PF advisers tap compliance market

Regulators and investors demand 'horsepower' behind compliance regimes for smaller firms

Private fund advisers are bullish on an emerging market: private fund compliance.

Last year, the worldwide market for outsourced regulatory affairs consulting reached $6.3 billion, according to Grandview Research. The market is expected to grow by nearly 12 percent through 2028, Grandview says.

In July, Montagu Private Equity announced it had taken “a significant” stake in third-party compliance firm Waystone. Waystone, based in Dublin, has been an aggressive global player in outsourced compliance. The firm set growth targets north of 30 percent. Montagu bought out Waystone’s previous private fund backer, MML Capital Partners. Terms were secret but some reports suggest the deal was worth more than $1 billion.

The deal makes Waystone the largest valuated business in third-party compliance, the company claims. Rivals include London-based FundRock ($54 million in annual revenues) and Ireland-based Carne Group ($36 million).

“There has historically been quite a big involvement of private equity investors in the fund services industry, starting with fund administrators,” says Cyril Delamare, Waystone’s global chief growth officer. “The return profiles of our groups are interesting. They tend to be based on basis points, with recurring revenues and a long-term horizon.”

Regulatory pressures

Regulators have given the industry a shot in the arm. Earlier this year, SEC examiners said they wanted to see “robust” compliance programs, especially in private fund advisers, and compliance that’s part of the fabric of firms. Private fund advisers tend to be small shops – nearly three-fifths of the registered funds’ CCOs wear multiple hats – so compliance outsource companies offer a chance not just to scale up but to show regulators that they’re taking it seriously, says Julie Dixon, CEO of Waystone’s compliance arm.

“I think the SEC views the outsourcing firms very favorably, especially for the small and mid-sized operators, because it shows that they’re taking compliance seriously,” she says. “It’s an optional expense on their part. It shows that there is due diligence and care on their part.”

In 2015, the Commission issued a risk alert warning about “a growing trend” of outsourced CCOs. It scared many outsourcing firms away from top jobs, but it also opened opportunities for smaller firms to add “horsepower” to their compliance regimes, Dixon says.

“If you’re a five-to-seven-person firm – or even a 50-70-person firm – you don’t have a single person who can manage your regulatory compliance arm,” she says.

Investor pressure

The regulatory pressures to beef up compliance combines with investor pressures to beef up compliance, Dixon adds.

“Every year since Madoff, I think the allocators have become more strict about the guidelines for allocating to a new manager,” she says. “Every year, there’s some new tightening. I don’t think you can be a new manager anymore and get big institutional capital without a compliance firm on retainer. Now, you might be able to get some family office capital—but the SEC’s coming for them, too.”

Firms that are weighing outside compliance vendors ought to ask some questions, Dixon says:

  1. How many enforcement cases have come out of your client base? “You want to know that they can run the program and keep the Enforcement Division away,” she says.
  2. What is your staff turnover rate? More than 20 percent annual turnover can be a bad sign, Dixon says. “In a professional services environment, some turnover is expected—and you can run a really successful business with some staff turnover—but you can’t run it with 50 percent turnover every year,” she says.
  3. How do you handle multiple accounts? “You’ve got to have a lot of organization and structure and rigor around deadlines: How are you going to get all this work done on time?” she suggests asking. When outside compliance firms fail, it’s not usually because of a regulatory problem, it’s because the firm didn’t have the scale and scope to execute the compliance plan, Dixon says.
  4. Ask about policies, procedures and systems. “I think the control environment at compliance firms is really becoming important,” she says.