Braced for impact

What impact do you expect increased regulation to have on fund administrators and their hedge fund clients in 2010? Do you expect permanent and significant changes as a result?

A plethora of regulation may hit the hedge fund industry. However, the detail of these new laws remains unclear as both the EU and the US legislature continues to debate. With the surge of regulated funds, including Ucits products in Europe, it remains to be seen how this will impact or change the industry on a global basis.

Deborah Yamin at State Street says new registration requirements for US hedge fund managers in the US are likely to impact the industry along with generally more scrutiny by regulators.

“This shouldn’t pose an additional burden for hedge fund managers who can point to the operational soundness and integrity of their fund administrator’s operations through Level II SAS 70 certification,” advises Yamin.

“One permanent change is that hedge fund administrators will be providing increased investor transparency reporting and more detailed operational risk reporting,” she notes.

In Europe the regulatory developments are more complex and the source of vigorous debate. It is hard to predict the final form of the proposed EU alternative investment fund managers (AIFM) regulations but changes are inevitable, she says. “Fund administrators are monitoring areas such as valuation, the role of the depositary as it relates to any potentially new responsibilities and liabilities for administrators,” notes Yamin.

The effect on administrators of more regulation, believes SEI’s David Morrissey, will be the increased need for transparency. “Administrators must be built to service the regulated products,” he says. A strong compliance culture can give companies a competitive advantage, he adds.

“We believe that there will be a significant impact and, yes, we expect permanent and significant change as a result of major pieces of legislation being considered in the UK and the US,” declares John McCann at Trinity. The AIFM in Europe as well as the Transparency Bill, FATCA Tax Reporting and global financial reporting revised guidelines should all have an influence on the industry, he says.

For John Buckley at Omnium, regulation is likely to increase the level of disclosure required by clients to investors. “Administrators need comprehensive reporting capabilities to meet this need. Administrators must embrace the highest standards of control to minimise fraud or risk of error in the performance of their services,” he advises. A robust SAS 70 Type II accreditation provides a third-party validation of an administrator’s commitment to operating at the highest standards, he believes.

Regulation will have a significant impact on reporting requirements, especially transparency, and there will be an increased level of due diligence questionnaires as well as increased membership to independent oversight bodies such as the Alternative Investment Management Association (Aima), which observes and formalises best practices for administrators and hedge fund managers, predicts Jonathan White at Viteos Fund Services.

Ian Headon at Northern Trust expects the evolving demands of investors to have a greater impact on fund administrators and their hedge fund clients in 2010. “We are already seeing a growing trend for investors seeking extra protection through a regulated fund vehicle, separately managed accounts and Ucits vehicles. They are, and will continue to demand increased transparency, greater control and more robust governance frameworks from their fund managers and this will significantly impact the delivery of services by fund administrators,” he concludes.

Paul Stillabower at HSBC Securities Services believes the immediate impact will be higher costs for administration and custody services as well as more pressure (from investors and government regulators) to outsource services to independent third parties.

“We also expect more bundling of custody and fund administration, since this is the only model which will enable the supplier to cover its risks and liabilities,” he cautions.

“Over time this will lead to more consolidation in the fund administration and custody industry and severe pressure on the small-cap independent administrators and monoline custodians,” concludes Stillabower.

“Regulation can help reassure investors,” advises Hans Hufschmid at GlobeOp. “However, extremes must be avoided and regulation should not be implemented at the cost of innovation. Preserving market creativity is essential as hedge funds have a major role to play in absorbing distressed assets that may need to be held and risk-managed for several years,” says Hufschmid.

“Regulations need to ensure that all data needed is available, complete, timely and understood by regulators and that monitoring and enforcement is consistent. Experience shows that if you can’t measure it, you can’t regulate it,” Hufschmid advises.

Dermot Butler at Custom House agrees with others that the AIFM directive will increase the demand for EU-domiciled funds, particularly from the US and other managers who currently have Cayman funds or funds in other offshore jurisdictions. “This will incur greater regulation, particularly if they go for Ucits funds, but it will also increase the ‘book’ of the administrators,” says Butler.

He expects the changes to be problematic “only if the regulations are not properly written.”

At Citi, Richard Ernesti believes the move towards increased oversight will remain. Institutional investors will continue to demand increased transparency and as competition between fund managers grows, he expects funds that can provide both alpha and insight into their investment strategy including its risk profile will find greater favour among investors.

Akshaya Bhargava at Butterfield Fulcrum believes increased regulation, which will be permanent if it is enacted, seems inevitable. “Regulators will likely require more frequent and detailed transparency reporting from hedge funds and administrators will become more necessary – and be held accountable by their clients – for the production of these reports,” he predicts.

Oliver Scully at Citco agrees it is still too early to judge clearly the impact of increased regulation. “The convergence of the custody and administration functions will ultimately lead to less competition and independence in the market. Apart from cost, it is difficult to see how this benefits the investors,” is his assessment of the current regulatory initiatives.

At Bank of Ireland Securities Services, Liam McNiffe agrees that the regulatory landscape is still unclear. “The industry will, as it always has done, evolve and adapt to the changes that occur. Increased regulation will mean increased reporting and those administrators who have invested in their technology solutions will already have the flexibility to support their clients’ needs without adding significant costs,” he concludes.

“There will be significant changes and this is important to the global asset management industry,” notes Peter Hughes at Apex. “Administrators are independent and can play a critical monitoring role in the new regulatory environment and regulators should use administrators as an important resource to protect investors and monitor risk levels,” he says.