The alternative fund services industry in Guernsey continues to confound predictions that worldwide the sector is moving toward consolidation around a handful of giant players.
The alternative fund services industry in Guernsey continues to confound predictions that worldwide the sector is moving toward consolidation around a handful of giant players. While the island has seen its share of mergers such as HSBC’s acquisition of Bank of Bermuda and Northern Trust’s purchase of the Barings fund administration business, the number of administrators in Guernsey is growing larger rather than smaller.
The conventional wisdom is that as the administration of hedge funds and other alternative vehicles becomes more process-driven, an inexorable advantage will accrue to those organisations that have the resources to make massive investment in the automation of systems. This trend will be exacerbated, according to this view, by the relative shortage and therefore higher cost of human resources in island centres such as Guernsey, which will make the use of information technology to build scale even more attractive.
In addition, new regulatory developments that shift the burden of due diligence for the fast-track approval of certain types of alternative funds from the island’s regulator, the Guernsey Financial Services Commission, to administrators should by this analysis favour providers with greater resources to devote to this process. Finally, the increasing complexity of many alternative funds might also be thought to favour bigger players.
While these trends should not be ignored, much of the evidence so far suggests that the expected consolidation is for a later date, if at all, as far as the Guernsey market is concerned. Instead of forcing small players out of the game, they are increasingly occupying niche areas of the market, where a hands-on, personalised style may be more important to the client than number-crunching capabilities.
In fact, the increasing reluctance of large administrators to take on small or start-up clients is leaving a wealth of business opportunities for smaller providers in a wide range of alternative fund services jurisdictions, including Guernsey, and is prompting the establishment of new market entrants to take advantage. And the commission says that if some administrators have taken time adjusting to their new responsibilities, it is not necessarily the smaller ones.
There’s no doubt that the Guernsey fund services industry is currently in blooming good health. Fund assets under management or administration in the island grew by 7.8 per cent in the first quarter, the latest for which the regulator have published statistics, and by 26 per cent over the 12 months to the end of March, for a total of GBP140.4bn. Industry members expect this level of growth to continue under the impact of new regulatory initiative such as the launch in February of registered closed-ended funds.
According to the financial industry promotional organisation GuernseyFinance, 32 registered funds had been authorised by mid-June. The commission had also approved more than 100 Qualifying Investor Funds, which first introduced the shift in due diligence responsibility to the service provider in exchange for an acceleration consent timetable, between the launch of the regime in February 2005 and the end of March this year. The volume of funds domiciled outside Guernsey but administered in the island has also been growing, albeit at a slower pace, to GBP25.3bn at the end of the first quarter.
‘We’ve seen extraordinary growth this year, with figures for funds under administration up nearly 30 per cent,’ says Roger Le Tissier, a partner with leading offshore law firm Ogier. ‘But what is interesting is that over the past year I’ve done two venture funds with more than EUR5bn that so far haven’t drawn any funds down. The commission’s figures only reflect funds that are actually drawn down, but figures for committed capital would be massive. The money that will be coming into the island over the next two to three years runs into many billions.’
Aside from the figures, the industry received an important endorsement in June with the announcement that Citco Fund Services, the world’s largest hedge fund administrator with more than USD500bn in assets, had received a licence from the commission, citing Guernsey’s role as an ‘internationally recognised but pragmatic regulatory environment which we believe will continue to make it a jurisdiction of choice for many hedge funds and funds of funds operators’.
Some of the larger administrators insist that scale remains important. ‘The large global players are committed to investing in infrastructure, technology and straight-through processing to make it seamless to the client,’ says Brenda Petsche, managing director of HSBC Securities Services (Guernsey). ‘The smaller niche players offer a bit more hand-holding and expert advice in a particular area. However, boutiques are more reliant on their auditors and legal firms to provide additional support, whereas larger players like ourselves can provide that in-house. It’s all wrapped up in our overall fee proposition.’
Petsche is echoed by Kate Stallard, who is responsible for business development for the Channel Islands at Northern Trust. ‘The larger providers, such as Northern Trust, can offer fund administration services coupled with the advantages of an integrated custody and banking solution, including liquidity, foreign exchange hedging facilities for funds of hedge funds and access to a global technology platform for reporting purposes together with performance measurement and analytics,’ she says. ‘In addition, they also offer more extensive in-house corporate secretarial, compliance and legal teams which assist in addressing new regulatory requirements and business growth.’
However, most of the new firms entering the administration market are at the other end of the scale from Citco. ‘New administrators are emerging from banks and trust companies that see the potential in this market,’ says Neale Jehan, who leads KPMG’s services to the alternative investment sector in the Channel Islands. ‘A few of those are growing very quickly to become middle-tier firms and even challenging some of the big players for business.
‘People often ask me if Guernsey has a capacity issue with administration, but these new firms are really hungry and building with both people and systems, taking up a lot of the new work.’ While some of the newcomers are specialising in areas such as private equity or property funds, he says: ‘Firms may start out in a sector they are comfortable with, but a few are looking more widely at the alternatives sector as a whole.’
The emergence of these new players is epitomised by Heritage International Fund Managers, which has existed since 2001 as the administration business of Guernsey’s leading captive insurance manager but has developed rapidly since the Heritage group completed a management buyout from UK insurer Hiscox two years ago and especially following the recruitment of Mark Huntley and several senior members of his team from Northern Trust.
Huntley, who has overseen growth in assets under administration from a nominal amount to more than GBP4bn since his arrival as managing director in early 2006, says that in many ways the Heritage operation represents a return to the philosophy at Guernsey International Fund Managers, as the Barings unit was known before its acquisition by Northern Trust. ‘We’re doing the stuff where we made our reputation, such as private equity, property and funds of hedge funds,’ he says.
‘We have been able to put together a full-service capability with the benefit of the Heritage infrastructure, giving us a strategic advantage over competitors who are starting from scratch. We’ve been able to attract larger clients like Lehman Brothers, Colony Capital and Babcock & Brown, as well as assist new specialised managers that find our model of an experienced team within an independent organisation very attractive. We don’t have any conflicts of interest because we’re not a bank, we don’t have a custodian business and we’re not a law firm.’
Heritage wins high praise across the industry for the professionalism of its staff and the solidity of its infrastructure, but some members have reservations about the influx of new players. Some of them may not have the ambition or the means to make the investment required, warns senior manager Steve Fell of Fortis Bank (Channel Islands), which offers custody services but not administration in Guernsey.
‘There has been an explosion of new launches, primarily on the fiduciary side, where they have seen the opportunity to bolt a fund administration activity onto their traditional fiduciary, trust and company administration business,’ he says. ‘It’s a very specialised area, and you can’t just cobble together a system. To do it properly, you need to put proper investment into the systems required for a 21st century fund administration operation.
‘Heritage has done the job properly – they’ve identified a niche and employed people with the right level of experience and expertise, and have committed to making the necessary systems investments. But a number of players that have seen the opportunity have not carried out the intensive investment required if Guernsey is to maintain its reputation. The commission is aware of the dangers. As an offshore jurisdiction we have to be whiter than white. It only takes one bad apple, and all that work is undone.’
To date, however, the regulator is satisfied with the practical impact of the new regimes that place greater responsibility on administrators. ‘Six months after the QIF regime came in, we did a quick survey of the market to make sure the warranties we were getting were properly supported by the firms’ internal processes and implementation,’ says the commission’s director of investment business Peter Moffatt.
‘A number of firms that we inspected did it excellently. One of two, especially in the case of longstanding clients, had all the information but hadn’t drawn it together in a way we could access immediately. We persuaded them that if they were going to make these warranties, it was important for them to make very sure they stood up.’ A similar monitoring exercise is scheduled for around six months into the registered funds regime.
‘If people don’t meet the standards, our first sanction is that we won’t accept registered funds or QIFs from them; it is the licensed administrator who makes the application, so if they can’t make those warranties stand up through their internal processes, in the worst case they’ll be out of that part of the business. But we haven’t felt the need to do that so far.’
The commission does not see particular problems among smaller administrators in fulfilling their responsibilities to the regulator under the QIF and registered funds regimes. Says Moffatt: ‘We’ve not necessarily found problems at the smaller end of the market – in fact small firms seem to find it easier, perhaps because they are more focused. Certainly I don’t think the implication is that administrators have to get bigger or that the warranty process gives an advantage to bigger firms.’
He notes that most issues that arise with administrators can be dealt with through dialogue, but the commission is looking to broaden its range of disciplinary powers. ‘At present we have the power to remove a licence, the nuclear option. Alternatively we can impose conditions on a licence, typically where a firm’s internal control environment is not strong enough, but we are seeking wider powers to impose automatic penalties if various reports don’t come in on time. It stops people being lazy.’
An important area in which the commission has clarified the rules for administrators is outsourcing. Carrying out lower-value added functions in other jurisdictions is seen as a key way of enabling the sector to grow without placing an unacceptable strain on limited resources in Guernsey or burdening firms with a level of costs that would diminish their competitiveness.
According to Peter Harwood, a partner with Ozannes and head of the working party that produced the report that bears his name, the regulator’s willingness to countenance outsourcing is now more clearly articulated that in the past. He says: ‘There was always concern that with outsourcing you had to get the consent of the commission each time you outsourced new business; that’s been clarified. Sensible outsourcing relieves some of the stresses and strains that would otherwise build up in the island, and allows it to attract new business that is regulated through the licensed service providers here.’
As some industry members cite a figure of as many as 300 unfilled vacancies in the island’s administration sector, a number of firms are already taking advantage of their global network of administration offices or setting up dedicated facilities in countries including India and South Africa.
‘Groups like HSBC, Northern Trust and Royal Bank of Canada have operations all over the world,’ says GuernseyFinance chief executive Peter Niven. ‘We can manage the business by selectively outsourcing, but what we don’t want to do is go the whole nine yards to the Cayman model. We have a strength and depth of expertise here across all parts of the industry which we don’t want to lose.’
Stuart Mauger, head of sales and business development for corporate and institutional business in the British Isles with Royal Bank of Canada, says: ‘It is difficult to find quality staff, because there are competitors and independent administrators, and we’re all chasing the same labour. That’s where our global network comes in. On the custody side the operation is in Jersey, so we have access to another pool, and we are probably one of the largest employers on the securities side in the two islands.’
Says another Ozannes partner, Gavin Farrell: ‘There are three ways of approaching this. The first option, which we’re seeing more and more, is the manager wanting to do some of the investor relations and administration activities in its home jurisdiction, if it has the resources. The second is very large banks that offload some of the day-to-day work to offices in other jurisdictions that may not be as busy as Guernsey. The third is a purely commercial arrangement under which the administrator outsources to an unconnected company in Guernsey with which they have a good relationship.’
Says Moffatt: ‘Our policy on outsourcing has been virtually unchanged for 10 years. We will allow people to outsource all sorts of activities. We used to work on the basis that they would tell us what they wanted to outsource and we would look very closely at what they proposed to do, their systems and procedures and their agreements. We’ve moved much more to a notification basis, and we deal with outsourcing oversight as part of our monitoring.
‘The one thing people can’t outsource is responsibility. You can’t just outsource something, turn your back and walk away. And if the outsourcing doesn’t work, you have to either bring it back in-house or have another third party to whom it can be transferred. We tell people: ‘Don’t ever come to us and say something went wrong because the people to whom you outsourced it fouled it up. You fouled it up because you didn’t spot it.”
Says Capita director Richard Boléat: ‘There’s a lot more administration done in Guernsey now than there was a year ago, but most big players now chop up administration work into its constituent parts to be carried out in centres of excellence. Governance tends to be carried out where the fund is domiciled, but NAV calculation may be done in another jurisdiction and fund accounting in yet another where there are plenty of accountants.’
Capita is carrying out this work in Mumbai, while HSBC has launched an offshoring venture in Kolkata. Says Petsche: ‘We are looking at being able to provide 24/6 service from September out of our Indian office. It’s offshoring rather than outsourcing because HSBC has invested in bricks and mortar. It’s not something that we woke up one day and decided to try out, but an ongoing project for more than 18 months.’