The rising tide of regulatory and compliance requirements for hedge fund managers are prompting some to look at using ‘shadow’ fund administrators as a check on their primary administrator.
Interest in the practice has grown since $120 billion US hedge fund Bridgewater Associates hired Northern Trust last year to ‘shadow’ fund administration work being been carried out by BNY Mellon.
This is something that has been going on in Asia for some time, says Michael Langton, head of sales and marketing at Quality Risk Management & Operations. Hong Kong-based QRMO provides outsourced risk management services, including shadow fund administration.
However, Jeb Altonaga, Asia-Pacific head of Northern Trust hedge fund services, feels shadow fund admin is unlikely to be of interest to many firms Asia, at least for now, due to the smaller size of funds in the region.
In any case, Asian hedge fund managers are generally strengthening their risk management processes in response to tighter and more wide-ranging regulations, notes Langton.
Fund executives admit they are spending an increasing amount time and resources coping with the growing wave of regulation.
While not regulated directly by the US or European regulators, managers in Asia are still caught by the reporting and clearing requirements of the US Dodd-Frank Act and the European Market Infrastructure Regulation, by virtue of them signing International Swaps and Derivatives Association agreements with US or European entities. (Isda is the most commonly used legal documentation governing over-the-counter derivatives trades between two counterparties.)
Langton says some Asian regulatory requirements could also be onerous, especially for smaller managers in the region. For example, Australia’s short reporting requirements are relatively burdensome, as they require manager to have Fix connectivity with the regulator and report short positions on a daily basis, he says.
“Many execution management systems and order management systems can cover most front-office functions required by traders, portfolio managers and chief investment officers,” he notes. “However, where they tend to fall short is in the middle and back office.”
Certainly the likes of Citi, Northern Trust and State Street have been touting their services as outsourced middle-office specialists, in addition to the back-office functions they already provide.
But not all of them are positioning themselves as shadow fund administrators. Some have chosen to offer shadow fund admin services, either as a ‘full’ shadow offering services from post-trade execution all the way to NAV calculation; or ‘partial’ shadow focusing on some middle- and back-office functions.
For instance, Northern Trust will roll out its tri-party reconciliation solution in Asia this summer that will enable hedge funds to monitor their firm’s risk profile more efficiently.
Altonaga says it is aimed at helping managers address problems associated with reconciliation breaks – that is, when there are discrepancies between the valuations in an asset manager’s front-office order management system and in the systems of their brokers and custodians. This could be caused by trades being booked at different cut-off times by the three parties.
“If the reconciliation break is only rectified in the back office, the correction is not reflected in the front office to the traders in real time, as it may take a couple of days for such data to match across all parties and be resolved,” says Altonaga.
Tri-party reconciliation aims to ensure data is accurately matched across all three parties in the reconciliation process – the front-office system, broker and fund administrator – so that traders get a true view of positions.