Hedge funds are being pressured by investors to provide institutional-quality risk management, yet rely upon antiquated and error-prone processes for reconciling complex financial transactions.

To address this, fund managers are turning to trade matching and reconciliation systems, which can reduce operational risk by automating manual and paper-based systems to create proactive and exceptions-based transaction lifecycle processing.

“Fund managers are looking to automate reconciliation because of the growth in transactions and assets, plus a heightened awareness for having tighter operational controls post-Madoff,” said William Gates, executive vice-president of product management at SmartStream Technologies, a software provider.

“For the most part, they’re still relying on Excel spreadsheets or even paper,” said Gates. “One firm that we know of is producing 130 pages per day to demonstrate they have operational controls in place.”

By providing managers with daily reports that detail the net cash positions at all of their prime brokers, an automated reconciliation system allows hedge funds to know when trade transactions with prime brokers don’t match hedge fund accounting systems.

The benefits are two-fold: efficiency and transparency.

“By taking a pre-emptive approach to managing exceptions as they occur throughout the lifecycle, managers gain greater visibility into reconciliations and outstanding positions,” Gates said. “Automation also enables more cost-effective operations, with the ability to manage higher transaction volumes with a lower headcount.”

The importance of accurate reconciliations to hedge fund performance has not been apparent until recently.

According to a 2011 report of hedge funds conducted by accountant Ernst & Young, “few hedge funds or investors note the independent reconciliation of a hedge fund’s investment positions to custodians and brokers as a key benefit of the administrator, even though this has become an area of significant focus in the wake of the Madoff scandal”.

Empaxis, a provider of back-office outsourcing and trade reconciliation services, has launched a partnership with SmartStream Technologies to provide turn-key technology and processing service for trade reconciliation and will target small and medium-sized hedge funds and asset managers.

The joint offering will feature SmartStream’s reconciliation and exception management platform to manage their middle and back office workflow.

“A lot of firms are trying to use homegrown or off-the-shelf technology and have come up short,” said Empaxis chief executive Stephen Van de Wetering. “SmartStream is a leader in reconciliation. We will leverage this best-in-class technology provider to work with small to mid-sized hedge funds, where Empaxis has a strong presence.”

SmartStream’s latest reconciliation software, TLM Reconciliations-Premium, has at its core a powerful transaction matching engine that enables firms to gain higher straight through processing rates, the company says.

It highlights failing transactions and escalates those to users so that they can immediately see those transactions that represent the largest risk, investigate why they are failing, repair them and then return them to the transaction flow.