June 2016

THE FUND ADMINISTRATION & TECHNOLOGY SPECIAL 2016 A special supplement Facing the threat of cyber-attack The Panama Papers and private equity In-house or out? The CFO dilemma Fund admin in flux as firms consolidate AIFMD: Small players most at risk ...and more

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Age of data ISSN 1474–8800 JUNE 2016

TOBY MITCHENALL EDITOR'S LETTER

Senior Editor, Private Equity Toby Mitchenall Tel: +44 207 566 5447 [email protected] Americas Editor, Private Equity Marine Cole Tel: +1 212 633 1455 [email protected] Web Editor Victoria Robson Tel: +44 207 566 5463 [email protected] Senior Reporter Isobel Markham Tel: +44 207 167 2032 [email protected] Asia Reporter Carmela Mendoza Tel: +852 2153 3148 [email protected] Staff Writer Annabelle Ju Tel: +1 646 380 6194 [email protected] Contributors Eric Feldman Rob Kotecki Nicole Miskelly David Turner Production Editor Mike Simlett Tel: +44 20 7566 5457 [email protected] Production and Design Manager Miriam Vysna Tel: +44 20 7566 5433 [email protected] Head of Advertising Alistair Robinson Tel: +44 20 7566 5454 [email protected] Subscriptions and Reprints Andre Anderson, +1 646 545 6296 [email protected] Jack Griffiths, +44 207 566 5468 [email protected] Sigi Fung, +852 2153 3140 [email protected] For subscription information visit www.privateequityinternational.com. Group Managing Editor Amanda Janis Tel: +44 207 566 4270 [email protected] Editorial Director Philip Borel Tel: +44 207 566 5434 [email protected] Director of Research & Analytics Dan Gunner, [email protected] Publishing Director Paul McLean, [email protected] Chief Executive Tim McLoughlin, [email protected] Managing Director — Americas Colm Gilmore, [email protected] Managing Director — Asia Chris Petersen, [email protected]

j u n e 2016

The world is increasingly driven by data. The world’s largest growth companies today are not builders of cars or miners of ore, but harvesters of data. It seems fitting then that data is a recurring theme of this supplement. Our opening feature (p.8) is a walk-through some of the possible implications for the private equity industry of a significant leak of data: the Panama Papers. As one of the largest leaks in history, it is likely to affect the industry – both directly and indirectly – in a number of ways. Indeed in the immediate wake of the story breaking earlier in the year, a number of important financial centres, such as Jersey, Guernsey and Caymen, issued statements to underline their compliance with international regulation and to distance themselves from the concept of a ‘secrecy jurisdiction’. Beyond these statements, most in the industry have been reluctant to speak on the record about Panama.There is a legitimate reason for this; until the 11.5 million documents have been properly analysed, it is impossible to say with any certainty what their impact will be. Even those ‘named’ in the papers – and we have identified two prominent members of the private equity community in this category – may well be using the jurisdiction (or the law firm Mossack Fonseca) for entirely legitimate and defensible reasons. So pending further investigations, the data leak raises more questions than answers. One aspect that has drawn plenty of open comment from the industry, however, is the point it raises about data security. A private

equity fund manager holds reams – or more accurately terabytes – of sensitive data: on clients, staff and portfolio companies; as do the private equity firm’s counterparts: law firms and administrators. Is this data secure? Our survey of managers (p. 26) says ‘no’. The obvious question, then, is what can my COO or CFO do about it? Eric Feldman, chief information officer at The Riverside Company, has some detailed knowledge to impart on that topic. You can read about this in an extract from PEI’s book The Private Equity CFO & CTO Digest on p. 22. The demand for data – from regulators and from limited partners – is a significant driver behind the massive growth in the outsourced fund administration industry. Throughout the supplement, we learn how post-GFC regulation – specifically AIFMD and Dodd-Frank – has distracted many fund managers from their day job and, as a result, provided a market opportunity for those with the knowhow, technology and scale to take that distraction away. As we learn on p. 16 the industry is growing (in terms of assets under administration) and consolidating, as the major service providers look to keep pace with their clients’ geographic reach and diverse asset class offerings. I would like to thank our sponsors, Deutsche Bank and SS&C, and our supporters, Gen II Fund Services and SEI, for their valuable insights.

We hope you enjoy the supplement,

Toby Mitchenall e: [email protected]

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

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CONTENTS

THE FUND ADMINISTRATION & TECHNOLOGY SPECIAL 2016 4

New faces, places and partnerships The big stories from the fund administration world

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Keynote interview: Deutsche Bank Gavin Tobin of Deutsche Bank offers a guide for fund managers to decide which services to outsource and what to keep in-house

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The Panama effect The Mossack Fonseca leak raises a number of issues for private equity

10 Keynote interview: SS&C Fund administrators can play a vital role as GPs move into new areas, says Joe Patellaro of SS&C Private Equity and Real Estate Services

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12 Getting to grips with AIFMD Managers raising capital in Europe find there is ‘more than one way to skin a cat’ 14 Expert Commentary: Gen II Fund Services As LPs look to third-party fund administration and GPs consider what to outsource, Gen II Fund Services describes how fund administrators can satisfy their requirements 16 The compatibility game As the fund administration space continues to grow and consolidate, it may require even more due diligence to find the right fit for a long-term partner

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20 Expert Commentary: SEI Unprecedented change in PE has thrown up a new set of challenges, says Giles Travers, a director of alternative investment funds at SEI 22 Book extract: Cybersecurity In an extract from The Private Equity CFO and CTO Digest, Eric Feldman offers a guide to protecting your data 26 Firms unprepared for cyber-attack Regulators are increasing their scrutiny on cybersecurity, but the buyout industry is failing to respond 28 There’s an app for that Partners Group is the latest firm seeking to harness technology to communicate with investors

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june 2016

NEWS IN BRIEF

ROUND UP

New faces, places and partnerships The big stories in the fund administration world as reported on our sister site privatefundsmanagement.net CRESTBRIDGE EXPANDS FUNDS TEAM

Crestbridge, the European fund administration firm, appointed Colin Targett as director in its fund services team. He will be based in the firm’s Jersey headquarters. Targett joins the firm from Pantheon Ventures, where he served as head of fund accounting for seven months. Prior to Pantheon, he briefly worked as an offshore and onshore fund consultant after leaving his role as managing director at Apex Fund Services after nearly four years. His appointment follows the hire of Miranda Lansdowne as funds director in November last year. ZEDRA OPENS HONG KONG OFFICE

Fund services provider Zedra opened a new office in Hong Kong to further strengthen its existing Asia-Pacific team operating from Singapore. Leading the new office is managing director John Ashwood who joined Zedra in March. He is supported by executive director Mandy Cheng. Prior to joining Zedra, Ashwood was the founding managing director of fund and corporate services firm Vistra in Hong Kong. Zedra was acquired at the beginning of the year by an investor group led by the Sarikhani and Nielsen families from the wealth and investment management arm of Barclays Bank,

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130-strong European funds team, alongside the firm’s Asia funds operations. Elian also continued its global expansion with new additions to its Guernsey fund services team. Kees Jager joined the firm as associate director and will lead the local fund services group. He joins from Northern Trust, where he led a team of 16 people. Sally Ann Brehaut also joined the firm as an assistant manager focused on compliance, and will work under Jager.

which retains a 19.9 percent stake in the company. The new management team intends to double the size of the business within five years. SANNE GROWTH DRIVEN BY FATCA, AIFMD

Jersey-headquartered fund administrator Sanne Group has reported increased revenues driven by private fund managers seeking to deal with increased compliance burdens. Revenues at the group grew by 38 percent year on year to £45.5 million ($64.2 million; €57.5 million) last year. The firm attributed the growth to increasing demand based on more stringent controls and compliance processes being put in place in response to increasing transparency requirements, referring specifically to the European Alternative Investment Fund Managers Directive and the US Foreign Account Tax Compliance Act. ELIAN STRENGTHENS EUROPEAN FUNDS TEAM

Fund administrator Elian named Paul Lawrence as head of European funds. Lawrence has worked at Elian since 2008 and has been promoted from his most recent role as manging director of the firm’s Luxembourg office and global head of real estate services. As part of the appointment he will relocate to the firm’s London office, where he will oversee Elian’s

BEDELL MOVES INTO LUXEMBOURG

38%

Rise in Sanne Group’s revenues last year

$384bn

Assets under administration at Mitsubishi UFJ’s investor services arm

130

Headcount of Elian’s European funds team

private equity international

Fund administrator Bedell Fund Services opened its first office in Luxembourg, bringing in two former Arendt Services vice-presidents Anne Catherine Grave and Catherine Koch as directors in its new outpost. Grave joined Bedell in November 2015 from Arendt Services, the corporate services arm of Luxembourg law firm Arendt & Medernach, where she worked as executive vicepresident for six years. Koch also joined the firm in November from Arendt Services, where she worked as senior vicepresident and was in charge of the domiciliation activity for more than three years. Joining Grave and Koch in Luxembourg is existing Bedell director Phillip Bolton, who was previously based in the firm’s Jersey office. june 2016

NEWS IN BRIEF

JTC AND INDOS FINANCIAL

LANGHAM HALL GAINS THIRD

JOIN OVER AIFMD SERVICES

DEPOSITARY LICENCE

JTC has formed a partnership with Indos Financial to extend services to firms hit by the Alternative Investment Fund Managers Directive (AIFMD). The fund administrator and the AIFMD depositary services provider are working together to provide private equity, real estate, hedge, infrastructure and other alternative clients with access to a depositary, which will help managers meet the requirements of the directive. The partnership has been driven by the current trend for fund managers to review and change their depositaries, as well as investor demand for genuine independence between the depository and the administrator.

Langham Hall is now licensed to provide depositary services to fund managers from its Luxembourg office, complementing similar licences granted in London and Jersey. The licence authorises the fund administrator to act as a depositary to closed-ended funds primarily investing in alternative assets, such as private equity and real estate funds. The Alternative Investment Funds Management Directive requires GPs to appoint a depositary to each fund that they manage. Langham Hall is currently providing depositary services to 50 funds covered by the directive. The fund administrator’s Luxembourg depositary team will be led by former PwC real estate auditor Antoine Bonte as well as Langham Hall Luxembourg director Clive Griffiths.

IPES HIRES NEW OPERATIONS HEAD

Ipes has named Andy Pitter head of its Jersey operations and Nigel Strachan group head of business development. Pitter joins the fund administrator in the newly created role from private bank Kleinwort Benson, where he worked for 20 years as a director, having joined the company in 1985. The appointment of Strachan as group head of business development follows the departure of former commercial director Justin Partington last year. Strachan joined Ipes in 2011 as managing director of its Jersey office. He also joined from Kleinwort Benson, where he spent more j u n e 2016

Pitter and Strachan: two former Kleinwort Benson executives with key roles at Ipes

than nine years as head of new business. Strachan will continue to be based in Jersey, but will head Ipes’ business development and marketing activities across its other three offices located in London, Luxembourg and Guernsey. NEUBERGER BERMAN SPINS OUT FUND ADMIN ARM

Neuberger Berman has sold its private equity fund administration business Capital Analytics to MUFG Investor Services, the asset management unit of Mitsubishi UFJ Financial Group, for an undisclosed amount. As part of the deal, Tokyo-headquartered MUFG, which has offices in New York, acquired all of Capital Analytics’ business, including its 150 employees. Capital Analytics will continue to provide fund administration services for the same funds it administered for Neuberger Berman when it was part of the group. The acquisition adds around $120 billion in assets under administration to MUFG Investor Services, bringing its total assets under administration to $384 billion. the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

CRESTBRIDGE LAUNCHES LONDON OFFICE

Less than three months after expanding to the Cayman Islands, fund administration firm Crestbridge has opened an office in London specifically catering to its real estate clients. The firm will provide accounting, reporting and administration services from the London outpost, responding to specific client demand for UK-based real estate administration. Crestbridge had previously been working with UK-based accountancy firm WSM Partners in London, and as part of the new expansion, the WSM Property division has become part of the Crestbridge Group. n

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INDIA ROUNDTABLE DEUTSCHE BANK KEYNOTE INTERVIEW: ACTIS

OUTSOURCING

The CFO’s dilemma Choosing which services to outsource is one of the most difficult decisions facing fund executives. Gavin Tobin of Deutsche Bank offers a guide to when to go in-house or outsource

Tobin: in recent years regulation has been relentless

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Gavin Tobin, global head of private equity fund administration at Deutsche Bank, is sympathetic to the plight of fund CFOs. He notes that there are more regulations than ever before, constant new threats and customers’ requirements are ever more varied – reflecting the increasing diversity of the private equity investor base. “In recent years the number of regulations has been relentless,” says Tobin. “As a result, the burden of reporting to various regulators is much greater than it was five or six years ago.” However, Tobin makes clear that for CFOs wanting to shoulder this load within the firm, there are no easy answers; only questions. Should they take on new people? How much will that cost? Can the fund manager’s small personnel function cope with this? “It’s hard for CFOs to hire, maintain and deal with large teams of back-office staff in-house, and all the HR issues that go with it,” he says. Tobin’s answer is not to outsource everything indiscriminately to a third-party fund administrator, but to look at what should go out and what should stay in-house because it is what a private equity fund does. “I want managers to be able to focus on being managers,” he says. “That’s what they’re good at.” Top of the list of the regulations which private equity fund managers have recently had to deal with for the first time are the Alternative Investment Fund Managers Directive (AIFMD) in the EU and the Dodd-Frank Act in the US which brings the burden of transparency reporting to regulators for managers, says Tobin. Asked for an example of why these rules make life more complex for fund managers, he cites the requirement under AIFMD that non- EU managers marketing into Europe could have 28 different variants for their private equity international

Annex IV reporting. Unfortunately, however, the directive does not remove the time-consuming idiosyncrasies of different national rules, Tobin points out. For example, a non-EU fund marketed in Germany needs a depository lite solution – but this is not the case in other markets in Europe. Asked about new threats,Tobin mentions cybersecurity. Many fund managers have taken much greater notice of this over the past couple of years, after high-profile incidents such as the theft of the names, contact details and credit card information of tens of millions of customers of Target, the US retailer, and the leaking by hackers of sensitive emails written by executives at Sony Corporation, the Japanese conglomerate. “Cybersecurity is a real hot topic, particularly with regulators,” says Tobin – citing recent notices from the SEC and European regulators. Regulators are expecting managers to have a strategy to prevent, detect and respond to cyber security threats. “Fund managers have to deal with the more sophisticated type of hacker, who might want to steal data on investors, or acquire information on funds’ investments.” Poor cybersecurity could, he warns, lead to disaster: “Managers should be very concerned about the reputational risks of any data leaks as well as the legal and regulatory implications.” Moving on to the issue of the customer requirements of investors in private equity, Tobin has noticed a growing desire for customised reporting. For example, “investors might want quarterly, year-to-date or even inception-to-date reporting. It’s quite different from client to client”. How should fund managers decide what to outsource and what to keep in-house? “Where a third-party administrator can add june 2016

INDIA ROUNDTABLE KEYNOTE INTERVIEW: DEUTSCHE BANK

Where a third-party administrator can add value is in the low to medium complexity tasks value is in the low to medium complexity tasks,” says Tobin. He gives several examples of such functions that can be outsourced, across the range of a fund manager’s activities. On the accounting side, partnership accounting and financial reporting these include audit co-ordination and the generation of the annual statutory accounts. Day-today fund operations that can be done by an expert fund administrator include the cash management, vendor payments and performance reporting. Third parties can also take over much of the administrative interaction with investors, including their requirements for customised reporting, as well as processing investor capital calls and distributions. The functions that should be left inhouse are, says Tobin, “the real high risk items”, such as fund structuring, asset valuations, financing and hedging. The rationale for outsourcing is based largely on what Tobin calls “scalability”. He notes that even relatively simple issues can be labour-intensive for fund managers whose small scale means they do not have specialists with intimate knowledge of each task. However, for a large third-party administrator such as Deutsche Bank, the scale of the teams dedicated to a particular issue means that each task can be done very efficiently. j u n e 2016

He gives financial reporting to investors as an example. “We have specialist report writers who can provide customised reporting,” says Tobin. “If a fund manager only has three or four people in the administrative team, it won’t have a specialist in-house.” Tobin argues that for low and mid-complexity tasks, the huge spend and skill base of a firm like Deutsche Bank means that clients should not just be thinking about cost efficiency – an outsourced expert can do things more cheaply – they should also be thinking about performance; they can do things better. A good example of this is cybersecurity. “Banks have very strong and well-defined processes for cybersecurity, given that their industry is highly regulated,” says Tobin. “For example, Deutsche Bank has leading edge solutions in data protection, and specialist departments whose sole function is to protect bank and customer data.” Clients can shelter under the strong and large protective wing of an outsourced cybersecurity platform and the control functions that surround it.. The scale of the operations also means expertise in the new swathe of regulations. By contrast, for fund managers, “if you have a small team it’s hard to keep abreast of ever-changing regulations”, says Tobin. As a large third-party administrator, Deutsche Bank can guarantee a constant, unvarying level of expertise in each regulation or function, adds Tobin, who warns

I want managers to be able to focus on being managers. That’s what they’re good at

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

fund managers against making any such cosy assumptions about their own back offices. “If somebody leaves a fund manager’s small team, the chances are that this is a key person ,” he says. In theory a fund manager can make life attractive enough to retain back-office staff. However, in practice, “it’s difficult for fund managers to offer the career path in backoffice work that a big administrator like Deutsche Bank can provide”. Sceptics might argue that in many industries, clients do not want outsourcing. However, Tobin points out that in private equity, they tend to be keen on it. “For some functions, a degree of independence gives investors comfort,” says Tobin. “They’re not totally reliant on that manager to make the best decision and also report on it.” In other words, there are things that an investor would probably be shocked to find outsourced: the core issues where private equity fund managers have special skills. On the other hand, there are some things that an investor might well be disappointed to find done in-house, by back-office teams that don’t have the scalability or the controls framework. Finally, Tobin emphasises that once the fund manager has decided to outsource functions, the quality of the relationship between fund manager and service provider is key. “If fund manager CFOs use a third-party administrator, it’s important for them to view it as an extension of their own team,” he says. “They really need to work together, and the fund manager should give feedback on whether a particular service is good, bad or indifferent so that the administrator can deal with any perceived shortcomings. “Open and honest dialogue is the best way forward.” n

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THE PANAMA PAPERS

OFFSHORE TRANSPARENCY

Notes on a scandal The vast cache of confidential documents leaked from a Panamanian law firm raises a number of issues for the private equity community, writes Marine Cole The private equity industry has so far remained distant from the Panama Papers scandal that has rattled many corporations and individuals from heads of states to financiers and even artists. Among the 11.5 million client documents leaked from within Panamanian law firm Mossack Fonseca, there is still a sea of information waiting to be released, so the private equity world could yet find itself under the spotlight. And while there is yet to be any direct connection between the documents released at the beginning of April and the alternative investment industry, there are at least three ways its effect could be felt, if only indirectly. One is the location of the jurisdiction used by private equity firms to set up legal entities for funds or portfolio companies. Another is a likely push toward greater transparency over who are the beneficiaries behind investments in private equity funds. And the third is the reminder it gives the industry of the fast-growing importance of cybersecurity. NOT ALL JURISDICTIONS ARE EQUAL

Panama is an offshore jurisdiction and private equity firms make frequent use of such locations to domicile portfolio companies and investment vehicles. However, the offshore centres vary in their level of transparency. Some, like the Cayman Islands or Luxembourg, have established tax transnational treaties and

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are making sure they offer relatively transparent regimes. Others, like Panama, are more opaque. Panama is actually rarely used in the private equity world. Instead GPs prefer to choose jurisdictions that offer preferential tax treatments, such as the Cayman Islands,

11.5m

Client documents leaked from Panamanian law firm Mossack Fonseca

Delaware, Guernsey, Jersey and Luxembourg. Hong Kong is also targeting fund managers and passed a bill in July to provide tax exemptions on certain transactions conducted by offshore private equity funds. Some of the offshore jurisdictions used by private equity firms were quick to distance themselves from the Panama Papers scandal. Cayman Finance, for instance, said that the Cayman Islands is not a secrecy jurisdiction and has a proven track record of transparency and cross-border cooperation, as well as anti-corruption measures. Guernsey reminded the public that it has an effective anti-money laundering and antiterror financing regime in place. WHY GO OFFSHORE?

‘Main street’ critics are quick to conclude that regardless of talks of transparency, setting up an entity in an offshore centre equals tax evasion, but this is not the case. private equity international

Most often, private equity firms, which conduct cross-border financial transactions on a regular basis, want to avoid being taxed twice. While a fund established in an offshore centre may not be taxed in that offshore jurisdiction, profits on investments it makes in New York, for example, will still be taxed under the US tax regime. It’s also common for a private equity fund to have entities in several tax jurisdictions to fit the needs of different limited partners. One private equity lawyer says that his firm recently set up a Cayman fund for a client because a major LP is used to investing in Cayman structures. The choice of a specific offshore jurisdiction may also be dictated by regulatory efficiency. Offshore jurisdictions can offer more relaxed rules regarding the use of leverage and permitted investment strategies. The priority is to ensure that the public outcry over less credible jurisdictions such as Panama does not turn into a wider witch hunt that engulfs all offshore regimes. The key is to educate the public on the role that offshore jurisdictions play, and the value they add, not just to their financial clients, but to society and business as a whole. KNOW YOUR INVESTORS

Perhaps one of the most immediate impacts of the Panama Papers on the private equity universe may be to accelerate the adoption of anti-money laundering regulations for registered investment advisors as proposed last year by the US Treasury Department’s Financial Crimes Enforcement Network (FinCen). FinCen is in the final stages of drawing up rules that will impose enhanced due diligence requirements on private fund managers, which would force them to identify and june 2016

THE PANAMA PAPERS

There are important lessons to be learned about data security, particularly for professional services firms Duff & Phelps

Panama: a sea of secret information awaits

verify the principal beneficiaries of legal entities that invest in private equity funds. Similar efforts are underway in the European Union. Meanwhile, jurisdictions such as the Cayman Islands have expressed interest in participating in a recently launched initiative to develop a new global standard for the exchange of beneficiary information. There is a dense web of offshore financial legal entities that lie behind the investors in private equity funds. There can be several layers to remove before the name of an actual human beneficiary is disclosed. And it’s not uncommon for unwanted investments from persons looking to fund illegal activities – or to avoid taxes – to find their way into private equity funds, often unbeknown to the managers. The key point is that there’s currently not much transparency and that the Panama Papers has highlighted an issue that was already on the global business agenda. Most j u n e 2016

of the large private equity firms are anticipating legal changes and have hired a slew of lawyers and consultants to dig into entities that invest in their funds. They could eventually return money to those investors if they deem it necessary. While the outcome of increased regulation will also likely be greater transparency, it will also push up compliance costs for investment advisors registered with the US Securities and Exchange Commission. THE IMPORTANCE OF CYBERSECURITY

The Mossack Fonseca leak represents one of the largest and most significant data breaches in history. It should serve as a warning to financial institutions that their data is increasingly vulnerable to cyberattacks and that these can have devastating consequences for their businesses. “While much of the fallout from the Panama Papers has focused on the

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

high-profile individuals implicated and concerns about the opaque nature of shell corporations, there are important lessons to be learned about data security, particularly for professional services firms,” wrote law firm Duff & Phelps in a May note. The SEC has recently been outspoken about the need to strengthen cybersecurity, not only at private equity firms, but also at portfolio companies and third-party vendors. The idea of securing such a volume of sensitive data – from litigation information to fund formation and acquisition documents – can be daunting for private equity firms, who may simply shy away from the task. Strengthening cybersecurity programmes is not only an internal matter for general partners. Some firms have also expressed concern regarding third party entities, including law firms and administrators. The consequences, both financial and reputational, could be devastating for firms. For now, the private equity industry, alongside the rest of the financial world, will continue to pay close attention to future revelations emerging from the Panama Papers. n

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INDIA ROUNDTABLE SS&C KEYNOTE INTERVIEW: ACTIS

FUND OVERSIGHT

Change agents Today’s fund administrators can play a vital role as GPs move into new geographies, new asset classes and larger funds under the watchful eye of regulators around the world, says Joe Patellaro, managing director, SS&C Private Equity and Real Estate Services

Have the needs of managers and investors changed? Joe Patellaro: I

think several key themes have emerged in recent years. The amount of oversight and regulation in our space has changed substantially. Investor due diligence has increased and there is a desire for additional information and greater transparency. Many fund managers have also expanded into different asset classes. These factors have caused fund managers to pause and reflect on their internal operations, and to ask what they really want from their internal teams and to reevaluate what external partners can do to support them. Meanwhile, the outsourcing space has also matured. When I joined this industry almost 14 years ago, it was still a relatively boutique industry, and has now grown into something that’s quite mainstream, where you are able to demonstrate the critical mass, expertise, access to information and global footprint that meets the needs that firms in this industry are looking for. So what have those regulatory demands meant for outsourcing? JP: I think it’s been two-fold. First, it took

Patellaro: fund managers are re-evaluating what external partners can do to support them

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what truly was a ‘private’ industry and put a much finer light on most firms and most capital around the world. In turn, firms became introspective about their own processes and operating models, what they had built over time, and many decided it was a time for a fresh look. A set of procedures and an operating model that had worked effectively now required a new assessment to determine whether that model met with increased regulatory scrutiny, oversight and reporting, amid private equity international

increased investor due diligence. This left more firms considering or re-considering the outsourcing model, and we developed additional solutions to help support the new regulatory environment. In addition, certain regulation, particularly AIFMD in Europe, created a global connectivity that many firms had not experienced before, along with increased regulatory oversight and reporting specific to that regime. This created another natural evaluation point to consider how a global service provider could help meet these growing business needs. Ideally, when should a fund manager start looking into that partnership? JP: I think it used to be a relatively binary

decision: do you outsource or do you do this in-house? It certainly is not that black and white anymore. When we have the opportunity to meet with managers, we first talk about them, their organisation, their pain points, areas of growth and then work together to evaluate areas where they have needs to be filled. Many managers in recent years have raised capital in different asset classes than had been their core focus and that becomes a natural decision point. A firm that has traditionally raised buyout funds may set up its first credit fund and could be seeking a partner to assist on that product, where the skillset needed differs from their current core capabilities in managing buyout funds. We will evaluate the best way to join with their existing team and process and bring them additional capabilities without diverting their attention from what they already do well. june 2016

INDIA ROUNDTABLE KEYNOTE INTERVIEW: SS&C

Managers also have the pressure of continued growth on their operations and processes and being able to meet the needs of the firm and its investors. We strive to work closely with firms to think about ways we can help them with certain pieces of the puzzle, in addition to considering the full outsourcing model, in a way that would allow them to increase the size and scale of their overall operating model in a service partnership. We’ll lay out operational processes from beginning to end so they can see where a partnership might help them grow and allow them to focus on their business priorities. How should managers determine whether outsourcing makes sense for them? JP: I think it’s important to make a realistic, self-critical internal evaluation in terms of people, current operating model and technology so they can figure out what they have and how they got there. It’s not uncommon for successful fund managers on Fund III or Fund IV to make this evaluation and realise they’ve been doing it the same way since Fund I, which may or not still be appropriate. Raising a new fund becomes a good time to take a hard look at how things

With additional support, a firm can retool people to their full capabilities j u n e 2016

are being done and be open to considering what else is out there now. Things are far different than 10 years ago at the time of the first fund. It’s also important to consider the needs or issues of all constituents, internal and external, and to realise that while people are a key factor, it is not solely a people or headcount management decision. There are significant additional considerations and costs besides personnel, including ‘soft’ costs such as technology (cost, maintenance, keeping up-to-date), manager oversight and location costs. It is about maximising the overall outcome of a solution between the manager and service provider. Frequently, a firm will put together a substantial and sophisticated industry team but fail to maximise the team’s utilisation because time is taken up keeping the books and records, getting financial reporting out on a timely basis and addressing investor queries.With additional support, a firm can retool people to their full capabilities and get help on what we are experts at doing for hundreds of firms. So how have you evolved to meet this new landscape? JP: SS&C has recently completed the acqui-

sition of Citi’s Alternative Fund Administration businesses, creating one of the largest global fund administrators in this segment. The overall scale and size of the combined business – number of staff, clients, funds, committed capital under administration – is compelling, as is the global footprint. Having capabilities around the world, coupled with local service provision, means we can work with a local fund based in Singapore or Luxembourg and

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

We see a lot of opportunity in the credit space, particularly in Europe

service them directly on the ground in their backyard, and also help a US-based manager that sets up a fund there, perhaps for the first time. From a product evolution standpoint, we’ve spent a lot of time expanding our real estate offering, creating a product specific operating model, industry specific leadership and additional reporting capabilities. We see a lot of opportunity in the credit space, particularly in Europe where you have such a huge carve out from traditional credit providers to private capital, and have combined loan administration and loan reporting capabilities with traditional fund accounting and reporting to provide a product specific solution to this market segment. In many ways we’re mirroring the growth in size and sophistication of our clients. When they look at partnering with us, especially if they haven’t done this evaluation in a while, they might see a different mousetrap than they expected, with the global reach, experience, and problem solving mentality that we bring to the table. We have been at this for a long time, and we expect this positive trajectory of outsourcing in our space to continue for the foreseeable future. n

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COMPLIANCE

AIFMD

Getting comfortable with the new regime Managers raising capital in Europe find there is ‘more than one way to skin a cat’, writes David Turner They say that the bigger they come the harder they fall, but it is the smaller firms that look at greatest risk of being toppled or at least tied up by the EU Alternative Investment Fund Managers Directive (AIFMD). The directive has ramped up the weight of the regulatory burden faced by private equity fund managers active in the EU. Although it came into force in July 2013, market observers say that many funds are still trying to work out the best response. “A large fund manager with a large back office can afford all of this burden, but for a fund with six people, it’s not necessarily viable,” says Adam Turtle, partner at Rede Partners, the fundraising advisory business. AIFMD requires the functional separation of risk management from portfolio management: the same person cannot do both, so a small fund manager that did not previously have a separate risk manager must hire one. It also makes an independent depositary responsible for the safekeeping of assets. Responsibility for these functions has to be held by EU-based staff.

If a fund manager is serious about growing its pan-European business, it will eventually need to comply Alan Flanagan

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The regulations also require the provision of annual reports to investors, and quarterly reporting to regulators in the case of larger funds. The directive applies to any fund that wants to market in the EU without major restrictions on how it does so, regardless of where the fund is based. Asked what is toughest, in practice, about AIFMD,Turtle says: “The really problematic aspects, particularly for smaller general partners, are to do with compliance and the depositary function.” The days are over when the cost of such burdens could have been passed on to clients, says Alan Flanagan, global head of private equity and real estate fund services at BNY Mellon in Dublin. “Loading on additional costs is something that investors have a lot less tolerance for,” he says. One way to avoid the directive is to not accept Alternative Investment Fund Manager (AIFM) status. But then funds have to rely on “private placement” – the sale of stakes in the fund to a relatively small number of select parties – to secure funds from EU investors. Private placement is, however, highly constraining, says Aymeric Lechartier, London-based managing director at Carne Group, the governance firm for asset managers. He notes that because of various national and EU-wide restrictions, fund managers relying on private placement rules cannot seek investment from pension funds or private equity international

Flagbearers: while some managers have set up offices in the EU, others are outsourcing AIFM status to specialists

family offices in much of mainland Europe. In practice, few insurers will invest with fund managers that do not have AIFM status, because of the high capital charges they incur for regulatory reasons. Many smaller managers based outside the EU have responded to the choice between tough private placement rules and AIFMD by simply giving up, says Turtle. “If you’re a good US manager that doesn’t need to come to Europe but might do so just to get diversity in your investor base, you’re not going to bother any longer,” he says. Relying on private placement can work for a small fund whose investors are concentrated in one country. However, “if a fund manager is serious about growing its pan-European business, it will eventually need to comply”, says Flanagan. For this reason, service providers think many US fund managers are likely to seek AIFM status over the next few years. june 2016

COMPLIANCE

The really problematic aspects, particularly for smaller general partners, are to do with compliance and the depositary function Adam Turtle

But just as there is more than one way to skin a cat, there is one more than one way to comply with AIFMD. Some managers have responded by setting up or strengthening EU offices. However, others have outsourced AIFM status to governance specialists such as Carne. Lechartier puts the case for the AIFM status which firms such as his can provide. “Setting up full AIFM capability takes probably about a year, including nine months for the approval process and three months for preparation,” he says. The fund manager must also bear the running costs of maintaining the AIFM status – which Lechartier puts at “about a million euros for a UK AIFM”.This encompasses the costs of hiring “at least four or five people”, including two portfolio managers, a risk manager and a compliance manager, in London. j u n e 2016

The cost of outsourcing the governance aspects of an AIFM to Carne is, he estimates, between €60,000 and €200,000, depending on the fund size – “a fraction of the cost it would have taken to set up one’s own full-blown infrastructure”. This is because one person can do the risk management, regulatory filing and compliance work for a number of fund managers. Portfolio management is delegated back to the original fund manager which can be outside the EU. Jake Green, London-based partner in the financial regulation group at law firm Ashurst, notes that the outsourcing price is “not cheap – it’s a cost which managers need to think about”. But “funds dead set on a mass European marketing tour will need either this, or their own AIFM capability”. He says that US fund managers are increasingly accepting the need to have parallel fund structures, in, say, the Cayman

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

Islands and in an EU location such as Luxembourg. But AIFMD itself cannot entirely be blamed for the increased burden, says Giles Travers, a director of alternative investment funds at SEI Investment Manager Services: “There’s been a whole tsunami of regulatory changes over the last few years.” He recalls the financial controller of a big European private equity firm telling him that the time he spent on regulatory reporting and compliance had risen from 10-20 percent of his day to about 45-50 percent. Fund service administrators say that they ease the burden of dealing with regulations by enough to provide a cost saving for fund managers, though are reluctant to give precise figures. “There are definitely economies of scale for a fund manager in outsourcing, because we do this with a much greater investment in technology and infrastructure,” says Travers. Fund administrators can also act as the depositary for a fee, characterised by one administrator at “low single basis points”. There is also another reason to outsource it, says Travers: it liberates people. “If you’re running a finance, compliance or operations team at a private equity firm, you don’t want those people focused on low-value work which is not helping drive your investment decisions and fund returns.” n

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INDIA ROUNDTABLE EXPERT COMMENTARY: GEN II FUND SERVICES KEYNOTE INTERVIEW: ACTIS

DUE DILIGENCE

Asking the right questions LPs are showing a strong preference for the thirdparty fund administration model and GPs’ interest in outsourcing is growing faster than ever. GPs and LPs tell Gen II Fund Services the attributes fund administrators need to exhibit to satisfy their respective requirements At the 2016 PEI CFOs and COOs Forum in January, attendees may have noticed a different tone from fund sponsors with respect to outsourced fund administration in comparison with years past. This year, when the topic of third-party fund administration came up on panels and among delegates, many viewed these services as a viable option for their firms, and an important choice to consider given the complexities facing the back office. Indeed, EY made note of this shift in its 2016 Global Private Equity Fund and Investor Survey, which was unveiled at the forum. “As capacity constraints develop, finance teams may want to look out-of-house, creating demand for the offerings of asset servicers who see private equity as a major growth opportunity,” the survey noted. “Investors, conditioned by hedge fund models, feel comfortable with the concept, so the question is no long whether to outsource, but which functions to outsource and how many providers to rely upon and how to integrate them effectively.” The survey also noted the highest level of comfort with outsourcing in recent years on the part of fund sponsors. So, as more and more private equity managers are considering the switch to third-party fund administration, they need to ask the right questions in requests for proposals (RFPs) and during due diligence. It’s vital to ensure the sponsor is meeting

14

the institutional limited partner requirements for operational excellence and the administrator exhibits best practices for recordkeeping, transparency and reporting. “We now see sponsors vetting us in a similar fashion to how LPs due diligence them,” says Gen II Fund Services managing director Jeff Gendel. “A fund administrator has to be able to exhibit outstanding marks on a number of key items, like top-tier performance, a highly experienced team, certified processes and procedures, and intimate industry knowledge in the private equity industry.” Many GPs might not know where to start with the administrator diligence process, so we reviewed recent due diligence questionnaires on the topic. Some definite trends emerge from the questions general partners ask of their administrator to make sure the administrator can meet their funds’ demands, and, in turn, the demands of their LPs. THE PROCESSES

The first step every GP and LP will take in reviewing a potential fund administrator is asking whether or not they have an SSAE 16 (Service Organization Control Type 2 [SOC 1] Statement on Standards for Attestation Engagements number 16, issued by the American Institute of Certified Public Accountants). This certification marks the passage of a crucial independent private equity international

examination of the administrator’s control environment and is a must-have for sponsors and their institutional LPs. The SOC 1 report provides private equity clients and investors with confidence that the fund administrator has adequately described its controls, processes and procedures, and that its controls, processes and procedures are suitably designed and operating effectively to achieve their specified objectives, notes Steven Alecia, Gen II chief client officer. With the Securities and Exchange Commission (SEC) increasing its oversight role and a more intense focus on recordkeeping for funds, it is understandable that GPs and LPs want to hold their administrator to the highest standards. “GPs want to know that the administrator has certified processes and procedures to do the work that’s required, and as a result, every single RFP that we see asks about the SSAE 16,” says Alecia. “In fact, it is usually the first question on the RFP, so it’s clear that our GP and LP partners view this as a necessary qualification.” Another important topic GPs and LPs seek to understand is the additional steps taken by the administrator to ensure that client facing items are error-free. Gen II has met this requirement through the establishment of an internal quality control (QC) department, similar to a concurring partner role at an accounting firm, in order to be sure there are extra sets of eyes reviewing all sensitive and client-facing transactions. “QC is among the most important parts of our organisation,” says Alecia. “Our clients and their LPs take comfort in the additional checks and balances we evidence in our processes.” And while cybersecurity is a hot buzzword throughout the private equity june 2016

INDIA ROUNDTABLE EXPERT COMMENTARY: GEN II FUND SERVICES

THE MARKET’S REQUIREMENTS

As EY’s survey of private equity chief financial officers and investors reveals, outsourced fund administration is becoming a more popular option. In order to meet institutional requirements of private equity firms and investors, GPs and LPs concur that the following attributes are essential for fund administrators: • Experienced team with long standing private equity fund administration expertise; • Institutional grade infrastructure including: • SSAE 16 certification; • SEC cybersecurity compliance; • Independent quality control; • Robust, flexible, and transparent technology; • Evidence of firm performance at the highest levels; • Ability to customise service approach for each fund; • A long-term dedication to the private equity fund administration industry.

industry of late, many fund managers are struggling to determine what practical steps they can take to approach the matter. Having a fund administrator who is compliant with the SEC’s cybersecurity recommendations is crucial. Not only will the fund manager rest easier knowing their data is in good hands, but they can also turn to the fund administrator for advice on how to approach cybersecurity. “Each of these attributes – our SSAE 16, our SEC cybersecurity compliance, our quality control team – is an essential part of our service offering and firm infrastructure,” says Alecia. “We know these elements are required by all investors, fund managers and regulators as the focus intensifies on quality operational procedures, independent recordkeeping, and full transparency.” THE PEOPLE

Just as an LP would not commit to a fund because it looks good on paper, GPs also should not commit to a fund administrator j u n e 2016

without learning more about the team that will service them. That team will be an extension of the fund manager’s own staff, so it is crucial to know and to trust them, Gendel says. “You need to dig in and learn about the members comprising the team, their experience in private equity fund administration and how long they’ve worked together as a team. Have they seen a multitude of situations that enable them to effectively handle whatever comes up while administering one of your funds?” Gendel notes. It’s exactly how an LP would investigate a GP’s experience in the industries in which the GP is investing. “LPs would think twice about investing with a sponsor that can’t evidence a long and successful track record or has lagged in performance.” Another area of interest for GPs in RFPs is how long the administrator’s senior team has been working together. Turnover is an issue that has the potential to impact fund administrators, notes Gendel, so GPs must be confident their administrator has the

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

proper structure and incentives in place to ensure that key team members stay for a long time. “Team continuity is incredibly important in the fund administration industry, and GPs should be asking detailed questions about the stability of the team that will be servicing their funds. It’s analogous to an LP asking a GP to explain how they can ensure key team members are incentivised to stay with the firm and how the GP can avoid significant departures from the team. Fund administration is a service business and people are at the heart of it, just like within the private equity firm,” notes Gendel. Equally important, GPs ask about the administrator’s knowledge of the private equity industry and experience servicing complex funds. Private equity fund structures become more complex with each passing year. In Gen II’s experience, every fund is different, every limited partnership agreement is different, and every organisational structure is different. Private equity sponsors demand a customised approach for their fund rather than a one-size-fits-all methodology. Whether a firm is just starting out with Fund I, moving from one fund administrator to another or, as the EY survey predicts, moving their operations from in-house to out-of-house, all of the key attributes that LPs look for when considering a GP’s fund will translate into the GP-administrator relationship. GPs are increasingly focused on the administrator’s people, processes, performance, and specific expertise. “Sponsors are far more discerning now and smarter about fund operations,” says Gendel. “Our industry should be prepared to undergo more scrutiny.” n

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CONSOLIDATION

INDUSTRY LANDSCAPE

The compatibility game As the fund administration space continues to grow and consolidate, it may require even more due diligence to find the right fit for a long-term partner. Rob Kotecki reports It’s only natural that fund administrators would grow and evolve with their clients, into new geographies, asset classes and areas of expertise. And given the increased regulatory demands and complexity of today’s limited partnership agreements, GPs are happy to migrate their workload to thirdparty administrators. But it’s also natural that as the fund administrators swell in size and complexity, their service offerings change as well. The fund administration industry has been in flux of late, with many new boutique firms and a wave of consolidation. These new larger players may have increased capabilities, but some CFOs feel the quality of service has declined, with multiple points of contact and long response times. Selecting the right administrator these days often involves investigating less obvious areas like EXCELLENCE REQUIRED

Beyond track record, what are investors most concerned with? Reporting

45

Team stability

65

Proven operational excellence

45

Clear strategy

40 %

Source: EY/PEI

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technology, staff retention and client mix. GPs may be surprised to find today’s small to mid-sized firms can offer a range of services for big funds, or that larger firms may have a senior account manager that’s as fully engaged and quick to respond as any boutique provider. No matter who they end up choosing, GPs seem to be moving toward outsourcing fund administration. According to a recent survey by eVestment, private equity, real estate and funds of funds “assets under administration” grew by 37 percent in 2015, with administrators most bullish on continued growth from their private equity business. Last year, the fund administration space also saw a series of consolidations, including the acquisition of Kaufman Rossin by ALPS, Pinnacle by Apex Fund Services and, most significantly, SS&C’s acquisition of Citi’s alternative investor services business. While the transaction expanded SS&C’s geographic footprint and client base, there was another rationale for the deal. “Expertise is key in our business today,” says Joe Patellaro, a managing director at SS&C. “And the acquisition complements our organic growth strategy by helping us acquire talent.” Another rationale for these consolidations may be the reality of the fund administration business, where the cost of technology and the workload involved in meeting the demands of LPs and regulators are squeezing margins. One administrator pointed out that since they sign contracts private equity international

for the life of a fund, they have to wait for the next fundraising to increase prices, which could be years away. As a result, some larger players are shifting to a lower cost model, which often means moving operations overseas where there can be a decline in service. One CFO using a recently consolidated fund administrator admitted they were looking for another provider given how service has declined, citing long wait times for answers.While another CFO complained of multiple points of contact, which left them feeling as if they were managing an internal staff, just in another office. Back in 2014, a survey from PwC found that 70 percent of managers were satisfied with the level of service, but that was before the recent consolidations. june 2016

CONSOLIDATION

Right mix: Price, technology and staff turnover are all key critieria when choosing a fund administrator

Technology can’t compensate for a lack of understanding of fund accounting, private equity and the complexity of the practice Krista McCoy

is responsive and competent over the life of a fund? A recent survey from EY & PEI Media reports that beyond track record, 45 percent of LPs cited “operational excellence” as a major concern. So the stakes for effectively administering a fund are as high as ever. BEYOND PRICE

Small firms face those same shrinking margins, with their own limitations. Many cannot invest in the talent or technology to service hedge funds or real estate for GPs looking to diversify into other asset classes. However, geography might be less of a barrier for small and mid-sized shops. The consensus is that so long as the administrator can offer access to a GP’s data any time day or night, they can work with firms anywhere. “We serve 8,000 LPs on behalf of our clients from around the globe,” says Jeff Gendel of Gen II Fund Services. “No matter where the GP sits, they can work on our platform.” Yet even if administrators have offices around the world, and a full suite of services for every asset class imaginable, how can any GP be sure that they will have a partner that j u n e 2016

ARE YOU A MATCH?

Price and experience are always vital, but how well does that new service provider answer inquiries into the following? Technology How flexible is the offering? How easy is data to access by both GPs and LPs? How often will internal staff actually use that bell or whistle? Staff retention How often do senior managers leave? How well are they compensated? Is there a track to earn equity in the business? Client mix What portion of the business does any one client have? Can additional staff be tapped to meet competing deadlines among clients?

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

Price will always play a factor in choosing an administrator, but there are less obvious elements that may be more indicative of service quality. Technology plays a huge part to the service offering, but the most comprehensive system may not inherently be the best. “Technology can’t compensate for a lack of understanding of fund accounting, private equity and the complexity of the practice,” says Krista McCoy, EVP of fund administrator Leverpoint. A great tech offering can’t make up for a firm new to servicing the asset class. Furthermore, technology is only as good as its ability to adapt to the fund at hand. Which is why SS&C has been acquisitive on the technology front as well. “SS&C is as much a technology company as an alternatives fund administration business, and we continue to develop and acquire technology assets, which allows us to be nimble in ››

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CONSOLIDATION

HOME BIAS

Regions ranked by anticipated business growth, according to fund administrators

That said, there is always a risk the CFO will not have the same rapport with that new account manager. THE VIP DILEMMA

North America

Europe

Asia-Pacific

Latin America

Middle East

Africa 2015 2014

(from 6 being the greatest driver, to 1 the least, averages shown above)

2013

Source: eVestment Alternative Fund Administration Survey 2016

›› designing solutions for our clients,” says Patellaro. But a GP may not need the most muscular tech offering. One fund administrator admitted their clients rarely use more than a fraction of what their system can do. So several administrators stress that the best way to vet technology is about ease of use for the GP and its LPs, rather than the longest list of capabilities. What might matter even more is staff retention, since losing a primary contact at an administrator means starting over with a new face with all the risks of a new hire. “Turnover is an Achilles heel of the industry,” says Gendel. “Administrators need to make sure their senior team and the personnel that interact with clients are there for the long term.” GPs would do well to enquire about compensation, including if equity is part of the package. “We have a succession plan that includes granting equity interests to senior employees,” says Robert Aufenanger, a partner at Broadscope Fund Administrators. But beyond compensation, pure retention rates still matter, as a culture that churns

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Turnover is an Achilles heel of the industry. Administrators need to make sure their senior team and the personnel that interact with clients are there for the long term Jeff Gendel

through staff won’t show up in what they promise staff in money or upward mobility. CFOs may value a long-term relationship with a single account manager, but there are reasons to want a team on hand. “We feel being part of a larger organisation helps mitigate key-man risk. With a deeper bench of talent and a business wide process, there’s a better chance someone can step right in for a smoother transition [than hiring someone new for the role],” says Patellaro. private equity international

However, smaller firms can find themselves skimping on service quality as well, especially if their client mix is out of balance. Administrators warn that if one client is a majority of that boutique administrator’s business, it can lead to a situation where the major client’s needs are addressed before a newer, smaller client if they both need help at the same time. So it’s important to inquire where additional resources might come from in that scenario. There may be an inclination for GPs to choose an administrator that mirrors their own size and complexity, but that’s not as relevant as it once was. “We work with funds that range from a $60 million VC vehicle to a $3.2 billion middle market fund,” says McCoy. Part of that is due to efficiencies from technology, but smaller shops are also focused on a single asset class, which has its own benefits. “We are laser-focused on private equity administration,” says Gendel. “We have toptier, experienced talent, institutional grade infrastructure, cybersecurity compliance and full transparency.That experience and market focus allows us to cater to funds of all sizes, from start-ups to the largest in the business.” And smaller funds may find the right home in the hands of a firm as large as SS&C, who have built a dedicated team for mid-market clients. So GPs shouldn’t rule out an administrator as one too large, or too “boutique” for their needs. More often than not, the right provider will emerge only after a rigorous period of due diligence into a variety of providers. There may be no shortcuts these days, but the growth and competition in the market might increase the chances the perfect match is out there. n june 2016

Imagine it… A world where Private Equity firms are liberated from confining operational systems. Creativity flourishes and boundaries dissipate — from investment development to distribution, new opportunities arise. We see this future. SEI can turn your infrastructure into a progressive force.

SEI Investment Manager Services is innovating ahead of change. www.seic.com/imagineit

The future imagined: SEI Investment Manager Services: US Toll-free: (844) 4SEI IMS (473 4467) London: 44 (0) 20 3810 7571 Dublin: 353 1 638 2400 Global Head Office: 1 (610) 676 1270

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A Floating City, envisioned by The Seasteading Institute, will allow the next generation of pioneers to model new ideas for governance in a jurisdiction of technical, legal and financial autonomy.

INDIA ROUNDTABLE EXPERT COMMENTARY: SEI KEYNOTE INTERVIEW: ACTIS

Adapting to a brave new world Unprecedented change in private equity has thrown up a whole new set of challenges, says Giles Travers, a director of alternative investment funds at SEI The private equity market has grown at an unprecedented rate in recent years. It is also evolving quickly, perhaps more so than any other sector of the asset management industry. This has put pressure on operational requirements that historically have been much simpler for private equity firms than for most other types of investment organisations. This is no longer the case. To take a closer look at this increasingly challenging operating environment, SEI recently surveyed more than 200 professionals at private equity firms, institutional investors and consultants. COMPLIANCE CONUNDRUM

The regulatory environment is one area that almost everyone agrees is becoming more complex. The implications are profound enough that 30 percent of the GPs in our survey said compliance comprised their single biggest operational challenge. Regulatory compliance is also becoming a more expensive proposition. More than four out of five GPs (83 percent) say compliance costs are rising faster than other operating expenses. Almost half (47 percent) said they were rising much faster. An increasingly complex web of regulations challenges many private equity firms. This is particularly true for firms operating globally. The Alternative Investment Fund Managers Directive (AIFMD) has exhaustive reporting requirements for private equity firms in Europe. Form PF is now required by the Securities and Exchange Commission (SEC) of firms in the US. The Foreign Account Tax Compliance Act (FATCA) obliges firms to provide

20

accountholder information to the Internal Revenue Service, and other organisations are also looking for similar types of data. As daunting as these changes are, however, further challenges lay ahead. There is the potential for tax reform, including the treatment of carried interest. The rules for marketing and solicitation continue to evolve. And the definition of accredited investor is up for debate. Most firms recognise that compliance will continue to become more complex. The smart ones will prepare for even more audits, exams and enforcement going forward. Further challenges stem from increasingly influential investors. Large institutional investors in particular are wielding more clout, clamouring for greater transparency, negotiating lower fees and arranging for customised investment products. Their demands have taken on greater urgency over the past year, with the SEC warning about inappropriate expenses and CalPERS revealing that it could not adequately track fees paid to private equity managers. Meanwhile, deeper and stricter due diligence is becoming the norm. Almost two out of three LPs (63 percent) in the survey say they are intensifying their operational due diligence efforts. Many are bolstering their internal capabilities, while others are reporting that they have engaged independent consultants to carry out due diligence. Investor demands are also reshaping data and reporting standards and pressuring the bottom line. Almost one in five PE firms (19 percent) in the survey say data management has become their single biggest concern. private equity international

A similar number say investor reporting is their single biggest operational headache. Data exists, but in many cases does so in silos, and PE managers are often found lagging their hedge fund counterparts in integrating and utilising data from various systems. There is potential for it all to be brought together to generate meaningful insights, but this proactive approach has to date proven to be beyond the capabilities of most firms. BLURRING OF LINES

Another source of growing complexity is the increasingly diverse investment landscape.Traditional approaches including coinvestment, direct investment and separate accounts continue to dominate, but they are increasingly joined by more liquid options. The secondaries market continues to grow, as taboos fade and trading is facilitated by the proliferation of intermediaries and exchanges. There is also a blurring of the lines with other asset classes. Venture capital, for example, has long been viewed as a distinct asset class managed by specialists. That distinction is fading as VC firms invest in more mature entities while more private equity firms are getting involved with early stage companies. Meanwhile, hedge funds are launching products with committed capital and are therefore administered like PE funds. It is debatable whether there will even be a meaningful distinction between hedge and private equity funds as separate asset classes 10 years from now. The more important differentiators may be fee structure and commitments. Perhaps more fundamentally, the term private equity itself is becoming a misnomer. As direct lending vehicles continue to take market share from banks, private debt june 2016

ROUNDTABLE EXPERTINDIA COMMENTARY: SEI

is increasingly being heralded as a cornerstone of many private “equity” firms’ growth strategies. Even as all of these transformative trends force private equity firms to re-examine their operational capabilities, heightened competition is driving them to differentiate themselves from the pack. Some are placing greater emphasis on tracking, analysing and disseminating operational metrics in an attempt to optimise the value of their portfolio companies. Others are working to produce customised reporting that better meets the needs of their limited partners. These types of initiatives mean that data management is viewed more and more as a potential source of value. Combined with the challenges outlined above, they also mean more complex business models. In the past, private equity back- and middle-office functions were often handled by a skeleton staff using spreadsheets. In today’s world, these functions are seen as a critical part of the process that can make or break investor due diligence, client satisfaction, regulatory compliance and competitive returns. This shift has private equity firms looking to bolster their staff with operational specialists, acquire more sophisticated technologies and increasingly partner with external firms that offer access to best-inclass operating infrastructures. THE OUTSOURCING OPTION

Traditional processes – which are often performed manually – are stressed by growing complexity. Some firms find that their existing staff do not possess the requisite expertise, but they also face a growing talent shortage when they try to locate and hire the necessary personnel. Working with an outsourcing firm can not only provide the required experienced staffing leading to a reduction in errors, but it can j u n e 2016

infrastructure, but there are many excellent reasons for even these firms to work with an outsourcing firm. These include the ability to monitor complex investment strategies, handle customised portfolios and accommodate the increased blurring of asset classes and investment vehicles. NAVIGATING NEW FRONTIERS

Travers: compliance is becoming ever more complex

GPs say compliance costs are rising faster than other operating expenses also save time and potentially money.What can be a laborious and distracting chore for private equity firms can be done accurately, efficiently and cost effectively by experts who are tasked and equipped to do that very thing on a daily basis. Scalability is another benefit. There is demonstrable appetite for funds managed by smaller or emerging firms, but while they may have the desirable investment track records, they are less likely to have a robust operational infrastructure in place. An external partner with a good industrywide reputation not only allows the investment professionals running the firm to focus on their portfolio management jobs, but also provides a level of comfort to existing and potential investors. Large managers, on the other hand, may already possess operational expertise and

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

The industry is likely to sport a growing number of diversified, multi-strategy managers.The embodiment of the convergence we’ve seen across the investment landscape over the past decade, these complex organisations require an array of systems, platforms and processes to handle their various strategies, vehicles, securities and investors. However, unless they can solve the riddle of that additional complexity, large diversified firms may struggle to compete successfully against more specialised outfits. Most survey respondents took this view, with the majority of GPs, LPs, and consultants united in predicting that specialist firms were more likely to be competitive than diversified firms going forward. That being said, even firms maintaining relatively simple business models are unlikely to escape the additional complexity resulting from more competition, demanding investors and assertive regulators. Being successful in this environment means effectively navigating the new operational frontier. Expertise, resilience, scalability and flexibility all need to be embedded in people, processes, systems, and security. For many private equity firms, this will mean leveraging the expertise of specialised partners and plugging into stateof-the-art platforms. n Giles Travers is a director within SEI’s Investment Manager Services division based in London, with a focus on European private equity and alternative investment funds. He can be reached at [email protected]

21

BOOK EXTRACT

CYBERSECURITY

Being prepared In an extract from The Private Equity CFO and CTO Digest, Eric Feldman, chief information officer at The Riverside Company, explains how fund managers can map their firm’s data and start to protect against cyber-attack Cover.qxp_CFO&CTO 20/08/2015 17:21 Page 1

Most people assume that there is a welldefined map managed by someone within their company that clearly details where all of the company data resides. Experience suggests that there is considerable institutional knowledge across different areas of the firm around systems inventory, but a lot of the time it is not documented. CRM, ERP, HR management systems, fund accounting, file storage and a slew of other systems probably constitute the core of most private equity firms.What about your payroll provider or your outside counsel? Are they using systems that are storing sensitive employee or investor data? Once you start to think about how broad the universe has become in terms of containers of data, you quickly realise that you are storing sensitive data across dozens of different systems. Some you manage yourself, some in the cloud and some with third parties such as attorneys and tax consultants. Regardless of where the data resides, a plan has to be developed to map out where the data sits. This can be accomplished using a simple Excel spreadsheet where tracking a few additional points will help develop a process around protecting this data.Within the spreadsheet, list the name of the system or the application, followed by a brief description of what it does for your business. From there, add a column that defines the business owner of the application and the type of data it contains (more on below). Other data points to consider would be if the application is on premise or not, vendor

22

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contact name and address and a secondary business owner. A critical step during the systems inventory process is to include a column that identifies the data within the system as containing public, office use only, confidential or highly sensitive information.This categorisation step can be time consuming and will have to include the cybersecurity steering committee and key members throughout the organisation. This classification system will organically point out systems that need controls developed to ensure data integrity and availability are not compromised. LPs today want to know that you, the data steward, are safeguarding their sensitive information. This systems inventory will highlight which systems you need to pay attention to and who, internally, should have access to them. Develop a quarterly or bi-annual entitlement review process to your systems that contain office use only, confidential or highly sensitive data. The intention of this process is to work closely with the business owners of each system or each file share that is storing sensitive data to validate that correct individuals within your organisation have the appropriate access. People change departments and this entitlement process ensures that the movements within your organisation are accurately reflected within the permissions of your various systems. If a member of the investor relations team moves to a different role then they would more than likely no longer need access to june 2016

BOOK EXTRACT

the investor subscription documents, which contain highly sensitive data, and should have those permissions removed. The identification of data, classifying data and validating who has access to data are steps that can be managed within the company with minimal effort, and add significant controls to the complicated cyber world that private equity finds itself in today. For registered investment advisors, the SEC cares about this and so do investors. MANAGING ACCESS

Passwords are the bane of our existence, with so many to remember, but still a critical first step in managing access to systems that contain sensitive data. Much has been written about the reliability of passwords to protect our critical systems and whether there is a future without them.We are still dependent on them and two suggestions will help provide a degree of additional protections: 1. Require employees to change their passwords frequently. The change can be every 30 to 60 days.The important thing is to choose one and make it enforceable with no exceptions.This will not prevent a cyber incident but it will help catch accounts that slip through the cracks. For example, accounts that once belonged to interns and temporary employees who have left the firm, their accounts would automatically expire after their passwords expire. 2. Invest in a single-sign-on (SSO) solution. The technical aspects of this are beyond the scope of this chapter but think of this solution as an extension of the company’s identify management system. Many private equity firms today leverage systems in the cloud, which require separate user names and passwords. With an SSO j u n e 2016

platform, you can extend your companybased username and passwords to these cloud-based platforms. Having one user name and one password greatly simplifies how employees can securely access an expanding world of applications. Nothing, of course, is foolproof and passwords are an elusive means to truly protecting what is important to all of us. PREPARING IN ADVANCE

Imagine having a colleague tell you they received an email threatening to release sensitive investor data if you do not pay a ransom in 24 hours. What is the first step? Without an incident response plan already designed and tested, the private equity firm is facing a very grim 24 hours. Just like the current state assessment, securing the guidance and support from a cybersecurity third-party consultant to help develop the incident response will be of tremendous value. You must consider significant variables, define roles and responsibilities and properly manage communication in the event of a breach. Additionally, there are breach notification laws that differ from state to state and country to country that are very difficult to track and in some cases understand. The bottom line is that when, not if, your firm suffers a data incident or a loss of data, you have an obligation to report and manage it. Having a clearly defined plan on who should be involved internally and which external resources to contact will mitigate an uncomfortable and stressful situation. Do not wait to develop a response plan until you are in the middle of an actual cyber incident.Take the time today to meet with the cybersecurity steering committee and the company’s management team to build a right-sized incident response plan. ››

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

The bottom line is that when, not if, your firm suffers a data incident or a loss of data, you have an obligation to report and manage it Eric Feldman

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BOOK EXTRACT

RECENT LEGISLATION

In 2011, the Dodd-Frank Wall Street Reform and Consumer Protection Act introduced sweeping changes affecting the world of private equity. For technology professionals who weathered the passage of the Sarbanes-Oxley Act in 2002, there was a familiar pattern that tied these two events together; uncertainty, followed by confusion, followed by acceptance, followed by action. For many IT leaders at private equity firms, Securities and Exchange Commission (SEC) registration was unfamiliar territory, with much unknown and very few resources to provide guidance. It was not until February of 2014 that the foundation for the SEC’s cyber focus started to take shape. Almost three years after many firms became registered investment advisors, the SEC’s 2014 Cyber Alert provided some semblance of structure on how best to provide cyber controls and cyber risk management solutions to GPs. Since it was issued, there have been two additional alerts created by the Office of Compliance Inspections and Examinations (OCIE) and one by the SEC’s Department of Information Managers. More clarity, yes, but also many more questions.

The British Private Equity & Venture Capital Association (BVCA) and PwC published a cybersecurity guide in 2014 that reports on how a company should prepare for when their organisation suffers a loss of data. The steps this guide outlines are the exact steps you will be taking the minute you learn of a cyber situation within your firm: “[The incident response plan] should include aspects such as: who internally is responsible for leading the breach response; who to call if external technical response is required; what to do if the response needs to be conducted under legal privilege – how to tell and what to do; how to handle the PR side of a breach; if you have lost customer data for example, what is the communication plan to stakeholders.” Many funds would benefit from seeking guidance from a third-party consulting firm or a legal cyber practice group to help shape and develop the incident response plan that best suits their culture and legal obligations. In many cases, as part of your ››

24

The SEC Cyber Alerts serve as a reminder that the regulators’ focus on cyber protections is not waning. Although on the periphery it appears to be burdensome and onerous, this oversight is not without justification. According to James Rashleigh, the economic crime and cybersecurity director at PricewaterhouseCoopers, who published a blog post in February 2015 focusing on weak points within GPs, the private equity world is particularly vulnerable to cyberattacks. “Private equity firms are at greater risk than most businesses when it comes to higher value fraud attempts via cyberattack. You [GPs] are likely to hold financial and business information relating to your fund, your portfolio companies and your investors. All of this data has the potential to yield a high value of return for an attacker.” The threats are real but difficult to both understand and quantify. For many organisations, inaction is not an option so developing right-sized strategies to protect the management company is an essential first step to developing a more mature security posture throughout the organisation.

risk mitigation strategies, it may help to speak with an insurance broker about cyber liability policies as a means to transfer and manage risk. Many cyber liability policies will have panels of experts that can be recommended to perform legal guidance and cyber forensics work. Both will be essential during a cyber incident investigation. QUESTIONS TO ASK

The cyber world of today has many moving targets. Most funds will find that as cybercriminals better understand private equity they will become targets. Starting to analyse internal risks and developing the strategies outlined above today will position your firm to manage the cyber regulatory requirements as well as LP requirements of the future. It is not possible or cost effective to build a cybersecurity programme akin to Fort Knox.Taking appropriately measured steps that are appropriate for your company will do much to mitigate current and future cyber risks. private equity international

An effective cybersecurity programme will take many months or possibly years to have a stable foundation that you can build on and add to as needed. The regulatory environment will change and expectations from LPs and third parties will evolve, as must your cybersecurity programme. It is a vital tool for protecting critical assets. Ask yourself two questions the next time you think about your company’s cybersecurity posture: 1. What will happen to the firm’s reputation if proactive steps are not taken to protect the data? 2. Will it affect the firm’s ability to raise the next fund? Taking no action is not a viable option. n

Eric Feldman joined global private equity firm The Riverside Company in 2011. He is responsible for all aspects of the firm’s global technology strategies including application development, project management, information security and an IT infrastructure supporting 17 global offices in 11 countries.

june 2016

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CYBERSECURITY

SURVEY

Firms unprepared for cyber-attack Regulators are increasing their scrutiny on cybersecurity, but the buyout industry is failing to respond, a survey reveals

How would you describe the operational status of your cybersecurity programme?

6.7

4.4 23.3

65.6

Private equity firms cite cybersecurity as one of their biggest concerns, but how prepared are they for the worst to happen? Not very. That’s the conclusion from a cybersecurity survey by our sister title Private Funds Management and IT firm eSentire which polled the industry to asked how ready firms were for a cyber-attack. Two-thirds of respondents have only a partially implemented cybersecurity programme and just 23 percent have fully operational procedures that are compliant with US Security and Exchange Commission guidelines.That’s especially surprising given that 53 percent cited regulatory compliance on cybersecurity as most important to their firm. Only a small percentage rate awareness training and continuous monitoring and reporting to be most important. Even for those respondents with operational cybersecurity programmes, it is a relatively recent addition to the business – 43 percent have had it in place for between one and two years and only 23 percent for more than two years. Generally speaking,

these programmes are not expected to be a permanent fix, with one-third of respondents expecting them to be obsolete within a year and a further 49 percent expecting to replace them within two years. Firms are also failing to review their cybersecurity processes regularly. Only 7 percent review on a monthly basis, with the majority (57 percent) doing so annually. One reason why firms have been lagging on cybersecurity may be the seeming indifference of investors. Nearly three-quarters of fund managers interviewed said their investors only occasionally commented on the topic or simply never mentioned it.This is perhaps why more than half – 54 percent – do not believe that having a robust cybersecurity programme will give them a strategic or competitive advantage in the marketplace over the next two years. Despite the range of risks facing the industry, almost 79 percent do not possess cybersecurity insurance. The survey polled nearly 100 fund managers in fields including the buyout, real estate and infrastructure sectors. n

Fully operational and compliant with SEC guidelines, with ongoing updates Partially implemented Planned but not yet implemented Not yet planned Source: pfm/eSentire survey

Which component of cybersecurity is the most important to your firm?

13.3

12 53.3

6.7

14.7

Regulatory Compliance Incident Response Vulnerability Testing Awareness Training

The full survey, Cybersecurity in Private Equity: How Prepared is The Industry?, is available from www.privatefundsmanagement.net/cybersecurity-in-private-equity/ A version of this article appeared in the June issue of Private Funds Management

26

private equity international

Continuous Monitoring & Reporting Source: pfm/eSentire survey

june 2016

CYBERSECURITY

How long have you had your cybersecurity programme in place?

How long do you expect it to be fit for purpose?

How often do you review your cybersecurity processes?

11.2

18.6 23

34.6

32.6

42.5

6.7 24.7

57.3

48.8

Over two years

Over two years

Monthly

Between one and two years

Between one and two years

Quarterly

Less than a year

Less than a year

Annually Other

Source: pfm/eSentire survey

Source: pfm/eSentire survey

Source: pfm/eSentire survey

How important is your cyber readiness to existing LPs?

Could you see robust cybersecurity becoming a competitive advantage for your firm in the next two years?

Do you have cybersecurity insurance?

20

21.2

26.7

46.1 53.9 78.8 53.3

High — all LPs ask

Yes

Yes

Medium — occasionally commented on

No

No

Low — it’s never been mentioned

Source: pfm/eSentire survey

j u n e 2016

Source: pfm/eSentire survey

the f u n d ad min istrat ion & t echnology s pecial 2 0 1 6

Source: pfm/eSentire survey

27

TECHNOLOGY

INVESTOR RELATIONS

There’s an app for that Partners Group is the latest firm seeking to harness technology to communicate with investors. Nicole Miskelly talks to the firm’s CTO, Raymond Schnidrig, about what a reporting app needs to have and the risks involved

Schnidrig: technology provides interaction between firms and clients

28

Two years after a lack of client interest apparently killed off KKR’s attempt to launch an app that would allow LPs to search performance data and receive investment updates, Partners Group is attempting to revive the idea. The iPad app, which will allow its LPs to review performance data and explore possible investments, is an extension of the firm’s internal app created three years ago, says Raymond Schnidrig, chief technology officer at Partners Group. Technology is becoming “increasingly important in the private equity industry, because of the timeliness and accuracy it can provide, alongside the interaction it can provide between firms and clients,” argues Schnidrig. Partners Group planned to launch the app last month, having presented a beta version to its investors during its annual general meeting earlier this year. Schnidrig expects decision-makers within an LP to use the app to gain a “consolidated, high-end view” on their investments and any new opportunities. Partners Group clients will be able to find personalised intelligence on portfolio summaries and have the option to review performance using interactive charts. While some firms have the resources to develop their own solutions in-house, there are options for those who don’t want to build a dedicated app. An example is TopQ, which offers webbased performance tools that allow fund managers and investors to upload spreadsheet-based data about fund performance and cashflows. TopQ was set up by former SL Capital founding partners Graeme Faulds and Graham Paterson, and Drake Paulson, previously of fund administrators Vitech private equity international

Systems Group. “What really struck me was the way that fund managers and investors communicated performance to each other really had not changed throughout my 15 years as an investor,” says Faulds. Today’s investors want to look further than high-level performance numbers, he adds.They want to understand the key drivers of value within a fund manager’s track record. Instead of a dedicated app, TopQ was built as a software-as-a-service tool, which enables it to be accessed from any web browser. And despite a demand for mobile technology – TopQ has seen a steady increase in usage of the site on mobile devices – Faulds says technology does not have to be packaged as an app. Using technology to communicate large amounts of private data also comes with its own set of data protection and cybersecurity risks. According to Schnidrig, Partners Group has taken all of the necessary precautions: “We have done a specific penetration test on the app to make sure that we have all of the gaps closed and to make sure that the client’s data is protected appropriately.” Private equity firms often use investor portals to relay fund information to investors and Schnidrig says that Partners Group still intends for its investors to use their portal as a tool for more detailed fund information. “The app will give clients access to the most relevant information only. If they want the full history or more detailed data to process in their own systems then they are expected to access the investor portal.” n A version of this article appeared in the June issue of our sister publication Private Funds Management

june 2016

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