The smart money is choosing co-sourcing for fund services

Private capital firms will be spending more on cloud and desktop technologies than ever in 2023. They are under intense pressure to streamline amid higher costs, a turbulent financial sector, new regulations and more compliance burdens.

Many private equity, venture capital and funds of funds are turning to co-sourcing as they adapt to these fast-changing market conditions. Almost 95 percent of private companies will consider co-sourcing tax and finance activities over the next two years, according to EY.

The co-sourcing approach to fund administration and financial services is increasingly popular because it’s a tech-driven solution that grants firms absolute control over their data, better ensures compliance, and maintains security.

It’s true that co-sourcing comes at a cost that is generally higher than pure outsourcing because firms need to spend on software licenses and absorb other expenses when they possess their data. Those with sufficient assets under management, however, quickly see the value that they receive from co-sourcing in exchange for the cost.

Co-sourcing firms are free to hire the most innovative fund administrators who know their software’s capabilities and have the industry expertise and sensibility to manage and leverage their financial data. In the end, if co-sourcing is done correctly, general partners will unequivocally receive better service, especially those who partner with service providers that bring automation and other innovative technologies to bear on their work for clients.

Co-sourcing relies on cloud computing and shared platforms. Firms never lose control of their data, so their investment is far less risky and time-consuming than when they export that information to a third party. But they still enjoy the benefits of service providers who can best perform the fund administration and financial services that allow them to focus on strategy rather than back-office functions.

Switching providers with ease

These firms can also part ways with service providers easily under co-sourcing arrangements. A new administrator simply takes over where the previous one left off. One might argue that firms are already free to fire and hire fund admins at will. But fund managers are justifiably leery of switching fund administrators without serious forethought and preparation. The risk of losing data or access to data or jeopardizing fundraising and other operations is too great.

Co-sourcing makes these decisions easier and more predictable. If firms are self-administering or have parted ways with a service provider, co-sourcing allows a new fund administrator to simply step in and work directly inside whatever system a firm has set up. All they need is a username and password.

Most importantly, co-sourcing is essential to compliance. Proposed SEC rules will require firms to track and know more about their service providers. Those who can’t do so will face trouble. Maintaining control of data and the mechanisms to monitor how service providers use that data at all times will be the gold standard for compliance.

Formerly reactive by nature, compliance officers today have shifted into strategic roles in their organizations, including risk management and broader advisory services. Compliance leaders therefore must continuously reevaluate their operations to become more future-facing, an evolution that’s easier when they can add or remove capacity as their workflows require.

That’s why co-sourcing appeals to firms seeking to demonstrate how they are comporting with investor priorities. They like to have systems that assure their stakeholders that they are using valid and auditable data as evidence for their decision-making and the claims they make about their performance.

Here are four ways that co-sourcing flexibly serves the compliance needs of private capital today:

• Helping compliance officers focus on programs, management, and strategic planning, co-sourcing can boost productivity
• Managing compliance, improving metrics, and setting benchmarks, co-sourcing facilitates firms’ efforts to develop wiser data strategies
• Evaluating risks and risk mitigation measures, co-sourcing is an excellent response to recent SEC rules mandating firms to conduct due diligence and monitor service providers
• Retaining data crucial for auditing, co-sourcing mitigates risks associated with third parties, chain of custody, and similar issues

There’s a reason so many firms are exploring co-sourcing. At a time when new regulations, new financial conditions and new disruptions have become commonplace, it’s the smartest, most innovative way forward in fund administration.

Michael Trinkaus is chief executive officer at 4Pines Fund Services.