Currency Fund Operations - Why not let an administrator take the strain?

The past 18 - 24 months has been a dramatic transformation of the global financial landscape. A dramatic destruction of asset values as well as investor confidence.

The period leading up to the Bernie Madoff affair and then subsequently, has seen a paradigm shift within the international asset management industry. The hedge fund community experienced a massive upheaval as liquidity and credit dried up almost overnight, counter-party risk increased exponentially with the increasing number of large bank failures and investors naturally flocked to traditional safe havens such as cash and gold.

As the world has moved on from Mr. Madoff, there has been a momentous residue left from his imprint. The two common themes that ran through the Madoff affair and indeed the vast majority of all poster child hedge fund failures over the past twenty years, has been the lack of safe custody and segregation of assets from the investment manager and other counter-parties on behalf of the fund along with the independent verification and validation of the assets within the investment vehicle.

Moves toward Best Practice

The hedge fund industry has been progressing, or perhaps maturing is a better description, over the past number of years from an investor base principally consisting of high net-worth individuals and private banks to one of institutional investors. With this maturation comes an enforced transformation in terms of operational infrastructure and the application of 'Best Practice' in the controls and processes of any product or service offering, if a currency asset manager hopes to raise assets in the post Madoff world!

This requires improvements in infrastructure for middle- and back-office operations, enhanced reporting to stakeholders and independent verification of portfolio values. Consequently, the appointment of an independent third party administrator can go a long way to re-assuring investors and easing some of the increased fiduciary pressures that are now placed on managers.

With an administrator taking care of these key duties, it leaves the currency manager with a lot more time to dedicate to the fiduciary duties it has to the fund and, most importantly, trading performance.

Of course the key is finding an administrator that can do this work up to the new institutional standards expected and, as importantly, one that has the same ideology in terms of growing with the currency manager and consistently innovating with technology.

In this regard, at Trinity we predict that in order to attract the institutional allocation, it will eventually become standard practice and a prerequisite for portfolio managers to release unambiguous information to investors, such as large positions and exposures in their portfolio or by providing them with documents such as compliance manuals, valuation policies and risk management procedures. Investment businesses will have to evolve continuously in order to maintain their competitive edge over other less transparent firms and one of the best places to look for this edge is to evaluate what your administrator can do for you as the currency manager.

New operational paradigm

The new operational paradigm ensures that administration services are no longer centered simply on back-office functions dealing with accounting, valuation and share registration. Fund administration can now be defined as everything after the trade, and increasingly, prior to the execution of the trade. Therefore, the currency manager can turn to their administrator to take over a whole array of services over and above the traditional core services associated with fund administrators such as risk management, reporting, performance attribution, position monitoring, pre-trade compliance and investment analytics.

Within my own company, we have seen the writing on the wall and have embraced the requirements of the new paradigm, finding it necessary to increase significantly our investment into our IT capability and continuing to make comprehensive improvements to our proprietary in-house system by adding new modules for price-check reporting, revaluations and investment restriction monitoring. This is something already becoming a trend within the more progressive fund administrators.

Even within areas such as our web applications we've taken over hosting of our public web presence to allow further expansion of the functionality on offer to our external clients with real-time reporting. This allows any of our managers to go online in their time to see the latest transactions, NAVs, fund prices and other pertinent transactional information at the click of a mouse, with information updated four times daily, to provide data on a same-day and intra-day basis. And this too is becoming an increasingly demanded solution from investment houses across the business.

Credit exposure issues

Additionally, many currency managers implement their strategies using FX forward contracts or other such over the-counter instruments that often require only a contractual agreement between client and counter-party (typically in the form of an ISDA Agreement). This bilateral credit exposure is a point of regular discussion, particularly since the financial crisis in which counter-party credit moved to the forefront of investor concerns. Moreover, this credit is often agreed-upon without cash collateral, allowing for more efficient cash-managed portfolios. However, it should be recalled that potential deferred losses from FX positions can create significant liquidity issues at settlement, when portfolio managers may be forced to sell underlying assets to the detriment of the portfolio. While regulators may impose incremental oversight on the industry to address these concerns, it's up to market participants to provide their clients with process transparency that allows more continuous management of these issues. In this regard an industry experienced and technologically efficient third party administrator can assist the currency manager immensely in this regard.

John McCann

"Fund administration can now be deÀned as everything after the trade, and increasingly, prior to the execution of the trade."

Regulatory overhaul

As if the complete transformation of one's historical business model was not enough of a challenge for a currency fund manager to come to market and hope to attract significant institutional assets, there has also been a complete international sea-change in terms of the rules of the game in the form of global regulatory overhaul.

The nations of the G-20 and the prominent international regulators have been furiously busy over the past 18 months scrambling to implement rule changes motivated to prevent a repeat of the conditions that led to near global financial meltdown and to achieve that over-used phrase "Never again!"

As such, despite their communal pledge early on in the crisis to find a collective universal approach to improved regulation for investor protection and reduce systemic risk, regulatory and political groups have recently reverted to national or regional tendencies to impose disparate ideological approaches to achieving this lofty goal.

Over the past few months the world has seen a slew of major legislative announcements in terms of new rules to play the same game. As a direct result of these there will be a colossal impact on all stakeholders within the asset management industry. Administrators expect permanent and significant change as a result of these major pieces of legislation being finalised within the USA, Europe and further afield. Namely such ground shifting rule changers such as the Dodd-Frank bill, the Transparency Bill, the FATCA Tax Reporting, the AIFMD (Alternative Investment Fund Managers Directive), and global accounting and financial reporting revised guidelines, will raise the bar immensely.

The AIFMD for one, in recent days looks like it will be somewhat watered down from previous more draconian versions, to a more realistic piece of legislation than what was originally proposed. However, its most recent form will still have a transformational impact on asset management operations in terms of monitoring of risk and reporting duties for the currency manager. No attribute will be more important than transparency, and this means providing clients with insight into the importance of the various implementation decisions (contract tenor, rebalancing frequencies, trading filters, proxy currencies and so on). This is where a good fund administrator can add serious value for an investment manager, providing guidance on these decisions and also be able to measure their effectiveness through performance reporting tools.

As with the changes that were necessary to adapt to the new operational and reporting requirements, administrators equally need to adapt to the new regulatory requirements in order to support the increased demand placed upon our clients. This is a prime example of where over the past few years the traditional role of the administrator has changed beyond recognition from the days of simple accounting and NAV production. Fund administration companies are becoming very much involved in providing corporate secretarial and corporate governance services of a bespoke and industry variety, such as listing obligations and EUSD compliance. It is becoming more critical to provide support to fund boards and asset managers in terms of the multitude of international reporting obligations with respect to operational cross border compliance. This includes a wide array of local and international legislative requirements that may directly or indirectly impact the product and the business of the asset manager.

Selecting an administrator

Prior to 2008, the fund administrator selection process was straightforward and largely handled by managers, a check-the-box type of exercise that revolved around fund administrators' brands and fees. The problem with relying too heavily on brand awareness is that a brand's quality was often correlated with size. But size and brand do not ensure that an administrator deploys the most reliable technology, SAS 70 certified processes, domain expertise and scalability, not only in terms of size but the funds ability to adapt its operation to changing technology, regulations and market conditions.

When choosing an administrator, the manager should perform a thorough due diligence process and, where possible, visit the office and meet the staff and key personnel and view the technology in operation. This 'kicking the tyres' exercise can be the key factor in revealing if the administrator can really partner with the manger in growing the fund and take care of all the key duties we have mentioned above in an ever rapidly changing world.

Another key factor should include whether the administrator has experience in dealing with currency funds and whether they have the systems that can cope with the different scenarios of multi-currency management and pricing, including handling OTC products.

Conclusion

The international asset management industry has been radically transformed as has the global financial environment in the past 18 months post Mr. Madoff. Some of the change will be good, some will be not so good, but there is no doubt that it will be onerous, costly and all-intrusive in a new world order in which transparency and liquidity are the buzz words for investors and regulators alike.

The one sure thing is that change is constant and in order to compete in this new world order, currency managers will need to keep up with it's wide ranging nature in terms of the demand for best of breed operational infrastructure and compliance burden, in order to attract assets of an ever increasing institutional nature.

One of the best decisions currency managers can make to assist them complete is by selecting a properly qualified, internationally knowledgeable, technologically capable and service-oriented third-party fund administrator, to assist them. As an independent third-party manager, we believe that helps in facilitating flexibility when handling the changing needs of a more regulated and demanding world.