More clarity demanded

What is the impact on and challenges for administrators of the need for funds and funds of hedge funds to provide more detailed operational risk reporting to investors?

The repercussions of the poor results, gatings and suspension of redemptions of 2008 continue to haunt the industry. In the wake of the extraordinary measures taken by funds, investors are keen to receive detailed operational risk reporting from funds as well as more transparency into their operations. Liquidity concerns also remain, as investors want to be sure the underlying securities in which the fund invests match the redemption terms.

At Apex Fund Services, Peter Hughes believes in order to cater for the increased demand for detailed operational risk reporting, administrators must be able to provide middle office and risk reporting. “Funds are much smaller than they were and so their pockets are not deep enough to meet these investor needs. The investors will derive value from this so it is a service that can be charged to the funds and administrators should invest the time and resources to ensure they can deliver this for their clients,” he comments.

The need for openness in detailing how things are done, so as to generate increased certainty in the observed outcomes, rather than simple trust in process, presents a need for more robust infrastructure within administration and depositary companies,” notes David Aldrich at BNY Mellon.

Akshaya Bhargava at Butterfield Fulcrum says administrators need to have the tools to provide detailed risk reporting to investors. “The challenge becomes whether or not to build a solution in-house or partner with an external specialist provider. Butterfield Fulcrum has chosen the latter approach, choosing Risk Fundamentals as our risk management partner in 2009,” notes Bhargava.

Previously he thinks many of the risk systems were not adequate for the task of measuring the entire universe of risk faced by investors. “The current economic crisis has highlighted those risks and our risk reporting uniquely addresses concentrations, exposures and performance attribution, in addition to measuring liquidity and leverage risk, the primary causes of the current financial crisis,” he says. 

Oliver Scully at Citco Fund Services sees a challenge as well as an opportunity. “We anticipate significantly more demand for transparency and risk reporting. This is an ideal space for administrators to add value,” he notes.

“Clearly, increased reporting around operational risk requires additional investment. The lack of standard requirements makes it difficult to build automated and efficient reporting tools but this will change as the space matures,” Scully adds.

Citi’s Richard Ernesti sees a growing trend for fund managers and investors to demand operational risk reporting. “Regulatory requirements such as those associated with Ucits require value at risk and compliance reporting,” he notes.

“Administrators are responding by providing integrated risk analytics and reporting tools directly to fund managers as well as investors. Managers are also demanding improved liquidity reporting of underlying funds,” adds Ernesti.

At Custom House Global Fund Services, Dermot Butler says providing more detailed operational risk reporting to investors depends on whether the focus is on more detail of the operational risk of the managers or of the fund and the administrators. “In both cases the existence of a SAS 70 for administrators and managers goes a long way to help in this regard. A competent administrator will be able to provide transparency on their own operational risk and this can be ascertained by properly carried out due diligence visits by the investors,” says Butler. “Similarly, the manager can provide the same transparency, but the administrator will not be involved in that reporting process.”

For Stephen Castree at Equinoxe Alternative Investment Services, the key challenge is transparency. Looking at funds of hedge funds (FoHFs), depending on the extent of access to the detail in the underlying funds, he says it is possible to create aggregate exposure and ancillary risk reports. This, he says, has historically proven difficult. “This structure, however, is expensive to run as each portfolio requires independent administration and then an aggregation process to drive the operational risk reports,” he concludes.

GlobeOp’s Hans Hufschmid says funds need to demonstrate “the use of a robust, transparent, professional infrastructure and independent data and process validation. Investors will require more frequent reporting of independently validated data and in-depth analytics, in conjunction with scrubbed and validated data.”

According to Hufschmid, fund managers and investors may expect web-based reports on a fund or aggregate basis, customised to specific manager or investor requirements. Fund managers will need to be give investors permission to view different levels of fund data. This includes daily data requirements: portfolio positions; previous day trades; position and cash breaks; prime broker exposure; total exposure; trade expiries; corporate actions; risk analytics; fund net asset value and P&L.

“Comprehensive SAS 70 Type II audits will need to demonstrate sound operational processes and controls across all services and offices, and include a full-year time scale,” he says.

Paul Stillabower at HSBC Securities Services sees a potential “banana skin for suppliers”. This potential problem stems from the fact that the supplier does not have a contractual relationship with the investor. Nevertheless, the supplier can directly impact whether the investment manager gathers assets or not. “In a perfect world the supplier would be compensated for the risk of an avenue opening up between the investor and the supplier. However, the securities services players have in the main been asset gatherers who have not in the past ever emphasised transparent, component-based pricing,” he concludes.

Administrators need the reporting capabilities to provide this information and one of the largest challenges will be to agree a set of standards, believes Stuart Feffer at LaCrosse Global Fund Services.

“Administrators need to have the technology and expertise to provide their clients with access to more sophisticated tools and greater breadth and depth of data delivered more quickly than previously,” says Ian Headon at Northern Trust. “This ultimately requires significant investment from administrators,” he adds.

He points to the hedge fund monitor solution used by Northern Trust. “This has been specifically designed to allow for the FoHF manager and institutional hedge fund investor to track the performance, liquidity, counterparty exposure, foreign exchange exposure and scenario analysis for a portfolio of hedge funds,” he notes.

According to John Buckley at Omnium, as investors require additional reporting and transparency, the automation and flexibility of an administrator’s offering will be challenged. Currently there is little standardisation across transparency and risk reporting requests from investors. This, he says, tests an administrator’s ability to customise the offering to the unique needs of each investor.

“Without an automated platform that systematically stores and reports on data, an administrator will be unable to meet such requests,” he concludes.

“Commitment to risk mitigation is a key issue for the industry and clients will continue to require cutting-edge solutions,” states David Morrissey at SEI. “For risk analyses to have the most value, there must be a good data management process at the foundation. This ensures the quality of data is sound and that it aggregates all aspects of a manager’s business,” he explains.

“Transparency on just a handful of funds is not sufficient to allow investors to accurately evaluate and mitigate their risks. It’s also critical to deliver the data in a timely and flexible manner so managers can take action based on the data,” Morrissey adds.

Deborah Yamin at State Street Alternative Investment Solutions has seen a “widespread call for greater transparency from investors and regulators. FoHF managers are looking to their service providers for new solutions.” As a result State Street provides clients with an online, real-time view into their holdings and the status of their investment operations workflow.

Technology is seen to be at the heart of the fund administrator’s ability to provide the desired level of reporting required, according to Jonathan White at Viteos Fund Services. “In this environment, the service providers that have the flexibility in technology to keep up to date with market standards will prevail and others that do not could potentially find themselves with a regulatory breach,” he concludes.