Operational Due Diligence (ODD) has become increasingly important across the alternative investment industry and more resources and attention are being placed on this function. This was one of the main findings from a session on ODD at the recent Global Alternative Investment Management (GAIM) Ops Conference in the Cayman Islands.
Kristin Castellanos (pictured) of Deutsche Bank's Head of Regulatory Fund Services within its Institutional Cash & Securities Services, moderated a panel on the subject of ODD and how the process has changed over the past decade. She says: "10 years ago, most ODD was conducted around account policies and procedures. But as fund accounting risks have reduced, compliance and IT risks have multiplied."
Today, there is more dedicated focus – and at a higher level – on ODD meetings accompanied by greater transparency. Some 95 per cent of fund managers now provide transparency reports, a marked contrast from the past. ODD teams are also actively involved in counterparty discussions whereas in the past, these were handled almost exclusively by investment due diligence teams.
Within ODD activities, the most time-consuming is the constant review of controls and processes employed by the fund through its main outsourced service providers. Almost equally lengthy is the behavioural analysis of employees and principals of the fund manager and understanding the custody and security of a fund's assets.
What are ODD teams' chief concerns? At the top of the list is ensuring the budget is in place to maintain operational controls. Other important issues include the shadow accounting of the administrator and the segregation of duties between traders and internal accounting.
Castellanos adds that the drivers behind all the changes around ODD are the investors who allocate funds to alternative investment managers. "As competition is fierce when attracting investments from allocators, alternative investment managers must be prepared to pass rigorous due diligence standards, particularly in ODD," says Castellanos.
While the panel called for more background checks and transparency, among other things, cash controls at hedge funds were considered to be among the biggest risks. Explains Castellanos: "Although the industry has come a long way in terms of operating controls, there are still many firms that permit manual wire payments instead of using more secure electronic methods. There are some compensating controls that could be quick wins, such as having compliance staff perform testing of wires to ensure they are being completed in accordance with the policies in place."
Castellanos concludes by saying that there is broad agreement that ODD will continue to evolve in the coming years to meet the expectations of institutional investors: "At Deutsche Bank, we will keep ahead of market developments in order to work with our clients to try to help them navigate today's complex and challenging landscape."
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