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It’s not just about administration anymore

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By Chris Kundro, Senior Vice President, Head of Wells Fargo Global Fund Services – There should be little surprise regarding the on-going trend of bank-owned hedge fund administration businesses being sold or put up for sale. There should be even less of a surprise to find that banks have been the acquirers of most hedge fund administration businesses, both bank-owned and independent, that have been sold. Both sides of this trend will continue. 

Sellers will continue to exit the business primarily for financial reasons. Some banks have already reached this point due to a declining client base, a need for capital for other businesses or regulatory purposes, or simply the unwillingness to further invest in the business. 

Hedge fund administration, while providing an attractive annuity-like revenue stream, is a relatively low margin business. As a result, in addition to having a quality offering, administrators who are successful in creating a profitable business in the near term will take at least one of three paths: No1) establish economies of scale; No2) cross sell other products and services; No3) create a highly differentiated offering. Medium term success will require either No1 or No2, slowly leading to the demise or consolidation of independent administrators who will struggle to continue to differentiate their offerings. Long term success will require both No1 and No2 – which, over many years, will result in an oligopoly broader but similar to that in custody, trust and other securities services businesses. 

Certain administrators and non-strategic buyers, e.g. private equity funds, will continue to drive industry consolidation in the near term and perhaps even longer, by acquiring, restructuring and consolidating multiple fund administration businesses. However, the ultimate long-term survivors will not only have a quality administration offering and the economies of scale required for profitability but also offer the breadth of financial products and services that their clients require.

While bundling administration with other complementary securities services, such as custody and trust, will provide a competitive advantage to some degree, the most successful administration businesses will have one thing in common: the ability to extend balance sheet to their hedge fund and private equity clients. This would require offering, in addition to fund administration, the banking products and services that many hedge funds and private equity firms require such as: treasury services, prime brokerage, derivatives clearing, repo and securities lending, subscription financing, asset backed financing and commercial real estate and specialised lending. In turn, given regulatory driven balance sheet limitations, many banks have begun to look at their overall or potential relationship with a fund management company in aggregate when determining whether to offer them certain balance sheet-intensive products and services. Whether a manager purchases fund administration and other products and services that do not utilise balance sheet is now an important element in measuring the value of a relationship. 

Reflecting dramatic changes in the banking industry, some of the basic products and services that managers require to run their funds are now, in many cases, effectively in limited supply. For example, due to new liquidity and capital requirements some banks have recently begun to inform certain hedge fund and private equity clients that they are closing their bank accounts (e.g. operating and sub/red accounts) and in some cases leaving the market entirely. Suddenly treasury related products, which were once perceived to be basic commodities, are now being offered only to select clients. 

The quality of the hedge fund administrator offering will continue to be the primary factor in choosing an administrator. However, there are now other variables that must be considered before making that final decision. 

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