As the industry adjusts to the long-term operational changes from the pandemic, Nicholas Pratt examines how the absence of face-to-face meetings is affecting operational due diligence and regulation.
What began as an emergency response to a health crisis has now become a new operational reality as the industry prepares for its fifth month of remote working. And while the majority has coped relatively well with the transition from office to home, questions are being asked about the long-term implications.
For example, in the continued absence of face-to-face meetings or site visits, what will be the impact on regulation, capital-raising and operational due diligence (ODD)? And if the market manages to cope without meeting in person and embraces digital alternatives, will it diminish the value of human contact even for the aforementioned critical processes?
There is a general consensus that the investment management industry has exceeded expectations in how well it has weathered the impact of the coronavirus pandemic. “Most businesses were able to establish new ways of working in a matter of days and not weeks and it has been business as usual,” says Mitchee Chung, European director at investment consultant Mercer Sentinel Group.
It is a strong positive that the industry did not come to a standstill and there has been a general attitude of ‘how can we make this work?’, says Chung. And while there have been some delays to due diligence processes as a result of the work that was done in March to adjust to the introduction of various global lockdown measures, the operational priorities quickly came back on the agenda.
“Yes, progress has been slower because we have had to adapt to new ways of working, but we also wanted to allow everybody in that communication chain to have the space and time to provide information,” says Chung. “When you rush people in a stressful environment, you get bad information, which adds more time in the long term.”
According to Gregory Worsfold, founding partner of compliance advisory firm Optima Partners, previous events, from the global financial crisis of 2008 to Hurricane Sandy in 2012, have forced the industry to become more resilient to the unexpected.
“Technology has played a huge part in this and most firms have used the cloud and sophisticated systems to keep their data safe and to enable their staff to work from home,” says Worsfold. Consequently, the transition from office working to home working has been relatively smooth.
However, the duration of the lockdown and its effect on the work environment and the mental health of employees was largely unforeseen, says Worsfold. So too were the various new risks that have been created, although these have since been well noted by regulators, he adds.
“There are concerns around security flaws and the lack of end-to-end encryption in communication tools like Zoom and WhatsApp. Technology can help firms operate in new working environments, but it also creates new risk which firms have to document and monitor and adapt their controls and policies accordingly,” says Worsfold.
In the UK, the Financial Conduct Authority (FCA) is also looking at the changes in risk as a result of the lockdown and more remote working – especially behavioural risks, says Worsfold. For example, are employees as connected to the compliance process as they should be when they are not in the office?
“Firms really need to make sure that the compliance culture is not being watered down as a result of a change in social context, where you are working alongside flatmates rather than office colleagues.”
It is also worth remembering that the Senior Managers and Certification Regime came into force in the UK in December 2019. In the near future, firms should expect a greater emphasis on senior management’s role in oversight to feature in regulators’ examinations of firms as the market emerges from the pandemic, says Worsfold.
When it comes to ODD, a large part of the process, such as documentation and other tasks that can be performed remotely, have remained unchanged since the pandemic, says Mercer’s Chung. “It is only the on-site visits that have changed. It is a core tenet of validating a company’s systems, but when you look at all the hours spent on a due diligence programme, it amounts to one day in an eight-week process.”
This raises the question of whether the enforced switch to remote working and the fact that the industry has coped so well means that the importance of face-to-face meetings will be diminished. However, Chung does not believe they will disappear or be any less important.
“Across the world, we are seeing people return to the office and most businesses want to retain some form of office environment, especially for processes like trading. So, I think there will be a mixture of virtual meetings and face-to-face meetings.”
The risk that comes from the absence of on-site visits varies among managers, says Chung. “A large percentage of the managers that we assess are well known to us and we have assessed them and their strategies many times in the past. When changes are made to the fund, we can call them, so it is a way or working that we are already familiar with and that has given allocators a lot of confidence.”
For some managers, though, the change to remote working is very new, adds Chung. “Some have adapted well and others did not and are still uncomfortable with video calls, which can create risks. But in many circumstances, it is just a case of making adjustments. For example, whereas in the past we would have a full day of on-site meetings with 30 different people, we have had to break that down into a series of virtual meetings.”
Asset class can make a difference as well, he says. “When you are looking at a traded asset class like equities or fixed income, we will insist on a video call, but if it is human capital, we don’t necessarily need a video call, so we just need to make a practical decision.”
Good communication both internally and with investors has also been key to how well firms have managed the pandemic. And the challenges around communication and the absence of face-to-face meetings have been good for some businesses and bad for others, says Peter Rigg, director of Sagar Partners, which advises family offices on their alternative investment mandates.
“It is good for existing businesses because they can be even more efficient. There are lots of interesting webinars and Zoom calls and other firms have put out educational papers and training modules,” he says.
“The capital introduction events that the investment banks hold are extremely important and the hedge funds without an extensive travel budget are not able to send all their analysts out to the events. But now they can attend virtual events in New York or elsewhere and actually get greater access, albeit virtually.
“But it has been harder for smaller firms and new businesses for whom face-to-face or on-site meetings are more important and often a due diligence requirement, so the absence of this is inhibiting their ability to invest in interesting funds,” says Rigg.
Fortunately, the post-pandemic market has been less operationally complex for hedge funds than the global financial crisis when there were numerous redemption restrictions, suspensions and gating and investors with highly leveraged positions.
“There have been a handful of issues this time, but they have not been across the industry, so they are currently in a much better position operationally. And good communication with investors has been key to this,” says Rigg.
“Internal management communication is important for any business and you need to set times up to catch up with each other, because these are ultimately people businesses and you are not having those conversations around the water cooler or the coffee machine,” he adds. “While more experienced staff may be relieved that they are not in endless meetings, younger staff are missing out on training and other things that have a more personal touch.”
There are obvious challenges for capital-raising in the absence of face-to-face meetings, says Rigg. “If your client is a family office, it can be difficult to recommend a new fund or investment when you have never met in person. So hopefully, the lockdown will ease and people will go back to the office.”
That said, capital is being raised but it is more for the reallocation of existing funds than new money, says Rigg. “It has opened up significantly in recent weeks. Investors still need to make a return. Interest rates have gone even lower and equity markets have rallied, so conditions are quite good right now for alternative funds.”
In March and April, people were assessing the damage to their portfolios but since then, they have taken stock and have looked to make changes, adding managers they have seen perform well for a number of years and redeeming those that they think will perform more poorly in the current environment, says Rigg.
In terms of asset classes, there are pockets of value in areas like structured credit and anything that can produce idiosyncratic returns like real estate commodities. And then later in the year, there are likely to be opportunities in distressed assets, he says.
“It has been a great opportunity to upgrade portfolios. March was a big test, sell the weaker funds and add in some interesting areas like credit or Asian equities. But it is harder for new groups because of the communication challenges and the ODD difficulties, which is a shame, because it continues the trend for larger asset managers to get larger at the expense of the smaller ones,” says Rigg.
The new normal
Four months on from the imposition of the lockdown, thoughts are turning to what aspects of the pandemic response may become permanent operational changes. For example, might the funds industry become a more prolific adopter of new technology?
“The pandemic has changed the work environment and even when things return to normal, there will be an increase in the use of remote working and the technology you need for that,” says Worsfold. “Regulators have also become more comfortable with cloud technology to the extent that it is seen as one of the safest ways to store your data.”
The pandemic has also raised technology investment up the budgetary agenda, says Chung, which will help CTOs and COOs invest in the technology they need to adapt to the long-term changes in operating models rather than just the emergency response we saw in March.
Remote working has clearly worked, so there will be more IT and digital technology needed to support that, from cyber security and two-factor authentication, says Rigg. And it must also sound the death knell for paper filing. “Everything must move to digital record-keeping. It is not good enough to have an expensive headquarters with paper files that you can’t go into because of a pandemic.”
Thankfully, firms are considering the long-term human impact of the crisis, says Chung. “Returning to the office is not mandatory but voluntary, and there are a number of health-and-safety considerations, physical and mental, that will be critical to ensure the viability of the company and sustainability of their workforce.”
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