The pressure being exerted on the back-office functions of private funds continues to increase, as audit and tax-related demands grow alongside compliance challenges. While regulators are already ramping up the workload for chief financial officers, investors are adding a new package of requests for managers to deal with.
Tim Spence is finance director at Graphite Capital, a mid-market fund based in the UK. He says: “We last raised a fund in 2013, so we haven’t run that particular gauntlet recently, but in terms of day-to-day queries, we see many more audit and tax-related questions coming in from LPs. We see more people wanting to make sure the numbers we are giving them are audited, and more people wanting detailed tax information.
“There was a time when people were happy to accept a less specific set of information, but now LPs are more demanding in terms of asking us to prepare US tax information for them. We have been responsive to that, and there’s quite a lot more work involved as a result.”
Graphite expects to return to investors for its next fundraising in the not-too-distant future, when it will likely look to raise around £500 million ($643 million; €543 million) for investment (its 2013 fund, Graphite Capital Partners VIII, closed with commitments of £475 million). Spence says that when the firm goes back into the market, he expects the questions coming from LPs to be more detailed and comprehensive than four years ago.
“I’m anticipating that we are going to see LPs asking for a higher standard of professionalization during that process,” he says. “Things like cybersecurity are going to be on the list, and regulatory compliance, so having pretty robust internal documentation that we can present to people is going to be really important.”
The pfm/EisnerAmper CFO Survey appears to suggest that back-office management is seen to be ahead of the game when it comes to cybersecurity protocols, with LPs and GPs yet to fully familiarize themselves with best practice. We asked respondents how familiar they thought LPs, GPs and back-office management are with cybersecurity, and 72 percent responded that LPs are vaguely familiar at best, while 48 percent thought GPs have a working knowledge, and more than half (54 percent) felt back-office teams are very familiar with what is required.
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The fund details that LPs seem most familiar with, according to the survey, are operating documents and waterfall calculations, while investor understanding of allocations of income and expenses appears to have increased considerably since the 2016 survey when 59 percent felt LPs are either vaguely familiar at best, or have a knowledge of the areas that affected them. Now, 64 percent are thought to be either very familiar or moderately familiar with the details of expense and income allocations.
Spence says: “Another area is operations – I had some questions during the last fundraising about how payments get authorized, essentially trying to understand how money can leave the fund’s bank account. I was surprised by that at the time, but I expect more investors will be asking questions along those lines next time.”
On expense and income allocations, he adds: “Our investor reporting evolves over time, and we continue to increase our level of disclosure; that’s a one-way street. On areas such as expenses, I have tried to make sure we head off those types of queries by volunteering additional disclosure as we go along, making incremental improvements, and that seems to be working so far.”
Richard Hansford is an associate director at Ocarian, an independent fund administrator, and he says investors are increasingly looking for the back-office operations in private funds to be fully integrated in to the operations of the manager. LPs want more information, greater transparency, and more frequent interaction with their GPs, he says.
“We have seen so much new regulation and best-practice principles around investor protection and transparency, to make sure that investors are comfortable with what they are investing in,” says Hansford. “It’s now down to the back office to make sure information is collected correctly, and reported back in a timely manner. That means the role of the CFO in a private fund has changed considerably in the last five years.”
Running the back office of a private fund requires far more compliance skills than ever before, and is no longer about crunching the numbers and managing third-party service providers.
Hansford adds: “The CFO now touches all aspects of the business, so to be a successful CFO these days it is not enough to just be a good accountant. Today’s CFO needs to be a business professional, driving strategy at board level, understanding the impact of regulation on every aspect of the business, and on the fund structure, and maintaining interactions with investors.”
While most respondents to our survey judged the back-office management to be very familiar with all of the four fund details that we asked about, there is no doubt that the demands on the function are growing exponentially. Investors are getting more and more rigorous in their due diligence on asset managers, and are no longer content simply to see evidence of a track record of raising capital, generating returns, and distributing those returns to investors on time.
Now, CFOs have to potentially share information on regulatory and operational risk management, social governance and more. Investors want robust and tailored reports and ever-more granular information regarding valuations.
At the same time, the back-office teams must spend more time dealing with regulators, and getting to grips with the Alternative Investment Fund Managers Directive, the Base Erosion and Profit Shifting project driven by the OECD and more.
Spence says: “We now have MiFID II (the second Markets in Financial Instruments Directive) coming in, which will affect some firms. Then there is a big change to data protection law coming up next year, which affects fund managers a bit but can affect portfolio companies very significantly, so that’s another thing we need to make sure we are on top of.
“The role of the finance director now involves spending a lot of time making sure you’re not tripped up by the latest new set of rules or regulations.”
He says the amount of money being spent by private fund managers on lawyers and accountants has undoubtedly increased in recent years, while Hansford adds that more and more are turning to third-party administrators to support their back-office functions, so that they can focus on the day job.
“CFOs are spending far more time with their appointed law firms and compliance firms in order to understand the impact that regulation and various initiatives like BEPS will have on their operating models,” says Hansford. “This is to ensure the business is structured in a fully-compliant manner and is operating within all the rules. LPs have got a lot more sophisticated, driven by regulation and demanding greater levels of transparency, and back-office management is having to keep one step ahead.”
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