Good times roll for hedge fund administrators
It may be, as some market participants in Dublin candidly acknowledge, because the global hedge fund business is booming. It may be that an English-language environment is the key to attracting European hedge fund managers that are overwhelmingly based in London. It may be the simultaneous strength and flexibility of the legislative and regulatory environment, or it may be that clients are drawn to the increasing range of value-added services available in the marketplace. Whatever the reason or combination of them, business is pouring in for hedge fund administrators in Dublin (and increasingly other parts of Ireland).
Administrators small and large talk about the competitive pressures brought by rising costs and increased demand for skilled staff, and market participants ponder the implications of a series of acquisitions that have brought many of the world's leading custodian banks into the Dublin marketplace. But whatever the effect of these issues, they do not appear to have stemmed a surging tide of business that has confirmed, if there was any doubt, that Dublin is the preeminent European jurisdiction for the servicing, if not necessary the domicile, of offshore hedge funds.
Up to date or official figures on Dublin's alternative investment industry are unavailable, but the sector's growth rate is indicated by a survey published by the Dublin Funds Industry Association last December which indicated that the net asset value of alternative funds serviced in Ireland more than doubled between March 2003 and June 2005, from USD199bn to USD474bn, while the number of funds and sub-funds grew by almost half, from 2,113 to 3,020.
Although the DFIA statistics include private equity and venture capital funds as well as property vehicles, the latter represent a very small proportion of Ireland's administration business with USD3.6bn and USD5.5bn respectively in June 2005. Single-manager hedge funds accounted for USD289.1bn (61 per cent) and funds of hedge funds for USD150.1bn (32 per cent), with a further USD25.6bn of assets in other non-identified types of alternative investment funds.
'The pipeline is still very healthy,' says Clara Dunne, senior country officer for Caceis Investor Services in Dublin. 'Although there's healthy competition among the service providers, there's lots of business to go round. Luxembourg may be competing with us in a way it probably wasn't four years ago, but Dublin certainly has a head start, especially for servicing of Cayman domiciled funds. One of the thing that gives Dublin the edge is the English language; hedge fund managers working out of London and the US are more comfortable with the English language support they can get in Dublin, but also there's the infrastructure that we provide.'
Says Mark Sweeney, head of custody and trustee services at Bear Stearns Bank: 'Dublin and Luxembourg probably have a similar number of service providers and probably the same ones - it's just down to client preference. Perhaps continental European managers see Luxembourg as having a language advantage and thus better placed for servicing their products in continental markets, while US investment managers may see Ireland as a better location for their funds.'
This view is borne out by the figures. According to Ronan Nolan, partner in charge of investment management services with Deloitte & Touche in Dublin, there is 'a huge dominance of the Anglo-Saxon countries' as regards the origin of promoters whose funds are serviced in Dublin, with the United States with 40 per cent of the total and followed by the UK with 35 per cent. 'They are followed at a distance by Germany with six per cent and Italy with four per cent,' Nolan says. 'Anglo-Saxon promoters find Dublin an easier location to deal with, although it depends on distribution strategies as well.'
Ireland's administrators may have language on their side but they are also beneficiaries of the overall growth of the global hedge fund industry, according to Declan Quilligan, managing director of Citco Fund Services, which has some USD60bn in assets under administration in Dublin. 'The global hedge fund market is growing at about 20 per cent a year and now has assets totalling well over USD1trn,' he says. 'Dublin has evolved into a natural back office to London by virtue of its proximity, the fact that it's a regulated jurisdiction, its highly skilled workforce and the capacity that workforce provides. The greatest driver is the rapid pace at which the London hedge fund market has been growing over the past five to 10 years.'
Says Tony McDonnell, head of business development for HSBC's Alternative Fund Services: 'Dublin has attained a critical mass which is proving difficult for other jurisdictions to surpass. We are now a globally renowned hedge fund servicing centre and many large institutional clients are not interested in having their fund serviced from any other jurisdiction. Part of this is undoubtedly due to perception; their competitors have a Dublinbased administrator so, for fear of appearing different, new managers opt for Dublin too. However, the real factor driving the growth of the industry in Ireland is undoubtedly the number of skilled hedge fund industry personnel.'
According to Deirdre Lyons, head of international financial services at national economic promotion agency IDA Ireland, efforts to consolidate and expand the country's fund services ndustry include encouraging service providers to move into middle-office activities such as outsourced risk management. She also says Ireland is also enjoying success in attracting niche hedge fund administrators that focus on extremely specialised types of investment.
There is evidence that in seeking to offer more sophisticated services to hedge fund clients, administrators are starting to move into areas hitherto the preserve of prime brokers. 'The traditional lines between prime brokers and administrators are beginning to blur,' says McDonnell. 'This is especially true of larger administrators who are leveraging the product ranges of their new institutional parents to provide clients with more choice. It is a natural extension for these administrators to offer credit, leverage, FX and middle office functionality that would previously have been viewed as prime broker territory. For the larger players it is no longer purely an administration mandate anymore.'
However, there are limits on the range of services administrators can or should be providing, according to Dermot Butler, chairman of Custom House Administration. He says: 'As more funds invest in hard-tovalue instruments, the challenge for the administrator is to find an independent valuation of those assets. We do not believe it is appropriate for an administrator to build its own pricing models, first because of the risk if you get it wrong, and secondly because we're not advisers, and this is an advisory function. In the same way, we won't develop risk management tools ourselves, because again that's advisory. What we will do is provide links to Sungard Reech, RiskMetrics or Lombard Risk, to whom we can feed the information down and get the results back.'
Technology is today a feature of hedge fund administration unimaginable five years ago, but it still has its limitations. Says Mark Mannion, managing director of PFPC International: 'For single manager business, we have automated almost all processes for strategies ranging from straightforward long/short equity to the most complex creditbased funds. This allows us to have a scalable product and add signficant volume to our platform without needing significant increases in headcount. But funds of funds remain a largely manual environment. While internally we have automated the process as much as we can, we are limited by the extent to which our counterparties, the underlying administrators, have done the same.'
The increasing complexity of hedge fund instruments may make the use of technology more complicated, but also more vital, says Sean Flynn, head of hedge fund services at UBS. 'To have the ability to deliver asset valuations, you must have straight-through processing and robust systems to deliver information to investment managers and investors in a very timely manner,' he ays. 'The days of manual processing of trades are long past; there must be full automation with prime brokers, electronic pricing feeds, and web-based delivery of information to investors and investment managers.'
According to Quilligan, the next area in which automation should deliver significant efficiency gains is online investor subscription and application processing. He says: 'We have an investor web reporting product, but because hedge funds are aimed at institutions and high net worth individuals, there is rather a complicated bespoke application process, imposed by the requirement for investors to confirm they are eligible. In conjunction with AIMA, we are trying to produce at least a consistent administration agreement that the law firms and administrators are familiar with and have signed off on, but investor relations remains an area that for the moment is not as automated as in the long-only funds business.'
But like it or not, administrators are shouldering their share of the increased burden of compliance on hedge funds and their managers. 'The fact that managers can now outsource their entire back office means that they are also outsourcing part of their compliance to their administrator,' says Mannion. 'You see that not only regarding fund NAV but on the investor side, where it's critical that the administrator has sophisticated systems to identify money laundering or any other issues of concern.' These new regulatory demands are one of the factors behind the acquisition of independent administrators by large global financial services groups, according to Karen Tyrrell, managing director of BISYS Hedge Fund Services. 'We actually welcome the heightened regulation and compliance,' she says. 'We're able to absorb the extra requirements because of the size of our firm and our experience here. Smaller shops can see coming the equirements that will be made of them, and know that although the requirements might be going up, you can't put the price up.'
Many administrators say that although the level of competition in Dublin has not forced prices down, it has obliged service providers to absorb at least some of their own increased costs. Says Dunne: 'Hedge fund managers understand that the service they require is customised. They don't want to be channelled into a process, so they are typically willing to pay for that. hey're not willing to pay a hike in fees, but we're not yet seeing any great downward pressure on fees as has been the case on the mutual fund side.' However, Butler says: 'The pressure will come from the other side as administrators who carry out substantial compliance functions on behalf of funds or managers want to get paid for it.'
Over the past three or four years several Dublin administrators have passed into the hands of larger groups, and although most of the big custodians and administrators now have a presence in the market, Tyrrell believes there are still deals to be done. 'There are a couple of firms out there which, if some of the larger institutions wanted to get into the business, would deliver market share,' she says. 'However, because there are fewer potential acquisition targets, the price of those that remain has probably gone up.'
Custom House is one of the few remaining independents - albeit one hard to describe as a niche player after assets under administration rose from USD12bn to USD 19bn last year - and Butler says the firm has gained business from smaller funds unhappy that their specialist service provider is now part of a big group. He adds: 'Institutional fund managers always ask us whether we are in talks with anyone about selling out, because they don't particularly want one of the big global providers knowing what they're doing. There is a fear that in some cases Chinese walls are very similar to Swiss cheese.'
Says McDonnell: 'Consolidation at the upper end of the market is probably in its final stages. There are still one or two large independent providers that would make obvious attractive targets to an institutional player looking to enter the market, but there would need to be mutual desire for the transaction to take place. At the lower end of the market, smaller administrators may well consolidate to achieve critical mass or extend their geographic reach. But there will always be a place for smaller administrators offering services to start-up managers and niche sectors.'
Start-up administration operations do exist but are becoming rarer. Says Dunne: 'It will become less easy to set up from scratch, because barriers to entry are rising. You need quite a substantial book of business to justify the investment in technology. In addition, from a compliance point of view, hedge fund managers are now more comfortable with a well-established service provider, whereas five years ago they were happy to deal with niche players.'
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