Keeping up with the market

Administrators of private equity funds have developed rapidly during their average eight years of history, according to the first European private equity fund administration survey by Ernst & Young covering 30 leading service providers. While the starting point was clearly on the Channel Islands, other hubs such as London and Luxembourg followed some years later. Today, all major European hubs are facing strong competition in a highly fragmented market. Administrators are therefore reassessing their operating model in order to gain market share and drive future growth. Main questions currently being asked are: “What drives the market?”, “What services should be offered and how should they be priced?”, “In which jurisdictions should administrators position themselves based on which organisational structure?”. In the following paragraphs we aim to provide answers to these questions as well as insights into latest trends and issues within the private equity fund administration market.

What drives the market?

Two factors will significantly impact the future of private equity fund administration, the first being the proposed EU Directive on Alternative Investment Fund Managers (AIFMD) and the second being the increased influence and therefore requirements of investors. Both factors lead to enhanced transparency and thus reporting as well as additional compliance and risk management obligations. Investors place strong emphasis on the existence of stable governance and controls at fund level, which is more and more thoroughly checked in the form of due diligence before investing with a private equity fund manager. In addition, they are putting service quality and the related cost under scrutiny. It is therefore not surprising that the formalisation of processes and a robust controls environment (e.g. through SAS 70 or similar reports), as well as the enhancement of efficiency through scalable IT infrastructure, are currently on top of the list of strategic issues for many private equity fund administrators. Another reason why the latter point is important is that the use of specialised IT systems is no longer a differentiator, but has become a “must have” over the past few years. The market has clearly turned its back on spreadsheet-based support, with expectations of a continued move towards dedicated private equity systems. Over three-quarters of administrators have implemented specialised software (or are currently in implementation) to support their private equity administration business based on the Ernst & Young European PE fund administration survey. The next steps to be undertaken should now be the discontinuation of legacy systems, as they result in duplication of data and thus greater effort and costs, as well as the provision of online access to all stakeholders in a more sophisticated way.

No matter which IT systems are implemented by the different administrators, having skilled staff remains key in order to comply with business-as-usual and legal requirements. Most of the professionals currently employed by leading administrators have more than three years of experience in private equity and only a minority is new to the industry, with less than one year of experience. The skill set of professionals also includes financial reporting: 70 percent of administrators said that their accounting staff is able to keep up-to-date with developments on the financial reporting landscape. The remaining 30 percent are smaller administrators purely focusing on local GAAP.

What services should be offered and how should they be priced?

Today, the service offering of administrators can be described as close to fully fledged and covers a wide range including accounting, company secretarial services, investor registration and standard reporting. It is interesting to see that tax services such as preparation of reports and tax specific data are not yet on the list of many administrators, but it is an area of future development for many. Tax structuring is not being considered by administrators going forward, as this clearly falls in the expertise of tax lawyers and accounting firms. Also, value-added services in the early stage of the private equity fund cycle, such as assistance in the fund set-up, are not often provided. On the other hand side, provision of directors – a service offered by the majority of administrators today – is clearly on the decline due to increased risk. As this service allowed administrators in the past to receive first-hand information and to be directly linked with fund managers, new ways of communication need to be established in order to ensure stable information flow in the future.

When analysing the pricing of services, a high degree of flexibility is currently applied. 60 percent of administrators operate more than one fee model as part of tailoring their service offering. Fee models range from charging basis points on committed or invested capital up to hourly charge rates for time spent effectively on a certain task. Over the short-term, administrators should invest time and effort into answering the question as to how the current flexibility in the fee structure can be coupled with transparency, simplicity and predictability for their client

In which jurisdictions should administrators position themselves based on which organisational structure?

Private equity fund managers are likely to consider a shift of their funds away from off-shore jurisdictions and toward on-shore locations in the context of the current changes in governance and the draft AIFMD. This potential move is already anticipated by administrators, who are opening new offices in many European jurisdictions. The expansion of geographic presence is on the map of two-thirds of the administrators. The main target destinations are Luxembourg, which was by far the most named jurisdiction as per the above mentioned survey, the Channel Islands, the UK and Ireland. The most chosen international destinations are Hong Kong and Singapore.

When taking a closer look at administrators’ operating models, the majority is structured as local organisations, offering a full range of services in each local jurisdiction (see “Local organisation” on graph above). This is most likely based on the nature of the private equity model which requires higher manual input than traditional mutual funds. Administrators with expansion plans based on the local organisational model need to ensure that the existing operating model is fully applied in the new location and that people are sufficiently trained in order to fully service their clients locally. Some institutions lead the way in the centralisation of key services such as accounting or reporting in one central location such as Poland, Scotland or even Mauritius (see “Global organisation” on graph above). The decision in favor of a certain location is often based on a multitude of factors such as availability of skilled resources, level of wages or language skills. The main advantage of this approach is clearly scalability. Nevertheless, administrators need to ensure smooth information flow between local business units and a centralised processing-hub, since local specificities – mainly in the area of accounting – need to be clearly understood.

No matter which organisational model is chosen by administrators, they both need to be based on a client-centric approach. Being able to provide the same service quality in a multitude of locations to a multi-jurisdictional client is becoming essential.

Conclusion

The private equity industry is currently shifting towards increased regulation and investor scrutiny. Fund managers will therefore increase their diligence when selecting third-party administrators to ensure that all legal and investor requirements can be handled from a middle- and back-office perspective. In order to gain market share, administrators need to focus on their governance and risk management framework while at the same time providing full support to the fund managers based on transparent pricing. This includes support during the set-up of funds for first-time general partners by sharing local expertise, as well as assistance in the fundraising for experienced general partners by producing suitable reporting. Finally, having a global footprint becomes more important for servicing entire fund structures from the target, through the SPVs, and up to the fund.

Alain Kinsch is country managing partner of Ernst & Young, Luxembourg and EMEIA private equity fund leader. Kai Braun is manager and private equity advisory leader at Ernst & Young, Luxembourg.