Investors and Regulators Push Hedge Funds to Prioritize Fund Administration

Terry Flanagan

Goldman Sachs’ sale of its hedge fund administration arm to custodian bank State Street earlier this week highlights not only the growing importance of back-office operations, but also the trend towards administrator consolidation.

For Bill Stone, chief executive of SS&C GlobeOp, one of the world’s largest fund administrators with $430 billion in assets under administration, the rise in hedge fund regulation is a key factor in this trend.

“There are a tremendous amount of resources that have to go into creating and ensuring compliance,” Stone said in an interview with Markets Media. “More expertise, more technology and more infrastructure is required. The work is getting more extensive, which lends itself to size. My guess is that five to 10 years from now, there will be 50 to 75 administrators, down from 300.”

Additionally, investors—institutions, especially—are also influencing the increasing move towards the consolidation of fund administrators, whose activities support the actual process of running a hedge fund, stemming from greater pressure placed by investors on hedge funds to have service providers with deep and broad offerings. A report released earlier this week by Corgentum Consulting, a consultancy, revealed that investors it surveyed—high-net worth individuals, family offices, fund of funds, pensions and endowments—placed the greatest value on fund administrators (33%), followed by auditors (31%) and prime brokers (17%).

“Investors that have come into alternatives are demanding more transparency, demanding to understand who are the administrators, the service providers—they want comfort,” said Stone. “So when they want comfort, they prefer larger, more recognized names and that’s what’s happening in our industry—it’s putting tremendous pressure on the smaller fund administrators who are looking to hook up with larger ones.”

This industry coagulation is reflected not just by State Street’s acquisition of Goldman’s business, which will more than double State Street’s assets under administration at $877 billion, but also by SS&C GlobeOp itself, which merged as of June 1 this year. Approximately $300 billion of SS&C GlobeOp’s assets under administration are from hedge funds—who are consequently influencing how the fund administrator does its business, too.

“We’re under a tremendous amount of scrutiny from investors and hedge fund managers themselves,” Stone added. “And there are various regulators to whom we send information that are, again, looking closely at our administration business. There’s an awful lot of scrutiny in the administration business and an awful lot of regulatory hurdles.” Indeed, it appears that the long arm of Dodd-Frank (one of its more exhaustive requirements, Form PF, recently went into effect as of June), along with recent regulatory developments such as the Foreign Account Tax Compliance Act (FATCA), continue to affect not only hedge funds, but also the surrounding service provider industry.

Investor and regulator pummelings for both camps aside, Stone underscores three important points in any hedge fund/fund administrator relationship: an open dialogue based on trust in expertise, administrator independence as a key internal control (for utmost transparency and compliance), and the use of technology in order to capture, analyze and deliver tremendous amounts of information.

For the remainder of 2012 and going into 2013, hedge funds and fund administrators can expect to lean heavily on that relationship in the wake of what will likely be a wave of regulatory shifts, especially after November’s U.S. presidential election.

“No matter what happens in the election, we’ll be ready to react,” said Stone.

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