Fund administrators face increasing scrutiny

Susie Peer, Associate Director, Heritage International Fund Managers discusses the increased scrutiny placed on private fund administrators.

The trend towards transparency and deeper investor due diligence on private equity funds is placing more responsibility on third party administrators of private equity funds.

Both US and European investors are seeking the same level of reassurances as they come to better understand where the risks lie, and they are drilling far deeper into the workings of third party administrators.

Due diligence questionnaires are the first level of this deep dive. Core service providers must provide detailed intelligence on corporate information, compliance, IT systems, banking and valuation processes. Much of this isn’t new, but these questionnaires are now more frequently the starting point for a more detailed exchange.

Investors will cross-examine third party administrators on enquiries and concerns relating specifically to the controls and processes that the business has in place. Administrators are, with greater frequency, expected to participate in due diligence conference calls with investors before they commit to the investment.

The credentials of administrators themselves are also under scrutiny. In the past, investors might have been content with their own due diligence procedures. Now they want to view assurance reports, such as those prepared under ISAE 3402 where the control environment and processes are evaluated by an audit firm.

Where fund administration is regulated, investors want to understand the levels of reporting required by the local regulator and the obligations administrators are under, and most importantly, that they are meeting them. The tax regulatory environment is also creating greater workloads for administrators with the implementation of FATCA and now CRS building in new reporting requirements.

The lack of uniform obligations from state to state in the US means that administrators may need to provide different information depending on which state an investor is resident in. Changes in tax legislation can also create additional layers of transfer agency work for administrators as investors themselves keep up to date with evolving tax rules and modify the way in which their investments in private equity funds are held.

Investors are also paying greater attention to service level agreements between a private equity house and a third party administrator. While some detail may remain confidential due to commercial sensitivities, they nonetheless want to know how and with what frequency such agreements are reviewed.

The segregation of duties between the two parties is also under scrutiny. Investors want complete clarity over where responsibility lies for key risks, which party owns specific controls and processes and how this division of duties is handled. Where a risk is seen as residing with the administrator, investors are demanding greater transparency on how any failing might impact on overall performance.

Investors are paying far more attention to the amount of fees paid to the manager and on how these fees are calculated, requesting validation that the level of fees is accurate based on these calculations and that they are in line with the limited partnership agreement and any side letters in place. Another area of focus is investors’ desire to see that the administrator continues to police and verify all fees on an ongoing basis.

The IT function of an administrator is also a primary consideration for investors. The increasingly technical lines of questioning put to administrators frequently necessitate an IT professional’s participation in any due diligence call. They will be required to provide evidence of competency surrounding web-portals, operating systems and banking interfaces; they might also be cross-examined on protocols for cyber-security, particularly in relation to client communications, firewalls, infrastructure and backup systems.

Investors will also seek reassurance that the third party administrator has overall IT capability and resource to develop software and create reporting bespoke to their needs. With an increased awareness of fraud, investors want to be sure that administrators have robust systems to mitigate any risk of sophisticated fraudsters successfully infiltrating communications, particularly those concerning changes in payment instructions.

Extra emphasis on transparency creates a significant increase in the volume and frequency of reporting, from annual or half-yearly to – more typically – quarterly reporting. The reports themselves need to be far more detailed and bespoke. As a matter of course, many investors demand full ILPA-compliant reporting; this can be seen by some as the kite-mark standard.

While no industry should shy away from embracing higher levels of professionalism, the level and nature of due diligence and scrutiny faced by administrators has increased exponentially. In an environment where private equity houses are keen to deliver whatever is required to secure investor funds and where there is a perception that ever greater checks and balances are required to protect investor interests, it is unlikely that there will be a reversal in this trend any time soon.

Susie Peer is an associate director at Heritage International Fund Managers 

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