The credit crunch tsunami has touched all sectors within the financial services industry, with each being affected in one way or the other.
The credit crunch tsunami has touched all sectors within the financial services industry, with each being affected in one way or the other. Even Ireland has felt the impact, albeit to a much lesser extent than the US or the UK. While there is no doubt that the IFSC (International Financial Services Centre) and the Irish funds industry have performed spectacularly in the past decade, many are realising that a new age that has emerged within the financial services industry since the credit crunch last year.
However Ireland’s funds industry, which has been the envy of many competing jurisdictions, has not been impacted as much. Gary Palmer, CEO of the Irish Funds Industry Association, says, ‘Since the credit crunch and the liquidity issues of last year, no sector within the financial services industry has been immune from its effects. The funds industry, however, has been impacted less, for one reason – and that is – unlike investment banks, the affected assets are not held on the industry companies’ balance sheet.’
Senior fund administration executives agree that there will be a need for Ireland’s financial services sectors, including the funds industry, to keep their eyes on the evolution into the future and look more objectively on what may develop out of the current circumstances. They say that additional efforts by government, regulators and industry can help Ireland’s funds industry grow even further amidst financial uncertainty and increased competition.
The Irish Financial Services Regulatory Authority (the Financial Regulator), renowned for its pragmatic approach, has been preparing for this new shift in the industry. The Financial Regulator has already achieved a stellar reputation globally. In most cases this has been achieved by maintaining its principles-based system of regulation, which has been shown to be both robust and responsive over the last few months.
In a recent event, CEO Patrick Neary emphasised the importance of an international collaboration to form a strategy partly by the lessons learnt from the past few months. He said, ‘Domestic legislation cannot, in itself, provide responses to the market issues that have arisen; these are best considered at an international level and there are currently a number of studies underway… lessons will then need to be addressed on an international level by the market participants, central banks and regulators.’
The funds industry is also insulated by additional regulation that it has. For example, the fund companies as well as the products are regulated, whereas in other industries, the companies are regulated but their products are not.
In an overall context, the Financial Regulator is well-regarded by the industry. Don McClean, head of fund services, Ireland at UBS Global Asset Management, says, ‘Ireland, from a regulatory point of view, is in good shape. Our regulator encourages successful business activity in a strictly regulated environment – it’s an attractive environment for both investors and service providers.’
Ronan Nolan, a partner at Deloitte Ireland, adds that the regulator clearly recognises the imperative to combine a reputation for first class regulation with competitiveness and responsiveness to innovation.
The regulator continues to be supportive of the funds industry and its development in Ireland, whilst also maintaining the integrity of Ireland as a service location. Andrew Dillon, Managing Director at Baronsmead Insurance Brokers Ireland, says, ‘It is an invaluable partnership and creates an environment that is flexible in meeting the needs of fund promoters, whilst also protecting the interests of investors.’
All this is positive news for a burgeoning funds administration industry that now must sustain the spectacular growth it has achieved in the past. According to statistics published by the Irish Funds Industry Association, the number of Irish registered collective investment schemes grew from 361,760 in December 2003 to 805,989 by December 2007. The number of non-Irish registered funds administered in Ireland grew from 1,654 in June 2003 to 2,752 in December 2007. Over the same period, alternative investment funds administered in Ireland grew (in terms of assets under administration) from USD 199 billion in March 2003 to over USD 1 trillion by December 2007.
Ireland’s fund administration success has been based on innovation, good legal and regulatory framework, excellent business environment and the ability to provide experienced staff that can facilitate the processing of sophisticated products. And two of the main factors that fuel this industry are first mover advantage, and quicker regulation and approval of products. For the latter, Ireland took the initiative in 2007 where it introduced a new notification-only process for the approval of Qualifying Investor Funds (QIFs) under which applications for authorisation lodged with the regulator before 3 p.m. in the afternoon would be processed for 9 a.m. the next morning. This procedure was designed to remove what was seen as an important obstacle to the use of Irish alternative funds. More importantly, it highlighted Ireland’s flexibility and pragmatism in the funds area.
First mover advantage has always been vital but, with the changing times, it has proved to be even more crucial. Keeping up with the pace in the funds industry, in developing new products and services, in intensifying research and education, and in adapting to new economic and legal realities are challenges that all fund jurisdictions will face. As Gary Palmer says: ‘If you are a fast follower, all you do at best is come second.’
One of the biggest trends in the funds industry is consolidation. A lot of consolidation has been taking place – with bigger entities buying out small and boutique funds, or with two entities merging to form a bigger group. Palmer notes ‘While consolidation in the funds industry has been anticipated for some years, the last 18 months has witnessed quite considerable consolidation activity. While, in the past, much of the consolidation was to gain expertise in specific areas, recently the consolidation activity has also been to increase scale.’
By consolidating and becoming larger, these new groups can diversify risks and have a solid and bankable support system. And many funds are also seeking to consolidate part of their services and assets to larger institutions. Dillon explains, ‘Some hedge funds have looked to transfer assets to the big global custodians in the wake of the recent market turmoil and the write downs by investment banks/prime brokers. The global custodians would be seen as a safe haven and it also reduces the counterparty exposure that the funds face.’
Consolidation in the hedge fund administration sector is likely to continue but the sector is also likely to see a continuing stream of new entrants to the market. David Aldrich, Managing Director of The Bank of New York Mellon, says, ‘For every firm that has been taken over by a global custodian, several new boutiques have been created. One of the attractions for creating new firms has been the very attractive valuations that recent takeover targets have achieved, largely due to the need for the global custodians to acquire alternatives capability. That trend has largely played itself out, and the focus is switching to consolidation of medium to large firms into single businesses with greater critical mass. The top end of the hedge fund service provider market is dominated by firms with at least USD 200 billion in alternative assets under administration globally, which may be considered sufficient to justify the R&D and technology investment necessary to keep pace with the speed of innovation of the "premier league" of hedge fund managers.’
Dillon adds, ‘There are currently a number of firms entering the fund administration market with many being founded by former executives of firms that were swallowed up in the consolidation of recent years. Some of these have made promising starts and are filling an important gap in the market. This is a very positive development for the industry in Ireland and should ensure that service standards remain high.’
Further consolidation is bound to come as global players seek to increase their capacity and capabilities, and the smaller players look to survive. However, this does not spell the end of smaller boutique fund administrators, in fact, quite the contrary. Smaller boutique fund administrators will always be important in this dynamic industry where funds of all types and sizes need to be catered to. ‘The existence and development of smaller fund administrators copper-fastens the need for the broad range of company types in this sector,’ Palmer sums up.
Another trend that is likely to be exercised more in the near future is that of valuation. The funds administration sector is now operating in a new era. As with every other sector the impact and implications of the changing economic market conditions are obvious. While the funds servicing sector has been buoyant of late, many are also now paying close attention to the valuation of funds – one of the main jobs for a fund administrator. And Dublin, a centre of fund administration expertise, is likely to lead the way. Palmer says, ‘Challenges have arisen and the valuation activity of a fund has become much more involved.’
Alternative Investment Management Association (AIMA) guidelines and International Organisation of Securities Commissions (IOSCO) principles represent efforts to create a valuation standard that all funds should follow.
The funds servicing industry is very positively disposed towards the new standards and welcomes the developments. However, the industry needs to coalesce around a set of standards and focus on delivering against these.
This is critical in the development of the hedge funds sector as good and fair valuation standards are vital to encouraging investors to invest in a fund. They form an essential part of the policies and procedures of a hedge fund looking to attract significant assets in today’s markets. Clarity over valuations of assets gives confidence to investors and is also a requirement for new capital allocations.
In this new financial era, Ireland is well placed to continue to grow its funds industry. ‘Ireland has done a commendable job of balancing the needs of all the stakeholders in the industry including investors, managers and service providers. It has a strong advantage over a number of competing jurisdictions and a very healthy level of competition between service providers,’ says Dillon.
The key lies in avoiding complacency, attracting intellectual capital and keeping rising costs at bay. Unlike in 1987 [when the IFSC was formed], Ireland is now a high cost environment and needs to upgrade and accelerate investment in skills, training and education to support the higher productivity and value-added activities necessary to sustain and develop its funds servicing sector over the next 20 years.
The challenges of retaining talent and managing service provision in a rising cost environment can be managed, but require an unrelenting focus. The IDA, for example, is in the midst of an ongoing internal debate about how to take the funds industry to the next level. Plans to consolidate and modernise Ireland’s overall financial services legislative framework are expected to provide a competitive edge.
In the context of a challenging global financial services environment, it is important that players in Ireland’s funds servicing sector keep their eyes on evolution, rather than the confusion of the present. It is easy to get caught up in the turmoil and negative commentary, rather than looking more objectively on what may develop out of the current circumstances.
Palmer sums up, ‘There is an equal measure of optimism and concern [going forward]. Optimism because the funds industry still has a wealth of unrealised potential. Concern because we are operating in a very competitive global industry in a changing economic environment and will have to work very hard to realise this potential.’
