As consolidation continues in the alternative fund administration sector, Nicholas Prattexamines the implications for both administrators and their clients alternative fund administration.
Consolidation in the alternative administration sector has been ongoing for a number of years and shows no sign of abating.
The trend is being driven by both macro and micro factors. On a macro level, there is a need for more scale among smaller administrators and an allure for custodian banks in acquiring existing hedge fund administrators as a route into the lucrative hedge fund market. On a micro level there is a much more burdensome reporting load with new regulations such as the European Market Infrastructure Regulation and the Alternative Investment Fund Manager Directive (AIFMD). Furthermore, there has been an infiltration of institutional investors into the hedge fund market and they bring an expectation of more robust reporting. “Keeping pace with technology and being able to offer more than just fund administration is crucial to servicing hedge fund managers’ needs in this environment,” says Maria Cantillon, global head of sales for alternative investments solution at State Street. State Street’s 2009 acquisition of Jersey- based administrator Mourant made it the biggest alternatives administrator of the time with $600 billion (€ 434 billion) in assets under administration.
“If we just think about the implications for AIFMD, a custodian with a hedge fund administration arm is better placed to service the needs of hedge fund managers and their investors. Investors have reacted well to consolidation in the hedge fund administration sector. They like to see credible and high calibre names in this space.”
One of the largest alternative administrator acquisitions in recent years was the purchase of GlobeOp by SS&C Technologies in 2012. It has also completed a string of additional acquisitions in the last ten years including Dublin-based BDO Simpson Xavier Fund Administration in 2011 and US-based Hedgemetrix in 2012.
MORE CHECKERS
Bill Stone, chief executive officer for SS&C Technologies, believes the amount of consolidation in the hedge fund administration market is an inevitable consequence of the growth of hedge funds. “It has moved from a cottage industry to one with all the support structures that you would expect given its size. Consequently, there are many more checkers – compliance, audit and legal – and a lot more people looking over the timing of reports and the breadth and depth of suppliers and service providers.” The growth of the hedge fund market poses a problem for smaller administrators that may have unrivalled levels of service and expertise but then struggle when a key client announces its intention to open an office in another jurisdiction and expects its administrator to follow suit. “International expansion is not cheap for small administrators. Major servicing centres in very expensive areas can be costly,” says Stone.
Alliances are one of the options for smaller administrators but they can be very difficult, suggests Stone. “There is typically one set of technology, one set of rules. There are a set of circumstances that make it difficult to build alliances.” Stone thinks there will continue to be a tremendous amount of consolidation. “There are currently around 300 hedge fund administrators and we perhaps only need 30. Then when we get to 30, it could be decided that we only need 15. Then when we get to 15, we will end up with ten.”
MAKING SENSE
In May 2011, Northern Trust acquired Omnium, a US-based hedge fund administrator with more than $70 billion in assets under administration. “The acquisition was quite seamless,” says Peter Sanchez, head of Northern Trust hedge fund services and former global head of business development for Omnium. The existing Omnium platform was adopted as the technology for all new hedge fund clients.
The number of users on the platform has grown from 30 to 110 with the majority of these being new clients that are placed straight on to the Omnium platform. So far, there have been six Northern Trust clients that have migrated on to the new platform and there are still some remaining on the provider’s old platform. What integration work has been done has focused mainly on integrating the Omnium platform with custody and cash management services, says Sanchez.
The high barriers to entry in today’s hedge fund administration market will lead to more consolidation, Sanchez says. “Consolidation sooner rather than later makes sense for niche players. To be successful, you need capital backing.”
Sanchez also believes that ongoing consolidation in the sector is a good thing for hedge fund managers and there is actually more choice in terms of the breadth, depth and quality of services even if there are fewer providers offering them. “The offerings are light years ahead of what was on offer five or seven years ago: middle office services, daily transparency, a single desktop-based view across the whole business. The offerings and options are much greater as a result of consolidation.”
Sanchez also believes that the macro and micro trends in the hedge fund administration sector do make alliances between smaller providers more problematic. “Custodians are in the best position to make the investment in technology that is needed and to provide the scale that is needed. Furthermore, institutional investors are putting more emphasis on the creditworthiness of their counterparties and their service providers.” That is not to say there may not be a place for more co-operation between administrators. Karl McEneff, chief executive for Sumitomo Mitsui Trust Ireland, an administrator that resulted from the acquisition of the international asset services division of Daiwa Securities in November 2012 by Japan-based Sumitomo Mitsui Trust Bank, says: “We are willing to work with other administrators and other sub-custodians as well as our own. We don’t see competitors, we see friendly partners.”
SPLIT SERVICE MODEL
A critical catalyst in this new spirit of co-operation has been the AIFMD whereby hedge funds are required to appoint a depositary, many for the first time. This has led to some changes in the service provision model in which hedge funds can choose to appoint one provider to manage all of its servicing or else adopt a split service model whereby a number of different providers are responsible for the different services of cash management, custody and oversight. “The AIFMD brings with it new opportunities and we are more willing to work with other providers than the global custodians,” says McEneff.
“We have been providing this kind of service for more than 20 years and have built up good working relationships with other administrators in that time.
“In many ways, it is a return to a previous model where custody and administration were separated.” Ensuring continuity is paramount in any consolidation and this has placed more focus on technology. “Where a merger is about scale, then systems will need to be combined into a best-suited technology, which often means the buyer selects what suits their operations and demises the overlapping systems at the acquired firm,” says Dave Shastri, co-founder of software firm Comada.
“Technology is a major expenditure and mergers are in part justified on efficiencies in systems. But where a merger is about bringing in a new business or improving the overall business by adding key features, technology will often be unique and stay in place.”
For example, if a highly specialised administrator combines with a bank, there is a whole additional new scope to the business and it creates more opportunities for the whole enterprise, says Shastri.
“After all, in these mergers you cannot forget that the reason you bought that business in the first place may include the operations and supporting technology that drives them.”
Firms therefore need to regularly look at their technical architecture. “A consolidation complicates this and in a period such as we are in where consolidation is a growth strategy, keeping an architectural framework in place allows firms to merge in other businesses without losing sight of what they need for delivery.”
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