Outsourcing set to continue as investors push for transparency
Over the last few years, arguably since the introduction of the AIFM Directive in Europe, there has been a definitive trend among PERE fund managers to push their internal accounting and reporting processes to more specialist outsourced providers.
This has played to the advantage of fund administration groups such as SANNE, a leading provider of alternative asset and corporate administration services with more than EUR235 billion in AuA, supporting in excess of 1,000 real estate structures and funds and approximately 500 private equity structures and funds.
“I think that trend has been pushed from institutional investors who are requiring more independence and more transparency with respect to reporting and the processes that go into reporting,” comments Sean Murray, Managing Director, Alternative Assets (EMEA).
Part of this trend is intrinsically tied to the increased availability of innovative technology, with cloud-based systems putting far greater power in the hands of managers. New managers are receptive to outsourcing back-office functions to technologically proficient administrators, not just because it is cost-efficient but also because they get the benefit of wisdom from someone who is servicing hundreds of clients.
“There are constant regulatory reporting requirements today that require managers to follow best market practices. It’s not necessarily that they don’t have the resources; it is more that they want to concentrate on managing their investments and delivering best value, from a performance perspective, to their investors.
“Generally, they are looking for someone to partner with who can deliver those transparent reporting requirements. We are constantly investing in, and upgrading, our technology to prepare for any future regulation. The PERE fund manager community recognises that specialist fund administrators are best placed to keep on top of this ever-changing landscape,” explains Murray.
Although it is hard to provide concrete figures on the level of outsourcing in Europe and the US, most would argue it hovers around the 30 to 40 per cent mark, with Europe somewhat further ahead of the curve. This is a space that offers huge growth potential for fund administrators, akin to where the hedge fund market was 10 or 15 years ago.
Murray, who is based in Luxembourg, observes that over the last 12 months there has been a clear uptick in the number of regulated closed-ended funds being established within Luxembourg and the EMEA region in general.
This is partly being driven by European issues such as Brexit as UK-based fund managers look to future proof their existing structures; whether that involves creating a Dublin or Luxembourg-domiciled fund to either co-invest alongside existing UK funds into the same group of assets, or establishing new funds altogether to complement their UK suite of funds.
“From a global perspective, AIFMD has been driving parallel fund creation among US fund managers, which is similar to the trend we are seeing among UK managers in response to Brexit. In 2017, we saw a continuation of a number of PERE fund managers moving to Europe.
“Even prior to AIFMD, most pan-European RE funds either used Luxembourg as a structuring jurisdiction or created their entire fund structure there. That trend has continued throughout 2017 and we’ve seen significant growth in our Luxembourg fund administration business,” confirms Murray.
To capitalise on the outsourcing trend, SANNE’s strategy focuses around a couple of key ideas.
The first is to increase its jurisdictional coverage within EMEA to continue supporting those clients who are investing on a pan-European level.
The second is to continue to consolidate its position as a leading real estate fund administrator within Europe in addition to increasing its private equity footprint in Europe.
“To achieve this we recently entered into an agreement to acquire Luxembourg Investment Solutions and Compliance Partners (‘LIS’), a market leading third party AIFM. LIS adds further deep expertise to our service offering and enables us to provide clients, including those in the PERE fund space, with a fully integrated solution. We’ve seen a lot of uptick among our existing client base,” comments Murray.
The LIS acquisition is currently being approved by Luxembourg’s regulator, the CSSF, and should be completed in Q1, 2018.
Strategically, this will enable SANNE to act as the outsourced AIFM, the depositary and the fund administrator, all under one roof.
This is generating a lot of interest and has led to SANNE onboarding a large number of clients over the last few months to avail of this all encompassing service.
“It is a key aspect of our growth strategy for 2018 to facilitate the delivery of an increased menu of options to PERE fund managers operating in Europe,” adds Murray.
One of the foundations of SANNE’s success over the last decade has been its commitment to build dedicated teams to support distinct asset classes. It does not bring a hedge fund administration mindset to servicing private equity funds or vice-versa.
“We have a dedicated private equity division, a real estate division, a debt fund division as well as a hedge fund division. Whilst there are a lot of similarities between PE and RE fund administration, there are still a lot of specifics you need to focus on to deliver the required services to the fund manager and reporting to investors.
“In the real estate fund space, for example, you need the requisite expertise to handle IFRS 10 consolidated financial statements, INREV reporting, etc. We believe that having asset class-specific experts working with clients really does provide a lot of value,” opines Murray.
For those managers who are appointing an outsourced fund administrator for the first time they will want to ensure that the onboarding process is as smooth as possible. In that respect, SANNE invests a lot of time at the set-up phase with clients, understanding the fund’s day-to-day processes, individual items such as payments, information flows, through to bigger items such as carried interest calculations, overseeing the fund’s valuation policy and understanding what the valuation model is for a particular asset.
“It is crucial to invest significant time in the planning and pre-launch phase. It makes the administration of the fund more efficient and less risky. In terms of efficiency, this might mean getting the annual financial statements prepared and ready in advance of an audit, where we involve the fund manager and the auditors in that set-up process to achieve time efficiency gains in the future,” says Murray.
With respect to the carried interest calculation, he concedes this can be complex, depending on the number of closings in the fund. It requires a lot of upfront preparation and modelling. To handle this, SANNE has a team of industry system specialists who can tailor elements of the technology it uses in-house in order to build bespoke carried interest calculations.
“There are a lot of technology requirements involved to do this. A lot of testing work needs to be done with the investment manager, with the auditor, etc, to get the waterfall calculation right,” remarks Murray.
He further adds that there then needs to be ongoing verification, especially when a fund goes through multiple closings, to ensure the calculation remains in line with expectations.
“It is important to spend the time controlling the risk surrounding the carried interest calculation and getting the model accurate at the fund launch phase,” concludes Murray.