – Economies of Scale

One of the key benefits to working with outsource providers is the opportunity to leverage their significant investment in advanced technology and reporting platforms. All leading TPAs have invested heavily in these platforms, driving service and efficiency improvements across both traditional and alternative asset classes. Investment on such a scale, and the service and efficiency improvements that result, are the sine-qua-non for TPAs, in precisely the same way that asset managers are increasingly reluctant to undertake the scale of in-house investment required on non-core functions, just to keep up with more sophisticated investment techniques, asset classes, and regulatory requirements.

With all TPAs boasting impressive platform credentials, (some of which are more real and tested than others), the system and technology offering promoted has become an increasingly central selection criteria for clients selecting an outsource partner. However, the consensus appears to remain, in the PE market at least, that whilst the utopian vision of a “light touch” front end system interfacing seamlessly with a robust, complex administrator platform is edging closer, it is still quite some way off.

A Compelling Case?

With such a compelling array of factors pushing the PE market towards an outsourcing model, it is almost hard to believe that such a significant number of GPs continue to run their operations in house. The forum revealed a clear sense that, despite the significant advances made by the TPA providers in terms of servicing capability for alternative asset classes, and the efficiencies that result from their wider service propositions, there is still some way to go before many GPs would feel comfortable relinquishing the control and direct oversight they have over their own administration. The most common deterrents to outsourcing remain:

• A belief that administration can be performed cheaper in-house; and that the ‘all-in costs’ of outsourcing still remain comparatively high. Such costs include:
  • The maintenance of extensive and expensive administrator oversight functions
  • ‘Hidden Fees’ arising from the evolving complexities of the business
• Operational risk arising from the complexities associated with migrating funds
• The constraints that may be imposed on PE firms through having to adhere to standard models, and the limitations on TPA adaptability to business change
• Cultural differences between nimble PE firms and global TPAs

So whilst TPAs have created a far more compelling outsourcing proposition for PE clients in recent years, there is still work to be done before they are viewed by a number of their potential clients as genuine partners in this market.

Administrators, for their part, are responding to this challenge head on, targeting mandates for start-up funds, and adapting their value proposition and service capabilities to a level that they hope will open up opportunities for a wider outsourcing trend across the PE market. After all, with the continued squeeze on profit margins experienced in most large legacy asset manager outsourcing arrangements, it is precisely these sorts of new markets and opportunities that present TPAs with the most promising route to new, profitable business.

The Challenge and Prize Ahead

All market participants face challenges as the PE outsourcing market develops. For the GPs, it is about evaluating the real cost of running their business, anticipating the impacts of changing regulatory and investor requirements, and choosing an effective end-to-end operating model that best serves their future business needs. For bespoke administrators, the challenge is to maintain the momentum they are already building, in developing platforms, and a credible service proposition to take to the wider market in order to bridge the gap between niche provider and global partner. Larger, international TPAs must demonstrate that they can be flexible, client-focused and accommodating – which is always a tough balance to strike in a business which fundamentally demands scale and standardisation. However, their continued development of sound alternatives processing alongside their broader service offering is likely to prove an increasingly compelling proposition for GPs.

For further information about Alpha’s work and capabilities with Private Equity clients, please contact Ben Lucas: ben.lucas@alphafmc.com

Alpha completes first Fund of Hedge Fund Manager Benchmarking Study

Alpha has just completed the inaugural Fund of Hedge Funds (FoHFs) Operations Benchmarking Study. The study, (which is the first of its kind in the alternative investment space), assessed costs, capabilities and service levels for the Investment and Investor Operations functions at leading FoHFs managers. It uses the same proven approach as Alpha’s long-running studies for long-only Asset Management and our soon-to-be-launched study for Private Wealth Managers.

As the long-only and alternative investment management industries continue to converge, and more transparent and demanding requirements from institutional investors and their advisors, (such as investment consultants), are adopted, there is an increased demand for these kinds of external evaluations. The study has been widely praised for its approach and findings by our participants, as well as a number of industry bodies and actors.

The study is highly confidential and no data is shared with or sold to external parties. The objective is to allow participants to compare their own business models against those of their peers and industry ’Best Practice’, and to make any required changes to operating models to improve capabilities. Whilst studies of this nature are new to the alternatives industry, Alpha has been conducting benchmarking studies in the long-only industry for 10 years, with participants using them as valuable management tools and an agent for efficiency enhancements.

The study covered the following functional areas:

The participating group, which includes a range of leading players in the market, (and who jointly manage more than 10% of global FoHFs AUM), highlighted some interesting trends in this rapidly changing market. The success of managers, now more than ever, depends not only on performance but increasingly on having a strong handle on all components of the business and their related costs.

The last few years have seen an increased focus on the quality of operational capabilities in the alternative investment market in general, and the FoHFs sector in particular.

Historically, the back offices of alternative investment managers have taken a back seat to the total focus on investment returns. Many operations departments have been highly manual and lacked in many of the areas that would be considered to be ‘best practice’.

However, following the credit crunch and the Madoff scandal, both investors and regulators have been placing greater emphasis on the operational capabilities of FoHF managers. One reflection of this trend was a shift in investment allocations to the ‘larger scale’ managers. Such managers are often part of broader financial groups who have invested in infrastructure (whether IT, operations or other) on an on-going basis - and who have sound balance sheets.

To be able to compete for allocations from the main providers of assets, managers must increasingly be able to prove the robustness of their operations in a transparent manner. Benchmarking provides an extra level of independent due diligence and demonstrates to pension fund consultants and investors alike that participating managers are challenging themselves to enhance the management of their businesses, along with associated costs and risks.

Evaluating an operating model at a high level can immediately point to potential break points and areas of concern for both managers and investors.

Operating models are maturing, but the market is still fragmented

The operational models found in the FoHF industry are more heterogeneous than those in the more mature long-only industry, and may reflect the ‘cottage industry’ beginnings. There exists in some areas almost a “pick and mix” approach to outsourcing, with individual functions, rather than coherent blocks of the back office, being managed by Third Party Administrators. However, we are seeing a clear trend towards consolidation of providers and movement toward the type of standardised model prevalent in the more mature long-only market.

Concurrently, the number of software solutions targeting this market has ballooned in recent years, with more than 30 vendors targeting the core ‘shadow NAV’ space, maintained in-house alongside outsourced full NAV services. This has resulted in software costs falling and license terms becoming more flexible. However, it has also introduced further risks in the selection process as some providers do not have critical mass and may struggle to survive in the medium term.

For a number of reasons, the market infrastructure to support the FoHFs trade lifecycle still has a number of weaknesses

Some processes are still very much manual and will almost certainly impact operational risk levels and costs for all managers. For example, we estimate that only 60-70% of hedge fund share classes (i.e. units) have an ISIN code. In the experience of several major hedge fund database vendors, most manager clients do not request the ISIN code in their downloads, instead using internal proprietary instrument identifiers with a resultant impact on operational risk.

Other missing infrastructure includes the lack of a central market repository for hedge fund prices and terms and conditions, which is forcing managers to run this function in-house, thus needlessly duplicating the task and keeping costs high. Market initiatives are targeting the FoHFs’ trade STP process with some software vendors building automatic trade connectivity between managers and administrators, albeit using proprietary technology.

The lack of a market-wide approach to issues such as these acts as a drag on the market as a whole. We predict that due to investor demand, further regulation and business opportunity, the OTC nature of the market is set to shrink over time.

Managers who are able to leverage parent company infrastructure have an advantage

FoHFs managers that are subsidiaries of traditional asset management and/or investment banking parents that are able to leverage their parent companies’  operational and IT infrastructure have an advantage from organisational structure, cost, control and efficiency perspectives.

Business functions where such successful leverage is evident include systems pre- and post-trade compliance checking, client reporting, performance measurement and attribution/contribution and data repositories as well as core IT infrastructure, such as IT networks, e-mail and web browsing.

The 2012 study will launch in Q1 of next year and we are starting to recruit the participants for next year’s study now. If you are interested in further information, please contact Bo Lantorp, Alpha FMC’s Benchmarking Director, on bo.lantorp@alphafmc.com or +44 (0) 7958 304053  or Alpha Associate Sunil Chadda on sunil.chadda@alphafmc.com or +44 7967 687756.

The Alpha Benchmarking Function is a separate, “Chinese walled” part of the company with its own dedicated team, management structure, completely segregated benchmarked client data and a strong, proven methodology.

Over the past 12 to 18 months Customer Relationship Management (CRM) strategy and capability has featured high up the priority list of many Investment Management firms globally. Those that are embarking on or considering change programmes in the CRM space are doing so for a variety of reasons. However, some common trends are emerging as industry-wide objectives:

By focussing on the industrialisation of the traditional cottage industries of Sales, Marketing and Client Service business areas, it is possible to address these core objectives and drive out a genuine competitive advantage versus your peers:

The Challenge of CRM Change.

CRM programmes frequently fail to deliver the business benefits envisaged. On the other hand those implementations that succeed often have a much higher return on investment and further reaching benefits than the original business case.

It is crucial that businesses recognise the fact that effecting CRM change is not just about implementing a new CRM system. Indeed, the proportionate effort of selecting the right CRM technical solution and configuring it ready for release is, in our experience, c. 10% of the overall change effort.

As well as supporting our clients end to end from the naissance of their CRM strategy to the successful implementation, Alpha FMC has frequently been engaged by our clients to rescue existing CRM projects or re-invigorate/re-launch a “failed” CRM implementation. In both cases, the causes of failure can all be attributed to one or more fundamental elements that have not been addressed (see below).

Sponsors and the Project Team need to plan mitigation strategies well in advance of deployment of the tool to the business users and monitor impact throughout the user adoption cycle.

CRM Vendor Landscape – Investment Management

There are a vast number of CRM suppliers out in the marketplace today. However, in Alpha’s view, there are 2 or 3 CRM vendors that are emerging/have already emerged as clear market leaders within the Investment Management Industry specifically. The diagram below gives an indicative view of how it is possible to quickly filter the selection process down to a suitable shortlist.

Therefore, we believe that it is no longer necessary to undertake lengthy and costly RFI/RFP processes. By leveraging Alpha’s extensive knowledge of the Investment Management industry and nuances of/differing capabilities between the leading CRM vendors, our clients can move straight to focussed negotiations around contracts and commercials with a shortlist of Vendors and, if appropriate, run a focussed “model office” review period.

Alpha’s Approach to CRM

CRM is a core consulting offering for Alpha FMC. As a mark of our commitment to this area, we recently acquired TomTom Consultants (a CRM implementation specialist consultancy) to further strengthen our capability and credentials. We are now in a position to support our clients end to end from CRM strategy definition, tool selection through to implementation of that Strategy and toolset.

Alpha’s approach to delivery is underpinned by 3 guiding principles:

1. Seamless & Comprehensive Delivery – we manage end to end delivery without the need to engage with multiple partners, consultants or 3rd parties to fill skill gaps. This reduces complexity, role duplication, risk and cost for our clients
2. Lean Team – We will leverage client resources where available to ensure that we are not over-engineering our resourcing model and that costs are minimised
3. Knowledge Transfer & Client “Up-skilling” – working with client resources to ensure knowledge is transferred to their internal people, enabling our clients to take on later phases of delivery alone and build internal expertise

For further information about CRM and how Alpha FMC can support your business, please contact Mike Smith: mike.smith@alphafmc.com

Investments in Client Reporting and Institutional Client Support are starting to pay off for Asset Management Operations Departments

The 2011 annual Alpha FMC Investment Operations and TA Benchmarking Study is now being concluded and we have seen a number of interesting developments in operational performance across the industry.

Significant improvements in both cost and service performance for Institutional Client Reporting/ Client Support.

Over the past few years, our institutionally focused clients have directed a significant share of their operational development efforts into improving the customer-facing side of operations, but up until this year we had seen comparatively little tangible improvement in the results from the study. However, the 2011 findings show that these investments are starting to bear fruit.

The average cost per institutional client report produced report is c.20% lower than last year. This appears to be driven by both increased levels of automation as well as greater standardisation of processes and templates

Increased levels of automation have also allowed for greater economies of scale within the reporting function

• Vendor applications for work-flow management are replacing legacy Excel and internally built systems
• The average lead time for getting reports out to clients has been reduced and the number of reporting errors have been reduced to a minimum

However, during the coming 12 months, most managers will see the focus shift from the institutional reporting process to the retail side with the introduction of KIID documents. We will be looking to track and compare the different approaches that are emerging in this space.

Greater automation in the core Investment Operations functions drive continuously improving service performance.

The trends we have seen in recent years of both higher levels of automation and lower error rates continued this year. In particular, we saw a noticeable improvement corporate actions processing. We also observed a further reduction in NAV error rates, shorter derivatives confirmation times, and a stabilisation at last year’s levels for failed trades and reconciliations breaks (which in last year’s study has shown noticeable improvement from previous years).

The share of participants who reconcile stocks on a daily basis increased from 40% in last year’s study to 50% this year and we believe it is only a matter of time before daily stock reconciliation is the market norm.

With the exception of Customer Support, costs remain stable

We did not see any significant changes in the costs for non-client centred operational functions. However this is not necessarily surprising as a significant share of asset managers are outsourced and tied into long-term contracts.

As in previous years, outsourced participants in the study had, on average, lower costs than those who maintain in-house operations.

The 2012 study will launch in Q1 of next year and we are starting to recruit the participants for next year’s study now. If you are interested in further information, please contact Bo Lantorp, Alpha FMC’s Benchmarking Director, on bo.lantorp@alphafmc.com or +44 (0) 7958 304053

For Latin American fund managers casting covetous glances at the lucrative possibilities of global distribution, the good news is that there is an increasingly sophisticated asset servicing infrastructure available to facilitate geographic expansion. Improved capabilities of global securities services providers provide an ever-clearer route to attractive, flexible and globally-distributed fund structures (witness the Asian appetite for UCITS funds). Yet as ever, enticing opportunities need to be approached with care. For fund managers engaging in any sort of significant operating model expansion, the devil is most certainly in the detail.

The most obvious first step for many expanding Latin American firms will probably be establishing a foreign-domiciled fund for global distribution. A range of locations currently compete for this business – from Luxembourg as the base for UCITS-compliant SICAVs, to Dublin and Cayman which remain the most high-profile domiciles for alternatives funds, to numerous other specialised ‘offshore’ locations such as the Channel Islands or Gibraltar. Each of these locations are established hubs of expertise, and once a fund manager has selected the target fund type, most major global service providers will offer operating models that support these domiciles.

The evolving regulatory environment will likely impact choice of domicile. Luxembourg currently appears to be a winner from UCITS IV provisions - it was an early implementer of supporting legislation, and has seen significant recent growth in fund domiciliation. Ireland’s treatment at the hands of the Chilean regulator perhaps serves as a cautionary tale for domiciles which are struggling with sovereign debt issues (albeit fund inflows remain at record levels), and it has been suggested (and equally denied!) that Cayman may struggle under the AIFM regime.

So to the good news. You want to be a global fund manager, so you need a global operating model to support you. This is particularly important if your intention is to maintain the location of investment and dealing expertise in your home market whilst running funds domiciled abroad. Securities service providers have long boasted of their global servicing models; but in reality a great deal of investment in global support platforms has occurred in the last few years which means that there is now a range of genuinely global servicing alternatives.

You also don't want geographic expansion to cost....the earth. Here again, this will lead most LATAM Fund Managers down the road of engaging a global securities servicing partner. Many of these firms are beginning to pass on the tariff benefits associated with strategic and scalable platforms. Moreover, tariff competition between major providers remains (perhaps a little unexpectedly) intense. And all of this may come as a pleasant surprise to some LATAM Fund Managers dealing with domestic resources and cost bases that are notoriously expensive (some managers have found operational costs to be lower in the US than in Latin America). Markets throughout the world will have their own support and interface requirements (e.g. Euroclear, FundSettle, FIX, SWIFT). Leveraging the expertise and existing infrastructure of a global securities servicing firm avoids the considerable time, cost and effort involved in stretching legacy, in-house operating models to support global ambitions.

(Some managers may, of course, be looking to create in-house manufacturing centres outside their home markets - in which case all the above considerations will still apply, but many more besides from an internal structural and operating perspective.)

And finally, you want global expansion to provide easy access to global distribution channels. Here again, the ease of global distribution and appeal of UCITS funds - in particular SICAVs - means that through effective servicing and distribution partnerships, well-marketed, European-domiciled funds are an increasingly light-touch first step on the road to a global presence.

But caution and thorough due diligence are natural and obvious pre-requisites to selecting a global asset servicing partner, and establishing a commercial and operational model that will effectively support, rather than hinder, business expansion.

Firstly, 'global operating models' mean different things to different people, and there are several aspects such models that demand close scrutiny. From which location will your provider service your investment records? Does your asset service provider operate a full and effective 'pass-the-book' model globally - and does this mean that your investment business is fully supported for trading hours in your local market? Does this extend to full trade support late into the European night or from crack of the US dawn? And moreover, does this extend to full access to operational teams for your own in-house teams throughout your hours of operation? The advantage of your westerly time zone should mean that your fund managers will be able to start their trading day based off fully priced and updated positions - but this assumption deserves scrutiny and will be subject to the constituents and trading locations of your business.

Secondly, you won't want things lost in translation. Most global asset servicers will be able to interact with their clients across a range of languages - but certainly in English and the local language of administration location. But LATAM managers may not have staff as fluent in Northern European languages as managers in other parts of the world - and the experience of many managers setting up in or expanding from Latin America suggests that it's well worth ensuring a strong language bridge between fund manager and service suppliers.

Next up, risk, which must be monitored effectively across global businesses in the post-Lehman world. Increasingly sophisticated risk measurement services are available from the major providers, but this is still a function most commonly maintained in-house by asset managers. Expanding managers must quickly develop a clear view of how they monitor and manage risk across their business, and how their service provider supports them in doing so. Issues of data consistency and integrity in support of risk measurement will be more complex in global company with outsourced operations.

LATAM managers will also have specific requirements based on their domestic regulatory and tax environment. For example, the 2% Brazilian government tax on BRL FX instructions means that an effective FX netting capability should be employed across the book of business. All providers are likely to provide netting services of some description - but the extent, frequency and hence effectiveness of netting becomes important.

And finally, LATAM managers will face the same questions as all other managers seeking to partner with or leverage the capabilities of global suppliers - in terms of the scope and complexity of services they wish to purchase. Global expansion is going to mean more (multi-currency?) share classes and assets - why not let your provider hedge these for you, so long as you're satisfied the service is robust and economically viable? KIID reporting, end-client reporting, performance measurement? All such functions and more may be good candidates for leveraging existing supplier platforms and expertise. Nevertheless, all such functions will require close due diligence because despite what it may say on the tin, capability, service delivery and cost will vary substantially across the market.

The popularity of Emerging Market funds has been well documented in recent years, and increasingly sophisticated and credible LATAM fund managers are understandably keen to tap into the positive sentiment on their region. They will find plenty of willing and capable asset servicing partners, who in many cases will be major global institutions seeking a partnership beyond the traditional parameters of asset servicing. Establishing in-house asset servicing capability abroad is of course an option, but may prove restrictive commercially, technically, and from a time-to-market perspective. Leveraging the capabilities of existing TPA relationships may also be possible for some, but commercially, fund managers will find a favourable provider landscape. Technically, they will benefit from global platforms that have seen huge investment. They should seize the moment.

If you have any comments on this article, or would like to talk to Alpha about our experience or expertise in global asset servicing, please contact Nick Fienberg: nick.fienberg@alphafmc.com.

In the wake of the 2008 financial turmoil, the Performance and Risk functions of Asset Managers are coming under ever increasing scrutiny.

Both Risk and Performance are traditionally a mix of more tailored Front Office functions, and process-driven tasks more closely aligned to a Middle Office. A variety of organisational structures are adopted throughout the industry, with Risk and Performance responsibility either highly fragmented, or sitting in one team under a common head. This has borne a number of operating models and organisational or process issues, the results of which manifested themselves dramatically when the financial climate turned malign.

In response, a plethora of forces are now driving investment and change in these areas, ranging from internal management, through existing and new client demands, to the evolving regulatory landscape. The asset management community is more engaged that ever in the search for scalable, automated solutions that are better able to accommodate more varied and onerous demands from these different actors. Increasing numbers of asset managers are reviewing their operating models, with several identifying an urgent requirement to invest in their capabilities.

How organisations address such demands in a fragmented environment is becoming one of the hottest topics in the industry, with some firms actively looking at Risk and Performance capability as an opportunity to steal a march on their competitors and market their capabilities as part of their strategy for retaining and winning new business.

“A robust, scaleable, automated solution for both Performance and Risk is becoming a necessity”

The perfect storm driving improvements in Risk and Performance capability is the culmination of pressure from three fronts. Clients are becoming increasingly sophisticated in their requirements for evidence of robust risk control processes and performance reviews, evidenced in their demands for detailed performance and risk reporting. At the same time, asset managers are subject to unprecedented regulatory scrutiny, including evidence of daily VaR calculations and monthly stress testing for UCITS funds. The three-way pincer effect is completed by internal requirements to review and improve the investment process, which include enhanced MIS used (for example) to calculate Fund Manager bonuses and assess the effectiveness of the manufacturing processes.

Whilst the specific issues faced by asset managers within the Risk and Performance capabilities are unique to individual organisations, several common themes have emerged:

1. Inconsistent Risk and/or Performance output: Frequently, there are multiple sources of performance and risk output, for example Fund Manager calculations, other front office teams or the official performance team. There may also be a geographic dimension with different teams working from different data or different platforms in an inconsistent environment
2. Inefficiency of the Risk / Performance function: Work is often duplicated across the organisation given the mix of front office / middle office tasks. Mis-matches between the requirements of the end user and the solution put in place are frequently observed.
3. Problems meeting increasing and onerous client and regulatory requirements: The evolving regulatory landscape is evolving, impacting risk and performance capabilities, for example with increasing moves into UCITS funds, there is an increasing requirement for daily VaR and stress testing. Clients also increasingly require evidence of more robust tools and process, supporting both new business and client retention strategies.
4. Inaccurate Data and Output: Data integrity and accuracy are critical components to get right. If these are not achieved, risk and performance figures can be incorrect causing reputational and / or financial damage.
5. Opaque Responsibility & Reporting Lines: Asset managers have a wide variety of reporting lines for performance and risk, with the boundary between Operations departments and the Investment function often opaque, causing issues with responsibility, accountability and consistency.

To outsource, or not to outsource…..

Historically, the Risk and Performance functions remained in-house at an Asset Manager, and many have therefore faced a “buy or build” decision. With the range of depth of problems described above, could this be the time for a change of strategy?

The market for outsourced provision of these services has remained comparatively underdeveloped. Third Party Administrator (TPA) capabilities are extremely variable with some having mature platforms serving numerous clients, whilst others have not yet established a core platform to provide Performance or Risk reporting services. The more advanced TPAs have typically only offered Performance reporting services as an add-on to Middle-Office and Back-Office functions. As TPA-client relationships mature, administrators are seeking to provide more of these sorts of front office tailored services to their clients over and above the more traditional operational functions. More administrators are now looking at offering a Performance calculation service on a standalone basis, as a strong value add to their business and are investing in new capabilities as a result.

However there remain inherent challenges in a set-up where Performance services are outsourced to a different provider than the Fund Accountant / Investment Operations provider, and challenges for TPAs in whether to position their offering as a cheaper service than an in-house alternatives, or a service of enhanced quality (potentially more expensive).

Many asset managers still choose to retain performance in-house, often due to sensitivities around sharing what is regarded as market sensitive data. In addition, performance is often a function residing in or very close to the front office which would increase complexity and potentially making outsourcing politically challenging. For Fund Managers making this choice, however, significant investment awaits due to client-driven demand, entailing either enhancing or re-purposing in-house builds, or implementing new off-the-shelf packages. Selecting the right model, with the right tools or partner will be critical in the evolving landscape for performance reporting.

The provision of risk reporting as an outsourced service, on the other hand, is currently in its infancy - although increasingly administrators are looking into enhancing their capabilities as a key competitive differentiator. Nevertheless, for the majority of managers, the focus in this space is on existing in-house systems.

Whilst there are a range of risk systems on the market, new requirements have in many instances necessitated investment in new or enhanced platforms, particularly UCITS III daily VaR calculations, stress testing and external client demands for greater transparency. There is also increasing demand for managers to demonstrate a clearer understanding of the investment process than in the past, particularly for new business.

To achieve this, many asset managers use a combination of multiple systems to provide the desired functionality. Leveraging external packages is attractive although as with performance tools, some risk platforms have a particular bias towards a particular class of asset. Selecting the right tool or tools is therefore critical to the new risk-focused environment.

Many TPAs have recognised the importance of this service to their clients and have started to invest in this space. Given the fixed and industry standard requirements for UCITS III reporting this appears to be a service that could potentially be outsourced. Some providers are aiming to provide a fully integrated view of performance and risk reporting and are moving from providing standalone risk models to more complex ex-ante scenario analysis and stress testing.

Typically, only the more mature outsourced relationships are moving into this space although some providers are developing the ability to provide a Risk reporting offering on a standalone basis. This would result in a complex operating model if 2 providers were involved, but an intriguing hybrid model would be a manager with Investment Operations in-house outsourcing Risk reporting on a standalone basis. RiskMetrics have historically provided this service to Hedge Funds although this will come under scrutiny given recent corporate activity.

For asset managers considering outsourcing Risk reporting, a further hurdle will be that a typical financial business case may not be an appropriate decision criterion, and a more thorough review of capabilities would be required. Enhanced risk reporting capability is a key competitive differentiator in the current market, but given the wide variation in current TPA capability, selecting the right provider will be crucial.

Getting it right.

Whichever route asset managers choose to go, there is no escaping the client, regulatory and front office demands that are driving the need to stabilise or indeed significantly enhance Risk and Performance reporting capabilities. Potentially large investment and operating model upheaval looms, and any solution must be scalable, automated and robust. Both asset managers and TPAs increasingly view this space as an opportunity to differentiate and develop competitive advantage to meet ever more sophisticated client requirements. On offer to asset managers is the intriguing possibility of maturing outsourced capability, but given the current variance in TPA service capabilities, their choice will need to be made carefully.  There is no one size fits all solution, with the right answer being driven by existing capability and operating model, asset mix, client and geographical spread. Getting it wrong is not an option.

An entirely new approach to partnership between asset managers and their service suppliers is becoming evident in the more progressive deals, and it may yet prove a watershed in the effectiveness and profitability of outsourcing.

The maturing of asset manager outsourcing deals over the past few years has been well documented. Alpha FMC’s annual benchmarking studies have borne out this trend through improving and stabilising service delivery across an increasingly wide scope of services. But perhaps now, more so than ever, there is pressure on asset managers to reduce their cost base and improve service quality at the same time as service providers need to increase revenues and profitability.  These pressures are leading providers to extend their relationship with their asset manager clients to new services to supplement the margin squeezed, traditional core services.

Jon Benson, a Principal at Alpha, comments: “The provision of pure administration and custody services has long since ceased to be commercially or strategically exciting for most suppliers. Those suppliers who manage their client relationship proactively and offer a wholesale, strategic direction are more likely to develop long term, valuable relationships with their clients. Those asset managers who create wide ranging and deep strategic partnerships with their outsource suppliers are more likely to generate the maximum benefits and synergies from their suppliers.”

A number of asset managers are, with varying degrees of engagement, looking closely at how they can more effectively leverage the capabilities offered by their supplier. The most successful managers in this respect are those that have adopted a clear and structured approach to developing their outsourced operations. Often, through effective collaboration, asset managers can lead suppliers in tailoring their market offering. Such collaboration includes the ongoing and active management of a strategic plan to help both the asset manager and service provider grow their businesses.

The most effective suppliers will be those most adept at the identification, understanding and management of their evolving client needs. Suppliers need to present a clear & complete view of the full scope of services that they can provide (often easier said than done!), as well as a compelling narrative of how their service offering is evolving to address market developments and the business growth strategy of their client. The focus should then be on identifying the right new products to sell to clients to help them maximise the benefits achieved from the supplier – which in turn can lead the supplier into precisely the higher-margin areas to which they aspire.

Alpha is involved first hand in the evolution of these relationships from both perspectives. Of course, it would be an overstatement that this is a description of a general market trend at this stage. For every client/supplier relationship which is proactively forging ahead into new territory, there is at least another one where a genuine spirit of partnership innovation has yet to take hold. But for those with the will to explore extending their relationship, the opportunities are significant and varied.

In Alpha’s experience, the nature of such opportunities will depend on the asset manager’s motivation and the readiness and ability of suppliers to access more difficult service areas. However, key themes include:

• The Administration of Alternative Funds e.g. Real Estate, Private Equity, Fund of Hedge Funds.  Joe Docker, Manager at Alpha explains: “Market consolidation has meant that traditional asset managers have often broadened the scope of investments. This brings both operational management issues and compliance and risk management challenges. However, this in turn has created an opportunity for service providers to create scalable and robust Alternative Funds service models to help reduce costs for Investment Managers. For instance, a large securities service provider might look to leverage existing but fragmented property administration services to create an effective one-stop-shop for outsourced property fund administration. It’s an offering that can prove effective, even in the face of stiff competition from specialist providers.”
• The provision of dealing functions: by leveraging existing infrastructure suppliers may be able to generate market orders which can be filled automatically. The supplier may be able to build scale and hence reduce the operational costs associated with dealing in the market. Investment Managers in turn may be able to identify cost reductions for the dealing of vanilla, market priced securities. Suppliers can take an internal, fixed cost function and deliver a transaction-based cost model delivering dealing, matching, settlement process synergies.
• Financing – where suppliers can leverage long-standing administration client relationships to introduce their investment manager clients to Investment Banking functions to the benefit of the wider relationship, for example when an Investment Manager embarks on corporate activity.
• Foreign Exchange Overlay services: outsourcing the administration of currency exposure may offer clients a cost effective way to manage FX exposure
• Outsourced client reporting and performance services: suppliers will typically deliver month end data to investment managers for creation of client reports or calculation of performance and attribution reports. This is a logical extension to the outsource relationship and a key emerging area of opportunity, which is explored further in a separate article.
• Extending relationships across geographies: many asset managers are looking to leverage global platforms to enable a common service and operational model across all operational geographies. This is only achieved through a joint, strategic partnership with the supplier - which can minimise supplier interfaces, cost and create a common operational direction.

The common thread running through all of the above examples is an attempt on the part of both service suppliers and their asset manager clients to deepen the nature of their interaction, and to each leverage the widest possible array of capability available to drive value and revenue out of existing relationships. Suppliers attached to large banks in particular will increasingly look to sell all available group services to their clients – and this often means extending traditional service supplier relationships into the realm of corporate services, as well as the extension of a traditional service portfolio into wider and more complex areas. For their part, asset managers may well be looking to the wider group capabilities of their suppliers to see not just how service and cost might be managed through the relationship, but what value and custom the supplier can bring to their core asset and client base. And once we’re into this sort space, a huge realm of possibilities does begin to open up.

Of course the above examples represent a broad array of opportunities, which are being leveraged to differing extents across the industry. But far from settling into an established pattern, a number of asset manager / supplier relationships are increasingly being explored for mutual value opportunities. The most successful will be those that most effectively extend the scope of service provision into higher value areas in a secure fashion. As Benson notes, “No two suppliers or clients are the same. Knowing your client/supplier and effectively identifying the breadth of services that can be offered will enable the suppliers and clients to effectively grow together and meet their joint strategic service and financial goals.”

And this type of corporate partnership approach will certainly be required if suppliers are going to crack the increasingly aged problem of profitable securities services outsourcing, and if asset managers are going to drive the maximum value possible from their existing service outsourcing arrangements.

If you would like to know more about our Supplier and Client Management expertise and credentials, please contact Jon Benson on jon.benson@alphafmc.com or +44 (0) 7941 320299.

Alpha FMC has over the past few months conducted a survey of attitudes to benchmarking of Operations among Senior Executives from the European Asset Management Industry. The survey, which looked at attitudes to benchmarking in general and not to any particular studies or providers, generated a number of interesting findings:

Most managers use benchmarking studies to assess the performance of at least some operations functions

Even allowing for the fact that companies who have experience of benchmarking are more likely to respond to a survey like this, the share of respondents who reported that they had

participated in benchmarking studies over the past three year was, at 80%, higher than we had expected. Fund Accounting and Custody were the most popular functions for which to benchmark service and/or cost efficiency, with all of the positive respondents reporting they had done so in the past 3 years. Half the respondents reported they had benchmarked Investment Operations, Derivatives Processing and TA while 30% said they had also benchmarked Client Reporting and Performance & Attribution performance.

The most common reason cited for why companies had not participated was concern over the effort required to collect the data. This was in many cases an acknowledgement of a worry that internal operational MI was not comprehensive and granular enough to fit into the standardised models used by the benchmarking providers.

The most common reasons to benchmark are to identify areas for improvement and to gain reassurance of competitiveness

Understanding areas of underperformance and gaining assurance that of competitiveness were, not surprisingly, quoted as the most common reasons for taking part in operations benchmarking. The third most common reason was to support cost reduction activities – a likely reflection of the pressures caused by the recent market crisis.

Outsourced asset managers also quoted the ability to provide leverage with TPAs to improve cost or service performance as a key reason. It is becoming increasingly common to have regular benchmarking enshrined in outsourcing contracts between asset managers and outsource providers. Done correctly, this can be a very useful tool for both parties to ensure that tariff and service are maintained in line with market norms throughout the life of a contract. However, in Alpha’s experience, many companies who have these types of provision do not use them to the fullest extent and are not therefore realising the intended service and cost benefits.

In most cases, participating in benchmarking studies achieve the objectives set out

More than three quarters of the respondents agreed that taking part in investment operations benchmarking studies had allowed them to meet the objectives they set out, in particular with regards to identifying areas for potential improvement and for monitoring the performance of outsource providers.

However, there were also a couple of areas where the perceived benefits had been less clear. Less than half of the participants felt that the studies had allowed them to better understand key operational risk levels and a similar number reported limited benefits in terms of monitoring results of improvement activities. The very different approaches taken by companies when defining and measuring risk means that this has always been a hard area for benchmarking providers to cover. However an increased focus on risk among operational executives following the recent market turbulence is likely to put more emphasis into measuring and comparing this area in future studies.

Annual benchmarking of service performance and biannual cost comparisons was considered appropriate

Undertaking annual service reviews and bi-annual reviews of cost levels was the most common approach to operational benchmarking. However, 20% of respondents said they thought service should be compared annually and a further 20% every six months.

As a key player in the asset management benchmarking market, Alpha are of course delighted that senior industry executives value the benefits of operational benchmarking. However, we also firmly believe that many of clear benefits described above are applicable beyond the traditional areas of operational benchmarking. Whilst inevitably focus and objectives need to be tightly defined in more difficult areas, there are clear reasons why managers should consider reviewing front office, distribution and other functions for potential for external comparisons.

Alpha FMC is the global market leader in asset management benchmarking and run comprehensive studies for all parts of the asset management value chain as well as for the different industry segments (alternatives, property, etc.). If you are interested in further information,  please contact Bo Lantorp, Alpha FMC’s Benchmarking Director, on bo.lantorp@alphafmc.com or +44 (0) 7958 304053.

UCITS IV legislation has spawned a plethora of reports and conferences as well as much debate in the industry.  Much of the comment has been that a variety of issues such as tax constraints will mean that certain parts of UCITS IV will not result in major change for many managers.  However, our recent work with our clients has identified substantial efficiency and effectiveness gains that may exist through selective implementation of some of the key pillars of the new legislation.

“Firms not actively investigating and planning for UCITS IV are likely to be both delaying financial benefit and potentially duplicating product development work ”  

The most widely applicable opportunity for near-term simplification and financial benefit at many managers is the implementation of Master-Feeder structures, particularly where significant fund duplication exists. Duplicated fund structures, defined as funds with similar investment strategies, may exist as a result of earlier cross-border distribution strategies or M&A activity and are probably causing significant cost inefficiencies.

Whilst there can be tax incentives to investors from Master-Feeder structures, our work has tended to focus on the hitherto largely unexplored cost reduction opportunities offered to both asset managers and investors, as well as the knock-on impacts to third party administrators’ strategies, operating models and revenue streams.

“The Alpha Master-Feeder Efficiency Model shows substantial potential savings from Master-Feeder structures: moving from 2 duplicate (clone) funds to 1 Master, 1 Feeder can save 28% of core operations and custody Costs, increasing to 43% cost reduction where 5 duplicates exist” 

We have developed a sophisticated multi-driver model to quantify differences in cost between duplicate funds vs Master Feeder structures by assessing the aggregation of cost drivers into the master fund. TheAlpha Master-Feeder Efficiency Model (‘AMFE Model’) shows that even moving from 2 duplicate funds to 1 master, 1 feeder (the simplest case) results in a reduction in costs per fund of up to 28% of both core operations and custody costs. Clearly, these savings will increase with the degree of duplication, with the AMFE Model showing a distinct savings scale curve as duplication increases: 

Figure 1: The Alpha Master-Feeder Efficiency Model shows increasing savings with higher numbers of duplicate funds

Moving from 5 duplicate funds to 1 Master and 4 Feeders can result in costs reducing by up to 43%, a significant opportunity for asset manager profitability improvement whilst at the same time benefiting the fund holders. The savings are based on increased efficiencies across the structure reflecting the reduction of the drivers of cost (or fees in an outsourced environment).

These savings are significant, particularly if replicated across the whole book of business, although still greater benefits can be identified if Master-Feeder implementation is carried out as part of a wider product and / or capability rationalisation exercise. When combined with underlying pooling structures (which may be a necessary consequence for larger asset managers), the efficiency gains can be even more exciting.
Indeed, we believe those firms not actively investigating and planning for UCITS IV are likely to be both delaying financial benefit and potentially duplicating product development work, as product initiatives undertaken in isolation over the next 12 months are likely to require revisiting post adoption of UCITS IV. The winners are likely to be those organisations that develop a coherent product strategy and roadmap for the next 12 – 24 months, taking advantage of UCITS IV provisions, cost efficiencies, fee alignment and wider rationalisation.

“The COO cost reduction agenda and Product Development agenda can both be served by Master-Feeder implementation. Larger pools of assets will bring distribution benefits, coupled with scale economies and a more efficient operational structure”

Implementation of Master-Feeder structures is therefore not about cost or product development in isolation. Creating larger pools of assets in international vehicles is important from a sales and distribution perspective as well. Firstly many institutional investors, especially multi-manager funds and structured notes, are not permitted by internal or external regulation to own more than a certain percentage (typically 10%) of a fund. Secondly international business is increasingly won on the basis of products structured on flagship funds.  This is not possible where the underlying fund is of insufficient size to cope with the inflow and outflows deriving from the related multi-manager funds and structured notes.

The cost reduction potential of UCITS IV will pose a significant challenge to third party administrator revenue streams. Fees are likely to come under pressure from core operations and custody reductions as a result of tiering (due to larger masters) and lower per fund charges for feeders due to their simpler structure.

The revenue squeeze will partly be offset by a reduction of activity (and hence cost base) at an administrator, but only if there are dedicated efforts to support this cost reduction to defend margins. A degree of price renegotiation will also have to occur to balance these interests.  However third party administrators will benefit from the larger pools of assets that result – particularly in the netting of FX transactions and more effective stock-lending programmes.  Also, TPAs with a strong Luxembourg offering may also benefit from the flow of increased business to this jurisdiction.

Revolution or Evolution?

It is our belief that UCITS IV will bring change to the industry – but will this change be revolution or evolution?

Our view is that there is not a one-size fits all solution;  depending on business mix and legacy structure, asset managers will have to understand and quantify the full benefits of a master feeder structure, potentially combined with a wider rationalisation programme.  
There is a surprising lack of urgency prevalent in some managers, as organisations wait for implementation of the UCITS regulations. Clearly, this carries the risk of delaying potential substantial cost savings and undertaking inefficient or duplicated product development work.

Some managers are likely to find significant savings potential, whilst other players without much duplication will focus on other areas - for example rationalisation of ManCo’s and potentially cross-border mergers should their specific situations allow for capturing benefit in this way. Either way, to act now will position managers to be one of the immediate winners by enhancing profitability and/or gaining a distribution edge in the post UCITS IV world.

If you would like to know more about our UCITS expertise and credentials, please contact Matt Bacon onmatt.bacon@alphafmc.com or +44 (0) 7815 811556 .

The last few years have been an exciting if turbulent time for property (or real estate) investment management.  A much greater focus has been placed on the asset class and in some respects this focus has revealed an uncomfortable situation.  In particular, many long established property managers have suffered from a lack of investment in infrastructure over many years which has compounded the industry-wide issue of poor data quality.

In this context we believe there is much work to be done and benefit that can be achieved within the property investment management world.

One of the interesting issues being tackled by several of the large managers at this time is the appropriate level of integration with the wider asset management businesses.  Historically, many property managers have operated almost entirely independently even to the extent of occupying separate offices from the wider firm.  However, cost and sometimes quality issues have caused this to be increasingly challenged and a greater level of synergy sought.

In our opinion this is not a simple binary issue but a much more complex and subtle question.  Firstly, taking an asset type view we see some opportunities for synergies with the indirect property book and other businesses such as private equity and multi-manager.  For the direct property business the similarities with other areas are much less clear.  However, even for direct property we see potential in areas such as risk management, the support functions and distribution.

A further complication to this situation is the multiplicity sourcing models used throughout the industry.  On the securities side of managers, benchmark data demonstrate that operations outsourced to a third party administrator (TPA) outperform in-house operations for both quality and cost efficiency and this is increasingly recognised as the preferred sourcing model.  However, on the property side managers will disagree over the competitive edge that may be gained by performing various apparently administrative functions better than their competitors.  For example, many would argue that asset management activities such as lease management and renegotiation are important competitive activities that can protect and enhance returns.  There are some who would go further and argue that basic property management, which is outsourced by most managers, can also increase returns through improved tenant satisfaction and lower vacancy levels. 

It is not therefore surprising that a wide variety of sourcing models have developed with a combination of managing agents undertaking many of the administrative tasks. In recent years we have also seen administration outsourced to the TPA banks, often as part of wider outsourcing deals.  Unfortunately some of these deals have been executed without a full understanding of the differences between property and securities operations and have lacked a clear plan for improving the systems and processes.  This has therefore led in some cases to a degradation of service performance, staff demotivation and frustration all round. 

In theory there is no reason why the outsourced model prevalent on the securities side will not ultimately prevail, however, the TPAs have much investment to make in infrastructure and scale to build before we are likely to see this occur.  If the property managers have anything to learn from their securities colleagues in this area it is perhaps in how to manage outsourced services.  The discipline of service management is quite different from managing in-house functions as many firms have learned the hard way.  As our benchmarking data again shows, firms with well constructed service agreements and service management teams get more out of their outsource providers than others.

Add to all this, the complexity arising out of delivering pan-European or even globally integrated services and it is easy to see why some managers are finding it difficult to make rapid progress. Nevertheless, we are very encouraged that a fresh new impetus is palpable in the property world and that a real drive for improved cohesion, quality and efficiency in underway.

If you would like to know more about our Property asset management expertise and credentials, or are interested in participating in our Property Benchmarking study, please contact Duncan Spencer on duncan.spencer@alphafmc.com or +44 (0) 7967 738 913.

We have recently delivered the initial results of the 2010 (8th edition) Alpha FMC Investment Operations and Transfer Agency Benchmarking Studies with participants from Europe, the US, Asia and Australia. 

The Study, which compares cost efficiency, service levels and operational capabilities across all asset management middle and back office functions, has benchmarked more than 40 leading asset managers from across the world and has allowed us to build up a unique database of efficiency and effectiveness metrics.  This database, combined with our extensive consulting expertise, gives us a deep understanding of the strengths and weaknesses of the range of operating models that exist in the industry.

The Study is based on calendar year data, although we can always bring in participants at other times and assess different data time periods.  The 2010 Study predominantly looks at CY09 data, and has therefore shown a fascinating view of the full impact of the credit crunch on asset manager operations. Specific findings and data are only available to Study participants; however a review over a multi-year period uncovers some interesting macro trends. For example:

• Cost levels are stable but service performance is gradually improving.

  • For a number of years we saw a steady increase in cost efficiency, with unit costs for the key operations drives (trades, NAVs calculated, corporate actions, etc.) declining year on year. However, for the past three years this trend appears to have stopped with efficiency levels more or less stable. There are several explanations for this, in particular:

    • Many companies outsourced their operations during the period and are committed to long term contracts

    • Rapid increases in salaries during the years up to the credit crunch compensated for any savings in other areas.

  • While costs have been stable, service levels have continued to improve with performance against key KPIs getting better across the board. This is partly a reflection of the resolution of early issues following the bedding-down of new outsourcing deals being resolved and partly from increase automation of many processes.

• Trade Processing STP levels appear to have reached a plateau.

  • The Alpha FMC Study measure STP levels at four stages in the trade cycle: percentage of allocated trades -

    1. Received electronically by dealers

    2. Submitted to ETC

    3. Matched first time via ETC

    4. Communicated to Custodian electronically.

  • Most companies now achieve close to 100% for the first step.  However the cumulative total, which for a number of years showed a steady increase, has stayed broadly static since 2007 at around 70%. It appears difficult for a typical manager dealing with a number of markets and custodians with varying rates of automation to exceed this overall level of STP.   

• Outsourcing leads to lower costs and better service.

  • Managers who have outsourced operations on average achieve both lower costs and higher service levels than those with in-house operations. This is true for investment operations, fund accounting and transfer agency.

  • The service performance for outsourced operations has improved faster than for those with in-house operations.  The performance gap was particularly stark in the 2009 Study.

• Despite this, the general satisfaction with outsource providers has declined year on year.

  • The Study also tracks how the TPA performance is perceived by the asset managers across a range of dimensions (e.g. level of service, value for money, responsiveness to requests and delivery against commitments). Somewhat surprisingly, these scores have got gradually worse over the years despite lower costs and improving service levels.

  • Paradoxically, the better performance in the core areas might be the key reason why the perception ratings are declining.  As normal operations become “business as usual”, more focus is put on other areas such as delivery of change. This is an area where there is significant scope for improvement: on average one third of all projects and changes are being delivered late.

It is still possible to enter this year’s study. If you are interested in further information, please contact Bo Lantorp, Alpha FMC’s Benchmarking Director, on bo.lantorp@alphafmc.com or +44 (0) 7958 304053.

As tax advantages are ironed out, what do the traditional European fund centres have to offer investors? We investigate the enduring appeal of Luxembourg, Dublin and the Channels Islands.

A golden growth period for European offshore financial centres (OFCs), underpinned by historically favourable tax regimes, has been under threat recently. A two-pronged assault of European tax and regulatory harmonisation and ever-tightening onshore tax regimes has been threatening to erode competitive advantages and undermine the double-digit growth in the funds industry in Luxembourg, Dublin and the Channel Islands. To add to their worries, all three are facing increased competition from new offshore rivals both in Europe (e.g. Malta) and further afield.

Yet the figures belie these threats. In Ireland, the funds industry has grown to service over $1.3 trillion in investment fund assets, having passed the $1 trillion mark in 2005 and the $200 billion mark in 1999. By the end of Q2 2007 over €2 trillion of assets under administration (AUA) were domiciled in Luxembourg – representing annual growth of 24%, compared to a European average of 15%. By Q2 2007 the AUA in Jersey had grown to £195 billion, representing quarterly growth of 8.6% and annual growth of 24.7%. The picture is similar in Guernsey, with AUA at the end of Q2 2007 at £156 billion, up £15.2 billion on the quarter and annual growth exceeding 25%.

However Alpha FMC’s recent Product Development Benchmarking Study re-affirmed the growing industry conclusion that tax status is no longer a primary driver for offshore domiciling – and therefore does not underpin the growth in Europe’s OFCs.

It seems rather that the OFCs have shrewdly moved to consolidate their legacy as investment havens by successfully promoting existing institutionalised advantages such as accumulated scale and expertise, product innovation, regulatory nimbleness and geographic location.

Luxembourg is already the largest investment domicile in Europe, with a market share of 25%, rising to 28% for in-vogue UCITS funds. This already makes it a ‘go-to’ location for any company wishing to establish itself on the radar of the major European, Asian and increasingly global distributors. Many of these look in the first instance to the top of the Luxembourg league table when short-listing managers. This established distributor focus has already led to a number of large international fund managers seeking to consolidate their domestic fund ranges into their Luxembourg ranges in an effort to feature more prominently on the Luxembourg league table, and hence on distributor short lists. In addition, points out Richard Goddard, an independent fund director based in Luxembourg, "it's not just the big players flocking to Luxembourg. Increasingly, specialist investment and wealth managers choose it due to its status as a leading centre for distribution globally".  

Luxembourg also benefits from established scale more than any other European centre. It has built up a concentration of specialist service providers in fund management, administration and distribution, not to mention essential professional services (lawyers, accountants, auditors), which makes it an easy place to do business. Nick Wells, Artemis’ Product and Communication Director, backs up the point when referring to equity funds launched last year: “I was particularly impressed by the wealth of complementary businesses that wanted to help. From RBS, that offered a fully compliant management company, to PWC, who provided a wide breadth of advice covering all European jurisdictions, and to Elvinger, Hoss and Prussen for their carefully considered legal advice. It was clear from an early stage that Luxembourg offered wide choice for Artemis’ fledgling entry on to mainland Europe. We felt secure in the knowledge that we could grow substantially without changing partners.”

With scale, and the importance of the funds industry to the national economy, the country’s legislators and Regulator afford the industry a prestige and priority that creates a virtuous circle of regulatory pragmatism. Luxembourg was the first EU country to fully incorporate the UCITS directive into law and in February of this year swiftly introduced the specialised investment fund (SIF) regime, providing a more flexible framework for lightly regulated and tax efficient SIFs. Under the new regime SIFs can actually be launched prior to authorisation, speeding time to market significantly, which places a far greater burden on the fund managers and supporting professionals themselves to get it right.

Combine these factors with Luxembourg’s highly educated and multi-lingual work-force, as well as its physical location at the centre of Western Europe, and tax advantages form only a minor element in a range of investment advantages.

A combination of tax and regulatory incentives established Dublin as the leading European centre for Hedge Fund and Money Market fund administration. Ireland has sought to capitalise on this position through market-leading product innovation. The 2003 launch of Common Contractual Funds (CCFs) is an example of a vehicle that has enabled pension funds and institutional funds to pool their investments in a tax-efficient manner.

It is, however, arguably head-on competition with Luxembourg in particular that has both threatened Ireland’s position as well as driven its growth and innovation. For example, Ireland’s previous advantages that allowed it to accumulate the lion’s share of European money market funds have been steadily eroded. Luxembourg has steadily reduced its “taxe d’abonnement” (registration tax), making it competitive with Ireland and resulting in some flow of money market funds from Dublin to Luxembourg as managers increasingly seek to consolidate their fund ranges. And whilst Irish funds can be merged into a Luxembourg range, the reverse route remains problematic. With both locations competing as centres for fund rationalisation, this constitutes a non-level playing field for Dublin – a situation which the European Commission is currently examining.

Yet Ireland’s phenomenal growth is no accident and it has responded with characteristic robustness. The Irish Regulator, for example, has been far more willing to accommodate complex fund structures than Luxembourg, even though Luxembourg is attempting to compete in Hedge Funds by opening up listing opportunities. This means that Dublin will almost certainly consolidate its position as the primary centre for the setting up and administration of alternative investment vehicles.

As Alan Dundon, Global Head of Product for Fund Administration at BNP Paribas Securities Services, notes “don’t be surprised to see the Irish regulator responding to the Luxembourg SIF provisions in order to make Ireland even more accommodating”. Already certain types of funds (e.g. QIFs, Ireland’s current equivalent to Luxembourg SIFs) can now be registered much more quickly than previously, with solicitors permitted to certify certain aspects of the fund set-up. But regulatory innovation and responsiveness is only part of the picture. In fact, the Irish regulator is pro-actively seeking to establish Ireland as a more responsible regime than competitors, such as the Caymans, and has responded to the current US sub-prime crisis in a measured but non-prescriptive manner, in the knowledge that Ireland’s reputation as a safe and proper domicile is crucial.  

The Channel Islands, by comparison more niche competitors, have used their regulatory adaptability and accumulated expertise to grow from the base that they established using their historically favourable tax regimes.  Being outside the EU, UCITS has threatened their standing as a retail domicile. The response was the successful promotion and growth of property funds. This sector too has come under threat from UK REITS legislation, which erodes the advantages of domiciling property funds offshore and as a result growth in the sector has slowed. But once again the response has been innovative and successful. Guernsey has established itself at the fore of the private equity sector, with ‘light touch’ regulation producing a rapid cluster effect. And Jersey has made impressive inroads into the Hedge Fund sector after a late start. BNP Security Services’ Alan Gunton, Head of Projects in Jersey, points out that “promoting flexible fund structures has encouraged registration in the Islands even though administration is typically carried out in Dublin. Competitive legislation in domiciles like Gibraltar bears testimony to the success of its models.”
The Islands have a scale where supervisors can know and personally interact with the main industry players, and our Study evidence suggests that the industry appreciates dealing with a regulator that behaves in a flexible and interactive manner more akin to business itself than a government. And the Island Regulators can afford to do this because the business they seek and attract is largely from institutional investors who can look after themselves.

It is clear that scale and the associated cluster effect are strong pluses for Luxembourg, Dublin and the Channel Islands – and one that all three locations are continuing to exploit very successfully. The advantage of being a high-profile domicile for particular investment classes with established infrastructure, expertise and regulatory friendliness appears hard to overstate. And in an environment where domicile rationalisation is a key driver, the offshore centres provide convenient and politically neutral venues, particularly for those large multi-national fund managers who may struggle to choose a single onshore location as their primary centre.  

The role of competition, particularly between the ‘traditional’ offshore centres, as well as with new upstarts, should also not be underestimated. This competition has served to keep authorities and regulators agile and business-friendly, and all three centres have claims to be amongst the most innovative locations for fund development and servicing in the world. And so the question appears to be not whether the three locations can continue to attract business, but how each can cope with increasingly urgent capacity constraints. The Channel Islands are looking to attract more front end business, and outsource administration. In Ireland it no longer makes sense to talk exclusively about Dublin, given the recent and necessary expansion of financial services across regional cities. And Luxembourg too has severe labour market constraints on its hands. Innovative solutions are called for – and the relative strengths of such solutions could well be the next major battleground.

By Nick Fienberg & Nick Baker (Alpha Financial Markets Consulting)