In the driving seat of this revolution are large, institutional investors, attracted to hedge funds by the prospect of absolute returns and a more active approach to money management. At the same time, they are not prepared to compromise on service standards, and expect fund managers, and their service providers, to deliver the same levels of service and accuracy that they would expect to receive from a large mutual fund structure. This is tough if you are relying on a small, boutique hedge fund administrator to deliver your NAVs.
In recent years, we have been witness to a number of landmark deals that have seen major investment banks buying up many of the independent administrators that have been active in the hedge fund space in an effort to tap into the perceived growth in the asset class. The rationale has been to match the scale and infrastructural quality of a major international bank with the specialist knowledge and client base of a boutique administrator. There are, however, other approaches.
One such is represented by BNP Paribas, the major French bank which has been gradually building up its presence in the hedge fund world via a number of avenues, including its Securities Services arm. Other acquisitions for the bank in the alternative investments arena have included fund of hedge funds manager Fauchier Partners, and Bank of America’s prime broking operation. The bank is obviously coming into the hedge fund sector from a variety of different directions, and in all cases, employing its already extensive experience in operations, markets and instruments to give itself an edge.
As a group, BNP Paribas already enjoys considerable scale, with a presence in over 85 countries, 163,000 staff and the additional benefit of an AA+ credit rating. It is hard, in the current climate, to underestimate the value of being the highest rated securities services provider in the world. “We actually had an upgrade during the crisis,” says Maria Cantillon, Global Head of Business Development at BNP Paribas Securities Services (BPSS). “In the hedge fund world, where historically credit rating was not a top priority on a hedge fund manager’s radar, from an investment perspective they now need a credible minimum in their prospectus. Having an AA-rated bank, and a bank that can do prime broking, finance and leverage with that credit rating, brings additional gravitas.”
At the end of the day, it’s all about managing counterparty risk. Hedge fund managers in the current investment climate need to reassure clients that their service providers are solid. It is partly about liquidity but it is also about being a safe bet.
“For the larger institutional clients the bank services in Europe, having a single point of administration…makes a lot of sense as well”
The bank has always been strong in the derivatives space. Under the French banking system, from which it hails, banks have had to be very innovative. BPSS’ acquisition of Cogent, however, an established provider of mutual fund administration services, allowed it to match this area of the business with its custody and derivatives accounting functions to provide a formidable, institutional-grade offering. In addition, it bought the Royal Bank of Scotland/ Bank of New York’s joint venture in the Channel Islands, which has given it a huge slice of the real estate administration business, and in Italy it picked up a hedge fund administration business from Allianz, which has helped to cement its position in the country as the dominant player. In the US, BNP Paribas has purchased Bank of America’s prime brokerage business. It all points towards a bank that is enthusiastically taking the opportunity to acquire strategic assets which can be rapidly integrated around the world to offer a diverse, institutionally focused, service offering.
“The ability to execute on opportunities at times like this sets us apart,” says Chris Adams, Global Head of Product for Alternative Funds at BPSS.
“We are an institutional investor bank, we deal with other banks,” adds Cantillon. “The client base of European hedge funds at the moment is increasingly European banks. We are seeing European banks setting up their own hedge fund divisions, and historically they have probably owned a percentage of certain single managers and funds of funds in London. They’re now increasing their percentages of ownership, but also setting up their own shops under local domiciles in countries like Italy and Spain.”
Building quietly, but with big blocks
BPSS represents a very broad offering to fund managers that goes beyond NAV calculation. Outside traditional fund administration and middle office outsourcing, it offers direct access to local clearing, settlement, and custody in Europe, cash services, and foreign exchange and cash financing via its global liquidity services (which also encompass securities lending and borrowing, credit products and collateral management). It currently services over 650 alternative funds, holding assets worth more than US$127 billion. Says Cantillon of BPSS’ growth: “We’ve built our alternative assets from US$35 billion to US$127 billion now. We’ve decided to do it very quietly. We have been first into the Spanish and Italian markets. Having concentrated on our clients, and really looking at where this business is going – which is towards institutional money – we’ve been able to capture those market spaces very quickly. Obviously, those managers are now seeing success in those markets and are turning towards Dublin to set up Irish funds.”
BPSS is one of the few credible administrators that can service the onshore, European hedge fund arms of the big European banking organisations. It offers deposit banking, fiduciary, forex, and financing in Italy, France and Spain. In Italy it is the only one-stop shop, and enjoys 33% of the market share. In Spain it has 40%. “A manager will feel more comfortable with a credible administrator in those markets,” says Cantillon. “The business is moving more towards institutional managers and banks. Do they really want to go with amanager or an administrator with absolutely no understanding of these markets?”
If, as some reports indicate, the centre of gravity in the hedge fund investment arena is moving towards European institutions, particularly the large Spanish and Italian banks, then hedge fund COOs may well have to start addressing their administration arrangements going forwards.
This goes hand in hand with a gradual but fundamental shift towards the exploration by hedge fund groups of onshore vehicles as opposed to the traditional Caribbean options, domiciles that can still be viewed with suspicion by some European institutions and regulators. As an administrator, BPSS has had to ensure that it has the service options in place that allows it to meet this trend head on. “Servicing French, Spanish and Italian funds is very different from servicing Cayman funds,” says Cantillon. “In Italy we are responsible for everything. We are the depo bank. To get a licence as a manager in Italy can take from six to eight months, and will involve several meetings with the Bank of Italy. They will vet the depo bank that you choose. The Bank of Italy is very comfortable with us given our share of the market.”
Pete Townsend, BPSS’ Head of Operations in Ireland and Global Head of Alternative Investment Operations, reports he is seeing many so-called ‘hybrid’ launches combining elements of both hedge funds and long only funds, which are seeking authorisation for distribution under the UCITS III directive. It is a mark of the hedge fund industry’s quest for new regulatory credibility, particularly for structures that meet the European onshore appetite for funds that can be fully approved for distribution by a domestic regulator, but which can still tap into the investment management expertise of leading managers. BPSS has positioned itself expertly to meet the requirements of this rapidly growing slice of the market. The same can be said of Luxembourg’s Specialised Investment Funds, which must meet the regulatory requirement of daily liquidity and risk calculations. The administrator is faced with cutting the NAV and delivering VaR overnight, but this is what the regulators in Luxembourg now demand. The onus on the administrator is to keep up. According to Cantillon, such challenges mean the administrator needs to think like a manager. “We, as an investment bank, have always attracted institutional investors. We contract directly with institutional investors… We know and understand their needs and can therefore aid any hedge fund manager as they set out to win these mandates too.”
For many administrators, keeping up with hedge funds that opt for a UCITS structure can be difficult. For starters, there’s the daily trustee role, then all of the compliance reporting, and then the additional regulatory requirements. This also involves fixed costs, rather than fees based on assets under management. Yet, with many new start-ups in Europe going down the onshore route in order to ensure successful capital raising, the question of which administrators will be able to support these will increasingly come to the fore.
More than just hedge funds
BPSS’ business model is one that covers more than just hedge funds. Although currently catering to over US$12 billion in single strategy hedge fund assets (at the end of March this year), the bank’s fund services unit also deals with funds of funds (US$63 billion), real estate funds (US$37 billion), and private equity (US$16 billion). It is this multi-asset expertise that stands it in good stead when dealing with the larger hedge fund firm that is either already managing, or considering launching, multi-asset offerings. The bank is already seeing more than one formerly dedicated hedge fund manager diversifying into new strategies, and it is a trend that is likely to continue. Having a service provider with the expertise to move with the firm seamlessly into new funds is a considerable boon.
Not everyone covers all these areas. Specialised administrators will tend to goafter one particular alternative segment, but increasingly service providers are having to wake up to the diverse nature of their client base: private equity funds investing in debt structures, or funds of hedge funds putting money into real estate vehicles are just two examples.
“There is a tremendous convergence across the various asset classes, and the types of organisations and vehicles that are used to manage those assets,” says Adams. “In Luxembourg, a significant proportion of the private equity vehicles we service are holding real estate assets, either through REITS or other fund of fund type structures.”
Bear in mind that BNP Paribas’ owns strong, internal alternative investment management franchises, including Fauchier Partners, the fund of hedge funds, AtisReal, one of the biggest real estate operations in the eurozone, and BNP Paribas Private Equity. “For a universal bank like ourselves, the way that we’re successful is by putting all the building blocks together,” says Adams.
“We are careful about maintaining our segregation of roles, but our businesses on the buy-side do give us invaluable access to their expertise…These guys are in exactly the same place as our clients. The expertise, on just about anything, is in the group. It gives us a tremendous advantage, as it means we can anticipate our clients’ needs; if there are some technicalities we need to understand, there is inevitably someone within the group that we can go to.”
For real estate and private equity, for example, the skill sets required for month-to-month accounting values are very similar, reflecting the increasing synergies between the different ‘alternative’ investment classes that skilled service providers can capitalise on. “It does make sense from a client facing perspective, because we want to handle all of our clients’ investment strategies, but from an operational perspective, there are a lot of efficiencies you can gain,” explains Townsend.
For the larger institutional clients the bank services in Europe, having a single point of administration for their alternative funds makes a lot of sense as well. One point of contact can cut down vastly on the amount of time spent managing the outsourced relationship. Another major trend has been the increasingly international scope of large hedge fund and fund of funds shops. US-based firms have opened for business in Europe; and European firms have been establishing themselves in the Asian market, usually in Hong Kong or Singapore. BNP Paribas has a presence in all the major European, US and Asia Pacific markets, along with the expertise in offshore markets and products to complement this. For the growing firm with ambitions beyond its home region, this is a major plus factor.
Products
Because it is more than just an administrator, BNP Paribas has been able to offer client funds a range of additional services, including liquidity and leverage. It has an investment banking arm, and a considerable asset management division, and can consequently draw upon deep experience in both instruments and structures, including OTC pricing. It has been processing OTC trades from middle to back office since 1999 and is already handling massive volumes in terms of OTC and exchange traded derivatives for institutional managers, in total far more than it processes for hedge funds.
“We have one system, and it has all the bells and whistles that it needs,” says Cantillon. “It’s proven, and it’s out there. It doesn’t matter that it isn’t dedicated to alternatives. It’s not about an asset class, it’s about the ability of the system to price, and price daily.”
BPSS is deploying four core products that hedge funds may find of considerable value. Its Global Liquidity Services (GLS) capability is designed to provide active cash, foreign exchange, liquidity management, and FX hedging services. BPSS works with its investment bank to deliver this, and remains one of the few banks currently still lending to hedge funds. Other large global custodians might be able to offer credit on an uncommitted basis, but how many on an committed basis? “We have very robust before and after the fact controls,” says Cantillon. “That tool is not just for our benefit – it is also for our managers’ benefit. If I was a manager I’d want to use BNP Paribas as an aid in managing my counterparty risk.”
An Investment Reporting and Performance Tool (IRP) has been developed for fund promoters, managers, distributors and investors. It is being developed to support a daily reporting environment, and was originally designed for a German pension fund that wanted to understand the attributes of its investments in hedge funds in exactly the same way as it looked at its long only portfolio. It answers the sorts of questions major investors, like pension fund trustees, want to ask of the funds they invest in. (See Table.1)
“What the marketplace is asking for is technology, on a daily basis, that can handle the complexity of what is out there,” says Townsend. “From a technology standpoint, to be in this business, the two key parts are volume and the flexibility of your system. Can you handle 10,000 trades a day, for one particular fund, across a variety of instrument types? That’s one of the key differentiators for us: we grew up in the daily world; we built all the links to be able to handle that type of volume. When you are servicing hedge funds on an accounting platform, you need to be able to handle the short side of things and the complex instruments. If you can take both of those, with high volume, you’re doing well. That’s business as usual for us.”
This includes cutting NAVs on the system, rather than on spreadsheets. Townsend points to BPSS’ automated master-feeder capabilities as evidence of the bank’s abilityto deliver transparent reporting via web-based facilities. My Reports, its web-based reporting tool, is a highly customisable solution that also permits access to BPSS’ investment data warehouse, while PBLink is its internet portal providing quick and easy identification of investment opportunities.
These are part and parcel of a more accessible, non-Excel dependent delivery system that will allow a higher degree of automation and ease of reporting, something the long only industry takes for granted, but something hedge funds now need to be able to deliver.
“You want to make sure all your analytics are calculated on the same basis,” says Adams. “With all the will in the world, if you’re using five different prime brokers, and they’re using five different systems to calculate the same number, they will always come up with a different figure, just because of the way their applications are coded.”
What is becoming increasingly important, he feels, is that someone stands behind the manager who can calculate the risk across the entire portfolio on one consistent basis. If the risk data is generated by an independent source behind the prime brokers, it is much easier to spot if there are any issues or errors occurring.
Conclusion
Institutional investors are still, by many statistical measures, underweight in alternative investments. While the number of new launches and the average life expectancy of the average hedge fund has significantly decreased in the current investment cycle, it is the institutional dollar more than ever which is likely to be driving the growth of the industry in years to come. For example, of the top 20 funds of hedge funds in the worlds, 15 are owned by diversified financial services businesses.
The smart money will always follow the smart manager, and the smart manager in today’s world will be noticing the current convergence in the investing community. Those investors will, frequently, not be allowed to invest in Cayman funds and will need a regulated environment onshore. Be it Scandinavian pension funds or Spanish fund distributors, a big slice of the existing investment base in European hedge funds wants a more regulated framework.
“We’re seeing a large amount of managers now looking at Dublin funds,” says Cantillon. This is more than just a listing on the Irish Stock Exchange, mind you; it entails actual, onshore, Irish-regulated vehicles.
Investors want the manager to behave like a mutual fund organisation, even though they may still be running money like a hedge fund. What keeps some COOs at big hedge fund firms awake at night are the daily liquidity and VaR demands of large institutional clients. The monthly reporting environment is increasingly under pressure, and administrators like BPSS, which are already set up for the challenges of daily reporting, are bound to profit from this.
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