Dec 2008-Jan 2009


Industry efforts to bring more automation to hedge fund processing are gaining momentum. Nicholas Pratt charts the progress of the Sharp initiative and what it means for the alternatives industry Right now the hedge fund industry could be forgiven for having more pressing concerns than the benefits of new messaging standards. Nevertheless, the effort to bring more automation to the alternatives world is something that has been gaining gradual momentum and the various parties involved will be looking to carry this over into 2009.

A prominent player in this project has been the multibank cooperative and messaging standards body Swift (the Society for Worldwide Interbank Financial Transactions). Swift has moved beyond its original 1970s remit of lessening banks’ dependence on the telex machine by providing a standard, electronic messaging system for interbank payments by branching out into the buy-side world.

In particular, Swift has sought to engage with the investment management community and to have its messaging standards implemented as an ever-present constituent of the funds processing chain, mainly through its SwiftNet Funds programme. In the last two years Swift has also focused its efforts on the hedge fund market through its Swift Hedge Fund Harmonisation Project (Sharp).

To a large extent the alternatives focus was a natural extension of Swift’s general plan to have more influence among buy-side firms – from multinational corporates to mainstream asset managers and, ultimately, to the highly complex and largely non-standardised world of hedge funds.

But whereas the obscurity, complexity and absence of any operating standards among hedge funds had rendered previous campaigns to introduce automated messaging and communication between hedge funds as largely haphazard and disjointed, the flow of more institutional investment funds into the market and the involvement of large custodian banks has steered the hedge
fund market some way towards the mainstream thoroughfares of operational standards.

“Back in June 2006 we floated the idea of using the new ISO 20022 standard as a way of automating the process of investing in hedge funds to a number of hedge fund administrators and custodians in Dublin,” says David Hardman, senior account director, global custodians & administrators UK & Ireland, Swift.

“At the time we thought that hedge fund structures would be quite consistent but in the last two years we have realised that this is not the case at all and they come in many different forms. There is typically a lot of legal documentation concerning the status of prospective investors into these funds and that is all manually dealt with. Consequently the hedge funds have tended to grow up in a paper-based environment.”

Explosive growth
While the hedge fund market had tolerated manual processing for years, the explosive growth of the last three to four years has created an operational issue, says Hardman. “The explosion of volume we’ve seen in the hedge fund market has not allowed the hedge fund administrators, private banks and custodians to be able to take a step back and look at introducing more automation for these increasing flows, particularly the fund of hedge funds market where more institutional investors were involved.”

The Sharp initiative is intended to serve as the basis for a new and independent communications framework for all involved in the hedge-fund processing chain, says Hardman – so not only do custodians and private banks have a more efficient means to send information to each other, but the hedge fund managers themselves also benefit from a cleaner back office and, at the opposite
end, a more rapid trade confirmation process.

The scope of the Swift offering is to create eleven messages on its network specifically for the hedge fund community. This community includes administrators, private banks, prime brokers and custodians, as well as hedge fund managers. The kind of tasks that would be included in this range of messages would include cash flow reporting, cash reconciliations, arrangement of subscriptions or redemptions and the payment of prime brokers.

To help design the specific messages, Hardman and Swift first had to recruit a group of relevant administrators and custodians and find out just how they service their clients, a task which took some time, says Hardman. “From May 2007 we  worked on what was needed to go into the new message formats, the capture of the relevant data and then mapping these elements onto the ISO 20022 standard. We are now in the process of validating the message formats and testing them on our network.”

The technical side is, says Hardman, the more straightforward aspect. More time consuming has been the task of recruiting industry participants to sit round a table and discuss agreed definitions and working practices on which to base the twelve new messages. “We are currently working with the regulators in Dublin, Luxembourg and Switzerland and also working on developing a market practice document on how the message exchange can take place,” says Hardman. “And we have also established a Swift hedge fund working group in the last six months.”

Step by step
A prominent figure in assembling the working group and promoting the Sharp initiative among the Irish alternatives market players
was Ian Headon, who heads up product development for alternatives at Northern Trust and is also chairman of the Irish Funds Industry Association’s alternative investment committee.

“There are two substantive stages – convincing the market that the idea makes sense and then making it happen,” says Headon. The process of mobilising market participants is largely complete and the group is now working on finalising messaging formats and making the concept a reality. “All of the main players in the fund administration and custody businesses are involved and most participants are at the build stage, designing, systems architecture and related workflows in order to accept and send the messages that Sharp describes.”

Much of this work involves finding a way round the fact that the new messages are based on the latest ISO 20022 standard rather than the 15022 version that many administrators and custodians are still using for their investment services systems. However, at least all of the current participants in the working group are already Swift-enabled – something that was not the case two years ago before consolidation saw the majority of hedge fund administrators acquired by a mainstream custodian.

Another relief for participants is that there are no rival projects to Sharp. The US-based Depository Trust and Clearing Corporation does have its own alternative investment products initiative aimed at automating the processing of alternative funds, but Swift and DTCC have agreed to collaborate, saving firms from having to double their efforts as regards system changes. As Swift’s Hardman says: “The market told us that they did not want to sign up to two different programmes for the same objective, so to get the cooperation of the DTCC is a big benefit.”

A further benefit is the fact that the initiative requires very little action from the hedge funds themselves. “This effort is largely invisible to hedge fund managers,” says Headon. “It addresses primarily an issue between administrators and custodians, rather than something that is visible to, or within the control of, the hedge fund manager community.”

Benefits and beneficiaries
And while the administrators and custodians will be the main beneficiaries of an initiative that automates what were previously manual processes, the hedge funds and investment managers will also see some benefits, according to Gary Palmer, chief executive of the Irish Funds Industry Association, which has played a key role in facilitating the various Sharp-related meetings and discussions.

“The main benefits are the efficiencies and economies that it will bring to the industry. It will remove much of the potential for errors that come from the absence of identifiers on various funds and will benefit all the parties involved so I would expect fund managers
to see an immediate benefit,” says Palmer.

As the Sharp initiative evolves, fund managers and hedge funds are likely to become more involved, says Hardman. “The next stage of the initiative is to include those managers that are investing in fund of hedge funds and this will most likely happen in 2009 and 2010.”

Hardman is confident about getting the necessary cooperation and adoption from the investment managers. “I can’t imagine any investment managers saying that they do not want this.” Meanwhile the DTCC’s project may target the hedge funds and investment managers sooner than this and is contemplating establishing a central database for hedge funds to register their trade details.

Headon is more circumspect about involving hedge funds and investment managers. “Let’s first automate those processes that are currently manual – if we can take that a stage further in the future, that would be great but we are not in the business of imposing industry changes on our clients without their approval.”

Fortunately by 2010 the current financial turmoil should have dissipated and hedge funds will be able to devote some attention to
the issue of standardised and automated messages rather than simply worrying if they are going to survive the week. ©2008 funds europe

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