How will the increasing pressure to have independent validation of pricing impact fund administrators?

Significant investment in specialised personnel and systems is needed if administrators are going to cope with the increasing pressure for independent validation of pricing, says Oliver Scully at Citco Fund Services. “Investors will expect to be able to ascertain the level of independent validation and the ability of the administrator to add value to the pricing process,” adds Scully.

Increased pressure for independent validation has meant that administrators need to demonstrate the ability to deliver net asset values (NAVs) accurately and effectively regardless of frequency, explains Richard Ernesti at Citi.

“The value-added services are the ability to handle complex and illiquid instruments and to provide the controls and monitoring mechanisms which both investors and regulators are demanding,” notes Ernesti.

“Most fund administrators are already, or should be, independently validating prices used in the calculation of the NAV,” notes Dermot Butler at Custom House.

Equinoxe Alternative Investment Services’ Stephen Castree says the independent validation of pricing has been the basic standard in the industry for the past decade. “The increased pressure will, however, benefit those administrators who have robust operating procedures, detailed client-specific valuation policies and appropriate contracts with data vendors,” adds Castree.

Independent valuation requires considerable investment in people and technology, as well as coverage of and expertise in a wide spectrum of asset classes, notes GlobeOp’s Hans Hufschmid. “Funds and their investors will expect independent in-house pricing ability, access to an extensive database of multiple pricing data sources and analysis of pricing methodologies used. Fund managers will expect to benefit from enriched data from the most appropriate pricing vendors across their portfolio,” adds Hufschmid. “Investors will expect administrator valuation processes and controls to be independently audited in SAS 70 Type II reviews, as reassurance of consistent procedures,” he adds.

Akshaya Bhargava at Butterfield Fulcrum says administrators will have to increase the number of relationships they have with third-party pricing vendors or build in-house pricing/valuation expertise.

Independent valuation of assets is a core strength of third-party fund administration, particularly in Europe where this is standard business practice, believes David Aldrich at BNY Mellon. “The increasing scrutiny of pricing policies by investors is bringing welcome transparency to the administration model,” says Aldrich.

Peter Hughes at Apex Fund Services believes the largest risks to administrators are mispricing a portfolio and a fraudulent manager. “Some administrators prefer to charge lower fees and take on this risk by not providing independent pricing checks. They are not only adding risk to themselves but to the whole administration industry’s credibility by taking these short-cuts,” cautions Hughes.

At Bank of Ireland Securities Services, Liam McNiffe believes independent pricing has always been the cornerstone of the service delivery. “Instances can occur where this independence is compromised and this is where the administrator must ensure that a pricing policy is properly documented, communicated and, most important, adhered to,” says McNiffe.

Independent administrators – for example, those without custody, banking or prime brokerage businesses – could benefit from that independence and acquire business that either is currently undertaken in house, as is the case with many of the large US hedge funds, or is with a non-specialist competitor, explains Paul Stillabower at HSBC Securities Services.

Another possibility is that business will gravitate to administrators that have the balance sheet to stand behind the pricing of the funds they administer. “We think that the first possibility is probably only viable in the short term. In the medium term the one common feature of the specialist administrators – the lack of balance sheet strength – will eventually exclude them from the administration business in the long term,” says Stillabower.

He thinks the EU’s alternative investment fund managers (AIFM) directive offers “a hint why this might happen: in order to sign up to the strict liability clause, depositaries, administrators and others will require balance sheets to meet their obligations, unless an insurance-based liability solution emerges in the marketplace,” he concludes.

At Omnium, John Buckley believes independent validation of pricing is one of an administrator’s key roles. The increase in pressure for independent validation of pricing will continue to increase the number of self-administered funds outsourcing administration or at a minimum valuation validation, he says.

“As more funds focus on this offering, administrators will compete based on the quality and variety of the external and internal pricing sources utilised to facilitate valuation services,” says Buckley.

Independent administration and independent validation of pricing is good for the industry as long as fund managers outsource valuation and related administration functions and not simply look for ‘NAV lite’ where the administrator validates pricing without performing the underlying valuation and operational workflow, according to Deborah Yamin at State Street Alternative Investment Solutions.

“In addressing investor concerns for independent valuation, responsibility for the valuation should remain with the fund manager or the fund manager’s board,” she notes. The role of the administrator is to compute the valuation based on independently sourcing and calculating the price of portfolio holdings based on mutually agreed pricing input between the administrator and fund manager.

Independent valuation is an absolute necessity if the fund administrator is to maintain the trust of an investor, says Jonathan White at Viteos Fund Services. “There is far more due diligence being placed on fund managers and the service providers they have selected to use. The market has matured and investors have learned, in many cases the hard way, through failing hedge funds and the lack of regulation that surrounded this type of asset management both in the US and Europe,” he notes.

“Investors, auditors and analysts are far more aware of industry best practices and it is the administrator’s responsibility to ensure that they are able to demonstrate their compliance with this,” concludes White.