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The custodian of a fund of hedge funds plays an important role in protecting its assets and carrying out oversight of the manager and administrator on behalf of the shareholders. But custodians often carry out a further vital function by providing credit to the manager for hedging purposes, gearing of investments and to manage settlement timing, to enable them to stay in the market while waiting to receive the proceeds of an investment that is being liquidated.

The custody market in Guernsey is keen and competitive. Along with MeesPierson (C.I.) (part of the MeesPierson Reads group in Guernsey, and ultimately owned by the Fortis Group), there are six major players in the market, including institutions such as Royal Bank of Canada, Northern Trust, which last year acquired the Barings fund services business, and HSBC.

MeesPierson (C.I.) distinguishes itself from its competitors in two ways. First, as a specialist custodian, rather than as an institution offering a package of services to funds including administration, the firm is probably more attractive as a partner to independent administrators, who can be confident that MeesPierson is not pitching for their own business.

The danger for independent administrators in choosing a custodian that is part of a large institution with a comprehensive range of services is that once the client has entered a business relationship with such an institution, before long they are being lured by the benefits of a one-stop shop. The second characteristic that marks out MeesPierson is credit policies that are somewhat more flexible than those of many of its competitors. Other custodians can be unwilling to provide the same level of credit with hedge fund assets as collateral.

As a result, funds could potentially run into problems in obtaining credit for hedging and gearing purposes and potentially for the management of settlement timing. Each custodian has its own particular niche, and MeesPierson appears especially attractive to funds of hedge funds with a larger requirement for credit than other funds. The main issue facing custodians of funds of hedge funds is that in contrast to custody of fixed-income and equity funds (which also represents a small proportion of MeesPierson's business) is that it is very labour-intensive.

Exchanging faxes is required to carry out subscription to underlying hedge funds, and data is entered manually. There's very little opportunity for automation, so the requirement for people to administer is high.

Finding the right people is not always easy or inexpensive. Guernsey's workforce is limited in size, and the number of skilled people looking for work is extremely small. As a result,
demand for staff has pushed wage inflation higher than normal over the past couple of years, although measures to make it easier for the financial industry to recruit outside the island have helped to ease the pressure. The importance of the custodian in overseeing a fund of hedge funds should not be underestimated. They check that valuations are carried out correctly,  monitor that investments are appropriate and do not exceed predetermined limits, oversee that risks are properly spread, and perform regular due diligence checks on the administrator and manager.

The past year has been a particularly good one for Guernsey funds of hedge funds, which is one of MeesPierson's core businesses. It also acts as custodian for some non-Guernsey schemes, as the regulations allow, some of which are now converting into Guernsey funds. With steady growth in the number of funds seeking custody services, the outlook for the next year seems as positive as the past 12 months.

By Paul Redhead Paul Redhead is a director with MeesPierson (C.I.) in Guernsey

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