The next evolution of shadow accounting is co-sourcing

Managers no longer have to choose between streamlined accounting processes and control of their data. By Yuriy Shterk, chief product officer, Allvue Systems.

The UK and EU’s private equity environment is known for leaning on a very specific and entrenched back-office outsourcing arrangement, with most GPs choosing to outsource accounting and investor reporting needs to a fund administrator but simultaneously practising shadow accounting by having staff keep its own duplicative accounting ledger internally.

However, this arrangement may be on the brink of replacement by a new innovative software and service partner arrangement – co-sourcing, in which a fund administrator executes a fund manager’s accounting and reporting workflows through that fund manager’s back-office software system.

The drawbacks of shadow accounting

At face value, the duplicative work of the typical back-office approach is inefficient – GPs pay for both a fund administrator and extra staff to meet the needs of this current model and create two sets of data. But the private equity industry has embraced this practice in the absence of a better approach due to a few driving factors.

Primarily, UK and EU regulations governing AIFMs (alternative investment fund managers) require them to be capable of sharing any fund document with the respective regulatory bodies at any time. As such, having this data in-house is a key part of being able to comply.

Secondly, many LPs – especially at large funds – often demand a backup set of books be kept internally as a due diligence measure. Finally, some GPs simply value the double-check that shadow books can provide.

But co-sourcing as a new hybrid administration model gaining traction in the US could offer managers a streamlined option that lets them keep their data in-house while minimising the administrative burden.

How does co-sourcing work?

Co-sourcing acts as a blend of the best parts of outsourcing and insourcing. Fund managers keep control of their data by selecting their own software to run on their systems while granting access to their chosen fund administration partner. All accounting and investor reporting work is then carried out by the fund administrator via their access to the manager’s back-office system.

The benefits for both parties are quickly evident.

For fund managers:

  • Software selection. They select their own software responsible for their general ledger and investor portal rather than being pigeonholed into their fund administrator’s contracted software. Particularly when it comes to their own investor portal selection, the fund manager is afforded more control over their own LP experience.
  • Centralised data location. They keep control of their data in one central location – an appealing feature from both a data security perspective and an LP relations perspective, as they’re no longer forced to play out a chain of communication with their fund administrator every time an investor reaches out for ad-hoc reporting.
  • Freed-up internal resources. They benefit from the skill and expertise of a fund administrator, allowing them to maintain a smaller back-office team or utilise their back-office team on more value-additive tasks besides overseeing shadow books.
  • Decreased risk in fund administrator selection. They experience the benefits of working with a partner without the risk of staying with a fund administrator who isn’t the best fit. In an outsourcing model, back-office data ramp-up can be a significant time and resource investment. Now that all their data lives on their own systems, they’re free to move on from a partnership that isn’t working and choose a new partner without the headache that goes into moving their accounting data from firm to firm.

For fund administrators:

  • Access to new revenue. Fund administrators would see a wealth of new business opportunities as they gain access to fund managers who would otherwise never consider a fund administrator without this unique blend of insourcing and outsourcing.
  • Decreased IT and administrative burdens. Co-sourcing removes certain burdens that draw fund administrator teams away from the true value they seek to add in handling a fund manager’s accounting and investor reporting. From technology troubleshooting to reacting to LP enquiries, these elements would no longer fall to them, and they can focus on shining a spotlight on their service and solidifying the client partnership.

What would a co-sourced future look like for European private equity managers?

Ultimately, today’s model of shadow accounting in tandem with fund administration meets the needs of most private equity managers and has deep roots in Europe. Few question the setup, and it will likely remain the go-to back-office arrangement for now. But as a new model emerges that fulfils all these needs while creating efficiencies for both sides of the existing arrangement, we will see industry participants latch onto the innovation – first among emerging managers and smaller, nimbler fund administrators before moving up and becoming a legitimate trend for the industry’s larger players. In my view, co-sourcing has a natural place in Europe’s private equity world.

© 2023 funds europe

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