How GPs’ special relationship with fund service providers is evolving

The remit of fund service providers is widening as a global pandemic and technological and regulatory pressures force managers to turn to outside help.

Covid-19 has accelerated the mega-trends that shape every aspect of our lives, condensing years of evolution into just a few short months. And the world of fund services is not immune to the fast-forward effect of the virus. The trend towards outsourcing has notably intensified.

“Exacerbated by remote working, funds are now expressing a desire to move most non-investment activities off premises in order to cut overall expense to the manager, and to have the flexibility to scale up or down as required at any time in the funds’ lifecycle,” says Elaine Chim, head of private equity for America and APAC for Apex Group.

The transformation of fund administrators from the keepers of historical records to forward-looking strategic partners has also gathered pace. “GPs have been looking to their administrators for support more than ever before,” says Nikolaos Perros, head of private equity services at Citco, “and often in non-traditional ways.”

Demand for value-add services beyond core fund accounting and reporting was already proliferating; for example, accounts payable management, performance fee calculations, investor portals and data integration services. The magnitude of the challenges presented by the pandemic has expanded parameters further.

The world moved to an exclusively online environment overnight. This required advice on remote working security. Innovations include online board pack production and digital signing tools, which have allowed board meetings to become fully digitized, from preparation to hosting and documentation
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Chim agrees covid has shifted requirements. “The impact of the pandemic on the private equity industry caused immediate and significant disruption,” she says. “Fund managers suddenly had to prioritize business continuity, ongoing regulatory compliance and maintaining business as usual whilst facing practical obstacles like implementing working-from-home infrastructure, lack of face-to-face meetings and liquidity shortfalls among portfolio companies.

“As such, GPs have become increasingly reliant on their administrators and are continuing to seek their help to weather further market turbulence. We spend considerable time, effort and resources to ensure we have the infrastructure and technology to solve these problems for our clients; for example pushing out digitized fundraising and onboarding solutions and focusing on straight-through processing.”

Jonathan White, global head of fund sales at Intertrust, says early in the pandemic, GPs were in close touch with their service providers to ensure critical services weren’t impacted. “Those conversations have now evolved to assess how the GP can benefit more from the expanded services, flexibility and capabilities of their partners,” he says.

“Covid-19 has clearly become a trend-accelerator in how GPs look to leverage service providers and outsource more. Not only are they thinking about how their businesses can scale but also their relationship with investors.”

Data demands

Indeed, it is the demands of LPs that continue to be the driving force behind the evolution of the GP/fund administrator relationship. LPs now expect outsourced administration as standard and where that standard is not applied, GPs can expect a significant increase in due diligence. “As more and more money flows into private markets asset classes, the demands of LPs around transparency and process are being amped up,” says Perros. “And those operational issues are becoming increasingly relevant when LPs are choosing which managers to invest with.”

Blockchain: The next frontier

The buzz around the technology in private markets is growingBlockchain

Certainly, it is a technology that could address many of the fundamental challenges of fund administration, notably the need for transparency. “Private markets are one of the best use cases for blockchain that I have seen,” says Eric Berstein, president of Broadridge Investment Management Solutions. “The volumes are not terribly high. The data is far from standard. The potential benefits could be huge.”

Those benefits include a single source of immutable data, accessible by LPs, GPs, service providers and regulators, as required. Everything from investor onboarding to drawdowns can then be dropped onto the blockchain, creating potentially huge efficiencies.

Fund administrators have been exploring a number of different theses when it comes to the distributed ledger aspect of blockchain, including the case for using blockchain to immutably house all the pertinent AML and KYC information for investors looking to deploy capital across different geographies and asset classes.”

Take up so far has been limited, however, and that lack of participants is, in itself, hindering progress. “It is a chicken and egg situation,” says Bernstein. “The more people who play, the better it gets for everyone.”

But there seems little doubt that blockchain is coming to private markets. Regulators and auditors love the concept of a digitized and immutable system, and a small number of firms are now actively exploring its use.

“As that happens, the benefits will be felt by fund administrators, GPs and ultimately LPs,” Bernstein explains. “The minute those LPs see the difference blockchain makes in terms of speed and transparency they will start demanding the same of all their managers and their administrators. There will always be first movers. But when the big sovereign wealth funds and pension plans start to pound their fists on the table, the rest of the market will follow.”

Chief among LP demands is access to accurate, timely and homogenized data. Those demands are only going to increase, according to White. “GPs are going to turn increasingly to the service provider community to solve their data challenges.”

Furthermore, GPs are starting to understand the value of the data they are sitting on and are working to use it to differentiate themselves. Gaining insight to support decision-making is critical and that means significant investment in technology.

“The increasing complexity that arises from these demands for data means that cohesive investment and development of technology tools should be front and center for GPs,” says White. “Being able to provide better outcomes and actionable insights for GPs through data is a huge driver behind our business. This means GPs aren’t just looking at us as providing back-office and investor services; they’re looking at us to solve their current and future data needs and mitigate the need to address this in house.”

Janna Christiana, managing director and head of Broadscope, says GPs want the benefit of best-in-class technology without the associated costs of licensing and the burden of implementing the technology, converting historical data and employing a large staff to train on the systems and maintain the workflows. “Service providers take that burden off the GP’s plate so that they can focus on fundraising and investing activities while maintaining a lean accounting and finance team,” she says.

New challenges

Advances in technology have proved a boon to the GP/service provider relationship. “Technological advancements, such as investor and reporting portals, have allowed for full transparency and accessibility to data, which has gone a long way towards making GPs feel comfortable enough to release full control over their data processing,” explains Christiana.

Alex De Santo, group head of private equity at Crestbridge, adds that technology and digital transformation is also critical to tackling relentless regulation. “Our GP clients need us to deliver timely, accurate and granular data to them and their investors, and GPs rely on us and our technology to do that,” he says. “It’s important, as a fund administration business to ensure we are always pushing the boundaries of technology use. In an increasingly complex and demanding market, we need to always adapt and improve our capability.”

The data requirements of private markets managers have been exacerbated by the trend towards multi-asset-class platforms. “We are increasingly working with managers that may have started out in one asset class before expanding into others, either organically or through acquisition. That brings its own set of challenges on the data side,” says State Street senior managing director Cesar Estrada.

“Consistency across business lines is imperative to sustain the next leg of growth. LPs may also be cutting across different funds and asset classes and will be looking for a consistent experience. Nonetheless, the different asset classes have different data sets that cannot be made to fully overlap. It is important, therefore, to create data models that can facilitate the aggregation and normalization of data to allow for portfolio monitoring across industries.”

Perros says that has particularly been the case where private equity managers have moved into credit strategies, where the processing requirements differ substantially. It could also lead to some consolidation among service providers.

“There has been a noticeable uptick in interest in private credit strategies, distressed debt and hybrid funds, and this has created renewed interest to outsource not just fund administration but also other services especially as it relates to portfolio monitoring, data gathering and validation and transparency reporting,” says Chim. “Overall, we are seeing a narrowing in the number of service providers being appointed – managers are looking for one provider who can deliver a single-source solution across value-add services beyond pure fund administration, in all the locations and global jurisdictions the fund operates and invests in.”

Other rapidly evolving challenges, of course, include cybersecurity, which has been taken to another level with the instantaneous shift to remote working. “We have seen a marked rise in phishing attempts during this period as perpetrators seek to exploit potential cybersecurity weaknesses in the current environment,” says Christiana.

“Cybersecurity is of vital importance,” adds James Duffield, group head of business development at Aztec. “The stakes are so high given the amounts involved. Criminals are always looking for the weakest link.”

Perhaps the biggest new challenge impacting private markets investors’ administration needs, however, is the rapid rise to prominence of ESG. Investors and regulators alike are clamping down hard on the availability and quality of ESG data. “With new reporting requirements in this month, ESG has gone from being just another discussion point to being front and center,” says Duffield. “Reports in the future will need to be comparable to be more useful to investors and charges of greenwashing need to become a thing of the past.”

“Historically, LPs have lightly scrutinized the ESG framework of their GPs – but now we are seeing ESG scrutiny at every level, from investor, to GP, portfolio company, consumer and service provider,” says Di Santo. “It is important, therefore, that GPs demonstrate their attention to ESG through reporting and KPIs. In time, this will become part of the ordinary course of doing business.”