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Dermot Butler, chairman, Custom House Group

Hedge funds face challenges of Form PF and standard communication protocols

By James Williams – Over the last three or four years the technology platform between fund administrators and managers has become all-encompassing in terms of supporting front- through back-office operations. There’s a clear push towards real-time integration of services between managers and their administrators, brokers and custodians, and whilst technology vendors are clearly meeting this challenge there’s still plenty of room for improvement.

One of the obvious consequences of managers paring back their technology infrastructure is that fund administrators are being pushed harder than ever to give them the support they demand. This in turn is because managers themselves are coming under heavy pressure both from the regulators and investors to sharpen their game, become more transparent, and present data in a fast and meaningful manner.

Last May, fund administrator Custom House Group launched what it called phase two of Chariot, the firm’s web-reporting platform. Clients log on and Custom House downloads all the information it wants to publish into Chariot for investors and managers to access. Regardless of whether an investor is allocating to one fund or five, they can see the latest information on each of the funds, be it the NAV, fund transactions, the offering document or any reports the manager has put out. That way, each investor gets to see only information that’s relevant to them. The system has recently been updated with the addition of a trading platform.

As Dermot Butler (pictured), chairman of Custom House Group explains: “Once we’ve done our AML checks and qualified an investor he can come in and place orders or redeem shares in a fund on the web. A lot of people say it’s risky. Frankly, I think it reduces risk because the main risk with subscriptions/redemptions is getting something wrong with your numbers – such as processing an order for 1,050 shares as 1510 shares for example. If the order is placed on Chariot, it will be processed as entered so it removes human error. Of course the original entry might be wrong, but at least we can then identify the error-maker without dispute.”

Last October, Butterfield Fulcrum decided to bolster its client-facing capability. It chose New York technology provider Paladyne Systems after careful consideration of the competition, principally for the strength of its front end and the fact that it is well integrated with Advent Geneva. Chris Mulhern, President and COO at Butterfield Fulcrum, explains: “What we got with Paladyne was an ability to deliver a full front to back solution with a strong order management system that executes trades to the street, and a dynamic client-facing portfolio management system. What made the extension of our product offering even easier was the fact that we had a relationship with Paladyne going back to 2009 and their products are already deeply integrated with Advent Geneva, our general ledger system.”

Previously, Butterfield Fulcrum had focused on back-office services like NAV calculation. By partnering up and using Paladyne ClientLinkTM the firm is now able to leverage Paladyne’s trading, portfolio master, real-time P&L, risk reporting and automated reconciliation tools to give its clients a more holistic front to back level of support. And Mulhern is already seeing the benefits: “We’re being invited more to pitch for more business and our closure rate for new business has gone up dramatically.

“Portfolio Master is already well integrated to the street. The technology communicates directly with the brokers, from order generation and communication to inbound fills of the trade coming back into the system. The application also has the additional functionality of locating short stock availability, pre- and post-trade compliance and great allocation capabilities,” explains Mulhern.

This is the kind of integrated support that managers are now looking for. Everyone sees the same trade flow and talks the same language. It’s a sign of deepening collaboration between service providers and managers. But things aren’t perfect.

Norman Hartmann is head of trading at Hamburg-based Aquila Capital. The firm runs a number of UCITS-compliant hedge funds and Hartman says that the main challenge remains streamlining front- to back-office processes. One of the most efficient ways of sending trade orders to brokers and getting confirmations back as quickly as possible is to use FIXML. “Your administrator also needs to be able to receive these confirmations from the fund manager, and also the brokers: that way their compliance systems are always up-to-date in real time.

“Nowadays, though, this is still not the case. There are many different environments. We looked at several systems recently and decided to take care of all the internal order management by ourselves. We have tailor-made systems, APIs (Application Programming Interface) and so on, where we can easily connect with our service providers,” confirms Hartmann. This illustrates that a lack of homogeneity still exists among different organisations, and whilst not all fund managers like Aquila Capital - who are highly systematic – will chose to develop in-house technology solutions it nevertheless suggests that the industry is still some way from being able to systematically integrate the workflow.

Andy Seaman, a partner and portfolio manager at London-based Stratton Street Capital would like to see brokers and custodians use a standard way to communicate with themselves. He says the firm uses thinkFOLIO for its front-office operations, which communicates with custodians using FIXML. However, like Hartmann, Seaman notes that not all custodians necessarily use it.

“Unfortunately what that means is when you want to send trade files everyone wants them in a different format. As a relatively small firm we have to do enormous amounts of work trying to integrate with large organisations,” says Seaman.

The advantage to FIXML is that it is able to translate certain words using a dictionary so if one party uses ‘broker’ in the codes and another party uses ‘dealer’, for argument’s sake, FIXML is able to translate one into the other. “It would make everyone’s lives easier if a standard like FIXML was used but for some reason banks and custodians want their own,” adds Seaman.

As if lack of standardised communication weren’t bad enough, the fact that managers today are using multi-prime relationships simply compounds the issue. Hartmann confirms that the OMS used by Aquila sends orders electronically via an API to the firm’s execution management system, which is multi-prime. Sending orders out, it seems, isn’t the issue. Rather, it’s getting them back efficiently. “When we ask brokers ‘are you able to send me the commissions of the transaction within the FIX drop copy in real time?’ still most of them say no. That’s because the confirmations and commissions data are always in the middle- and back-office not in the front-office. Many brokers aren’t able to deliver on this but they’re working on it,” says Hartmann.

To overcome the problem, after the transactions Aquila Capital receives something similar to a CSV file, which gets inputted directly into its databases to give a summary per market at the end of each day. “It was something we asked for and we’ve been running this for the last 12 months now,” confirms Hartmann.

“One of the challenges we face in the world of daily deliverables is ensuring good connectivity to broker data is available and timely. In order to deliver trade, position and cash reconciliations pre-market open on trade date + 1 it is essential that the process of loading broker data to reconciliation tools occurs seamlessly and in an automated fashion. Considering the amount of clientele who multi-prime and have many broker/counterparty relationships it remains a continuous obstacle in avoiding situations where we are forced into manual work and intervention,” asserts Mulhern.

Without doubt, ramping up the middle-office risk reporting function has become a key trend recently; administrators are having to move quickly to keep ahead of the competition. Again, timely reporting is key, but so is the way in which managers can use the products to meet their needs: chief among them using dashboard tools and applications on tablets and iPads.

Last month, Custom House Group decided to partner up with Nirvana, a risk platform provider in the US, increasing the firm’s ability to provide risk reporting, analytics and analysis for its clients. David Barry, EMEA Head of Sales & Marketing at Custom House, says: “Nirvana is a middle-office/reporting/risk solution for fund managers. We’ve always wanted to provide clients with more real-time information and should a client potentially want intraday information we can now provide it.”

Nirvana has a touch screen element meaning clients can use their iPad to view information e.g. for an equities-focused manager using OMS, as soon as they place a trade it goes directly to Nirvana who will then corroborate that information, price it and send it back to the client. “From a risk perspective it gives both the manager and investors more frequent, real-time risk information (VaR, stress testing) and portfolio information, P&L information, all on a touch-screen interface. When we pitch these services to new clients and existing clients they’re extremely interested as investors seek greater transparency,” confirms Barry.

Seaman notes that one of the significant changes in Stratton Street is the move into Apple-based products, confirming that the majority of staff have iPhones and/or iPads. These devices are fast becoming part of the business architecture, particularly with respect to doing investor presentations. “We currently use an application called Dropbox during presentations where we can pick from a number that have been pre-loaded and use them on the iPad. This gives you the ability to flick from one presentation to another, allowing you to quickly answer questions by calling up the relevant slide. I also like Roambi, an application that takes spreadsheet data and turning into eye-catching charts.”

The whole mobile device/cloud computing trend is interesting and a more engaging counterpoint to the other more pervasive challenge facing hedge fund technology: regulation. There’s plenty of it: MiFID II, AIFMD, FATCA, UCITS IV, Form PF, UK Bribery Act. Of them all, Form PF currently represents the greatest challenge. Technology vendors are relying on administrators to help them keep on top of things, and even though it’s ultimately the responsibility of managers to do their Form PF filing, they too are reliant on their administrators to come up with solutions.

GlobeOp have recently launched such a solution but Maples FS CIO Tyler Kim doesn’t think it’s easy to build a boilerplate solution that meets everyone’s needs. This is because Form PF presents a data gap challenge. Administrators like Maples FS can load data directly from their accounting engine for certain parts of Form PF but there’s a whole set of information that needs to come from the managers that no administrator ever gets into its system: for example, percentage of OTC swaps cleared through a CCP.

“Any vendor or administrator developing a Form PF solution will face the same challenges: about 60 per cent of the form can be populated based on data derived from within a portfolio accounting system (NAVs, exposures) but then there’s the residual part that we don’t typically have the data for. These responses need to be provided by the manager and may require judgment calls. We can help managers understand what they need to provide versus what we can provide: that’s as far as we can go,” says Kim.

Mulhern estimates that administrators have between 50 and 70 per cent of the data for Form PF. To bridge that gap, Butterfield Fulcrum has, over the last 10 weeks, been building its own Form PF solution with a technology provider whose identity cannot be revealed. “The technology will bolt onto our web portal and so the access will be there for our staff, and for the clients. The emphasis has been on data aggregation capabilities and being able to seamlessly import data from Advent Geneva, Paladyne and other sources for proper presentation in Form PF: that’s where the real challenges are and that’s what we’re dealing with right now,” asserts Mulhern.

Aquila’s Hartmann states that risk reporting in response to this new regulation will be a continuing theme in 2012, if not beyond. “You have to have your portfolio reconciled in real time as much as possible and have a good engine to run reports. Reports need to be specific and the time taken to send them out to investors should be as short as possible with manual input kept to a minimum.” It’s the reconciliation between administrators and custodians that needs to be improved thinks Hartmann.

Reporting aside, Hartmann notes that trading algorithms traditionally used in equities markets are now starting to apply to derivatives, for example using VWAP for futures orders: “This is something new. You can only use these algos in liquid futures markets. Whereas previously we had an execution trader working such orders over a 30-minute period, we’re now using a TWAP (Time Weighted Average Price).”

Another interesting future technology trend that banks will need to address is the curious issue of trading the Chinese currency, which, due to its application in the local domestic market (RMB) and offshore Hong Kong market (CNH) means it has two distinct currency tags. In February, Stratton Street launched a CNH class for its Renminbi Bond Fund. However, at present banks only have one SWIFT code for the currency, and this, thinks Seaman, will be a problem banks will need to overcome.

“They’re going to have to change their systems in order to cope with two currencies and one SWIFT code, some kind of a qualifier. I’m sure different people will have different solutions. It’s a unique problem: it’s not every day a currency like that comes along. Northern Trust, who administrates the fund, has luckily cracked that problem for us.”

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