Leading business advisors Fund administration in Ireland survey 2012 Managing uncertainty Fund administration is one of the great success stories of the Irish economy. From humble beginnings in the early 1990s, the Irish funds industry has become a global player, servicing assets in excess of US $2.4 trillion and employing 11,000 people. 1 These assets are held in both Irish and non-Irish investment funds across the traditional and alternative asset classes. Ireland continues to benefit from the trend towards onshore, regulated funds and the jurisdiction has attracted a whole new wave of fund administrators in recent years. Yet fund administrators globally are facing increasing challenges related to market uncertainty, regulatory change, cost and fee pressures, operations and service levels. These trends were confirmed by our recent Fourth Annual Global Fund Administration Survey. 2 In our Fund Administration in Ireland Survey we aim to drill down into these findings and gain further insights on strategy and operations as well as views on specific regulatory changes such as the Alternative Investment Fund Managers Directive (AIFMD), Foreign Account Tax Compliance Act (FATCA) and corporate governance. The findings reveal the extent of the uncertainty and challenges facing fund administrators in the current environment, when fees may be falling due to asset volatility but client and regulatory demands on administrators are increasing. How do administrators future proof their business models, enhance their profitability and provide more value added services? In the following pages we set out the key industry issues, views and priorities as articulated by Irish fund administration CEOs. We hope you find the survey report an insightful barometer of industry trends. Regards, Foreword Brian Forrester Partner, Investment Management Advisory 1. Based on statistics from the Central Bank of Ireland and the Irish Funds Industry Association. 2. Available at http://www.deloitte.com/view/en_IE/ie/industries/financial-services/investment-management/131640cc51512310VgnVCM2000001b56f00aRCRD.htm 2 Contents Executive summary 4 Strategy and operations 7 - Overview 7 - Costs and market uncertainty 7 - Service levels 7 - Revenue growth 8 - Product growth 9 - Fee models 10 - Human resources 10 - IT systems 11 - Process and productivity initiatives 11 - Looking to the future 12 Regulatory change 13 - Overview 13 - AIFMD 13 - FATCA 16 - Fitness and Probity regime 18 - Voluntary corporate governance code for fund service providers 18 - Central Bank outsourcing regime 19 - The regulatory horizon 19 Conclusion – it’s a balancing act 20 Appendix – respondent profile 21 The survey was carried out in December 2011/ January 2012 and all companies providing fund administration services in Ireland were invited to participate. We received responses from 17 fund administrators, accounting for 80% of assets serviced in Ireland. 3 Respondents service a mix of both traditional and alternative investment funds and include both large scale and smaller fund administrators. Finding a balance In addition to regulatory change, the survey found that Irish fund administrators face challenges in relation to cost and fee pressures, market uncertainty, increasing client demands and pressure on service levels. The pressure on costs and fees is closely related to the ongoing market uncertainty. Administration fees, typically calculated as a proportion relative to net assets, are negatively impacted by the current asset volatility and smaller fund launches. On the upside, administrators are buoyed by new business and additional volume from existing clients. New entrants to the Irish fund administration market in recent years confirm the strength of Ireland’s service offering as a centre of excellence for regulated funds. Administrators continue to invest in their business to drive efficiencies through technology and the development of talent while low staff turnover has also enhanced productivity. Add in the increased business levels associated with a move of product onshore and it is clear that opportunities exist for fund administrators, even in this uncertain market. Cost and fee pressure The imperative to drive down costs has resulted in ongoing efficiency initiatives and consolidation, which in turn leads to further fee competition. Fund administrators are being asked to do more by their clients since the financial crisis, as investors demand more frequent and detailed reporting. Over time administrators can find themselves taking on ancillary activities for which they are not necessarily remunerated. Administrators are also concerned about service levels as they balance cost efficiency programmes with increasing client demands and business growth. In response to these challenges, some fund administrators expect changes to fee models, such as charging individual fees for non-core services. However, in light of competitive fee pressure the scope for charging higher fees may be severely restricted. Strong revenue growth Irish fund administrators are bullish on revenue growth with almost 40% of respondents projecting increased revenues of over 20% for the financial year 2011. This revenue growth is mainly attributed to new client take-ons and additional volumes from existing clients. The roll-out of new services plays a role but to a lesser extent. The fund administration business model is clearly focussed on continued expansion but challenges around cost containment and fee pressure indicate that a greater focus on client profitability may be required. Executive summary 3. Based on the analysis of data from the Lipper Ireland Fund Encyclopaedia 2011-2012. The fund administration business model is clearly focussed on continued expansion but challenges around cost containment and fee pressure indicate that a greater focus on client protability may be required. 4 Low staff turnover According to responses staff turnover is at an all-time low of 6% which helps service levels, but fund administrators may continue to face resourcing pressures due to rationalisation. While the recruitment of general staff is no longer a significant issue in the Irish labour market, experienced hire recruitment can prove challenging. Efficiency initiatives Many fund administrators have already implemented efficiency initiatives and set up low cost offshore centres. Further efficiency programmes alone may no longer deliver the desired level of cost savings in the current environment and in a more uncertain market, fund administrators may not be able to rely as much on continued expansion to ease cost pressures. Industry consolidation and rationalisation is likely to continue in response to the cost reduction imperative. However, fund administrators will also need to re-focus their business strategies with a greater emphasis on client profitability, targeting of key client segments and the provision of value- added services to achieve a more sustainable business model over the longer term. Rebalancing the fund administration model Assess client profitability vs. cost to service - Is supporting this client viable? Target client segments - Match your service offering to the right clients New services Value added, middle office Strategic initiatives Mergers, consolidation, alliances Operational efficiency Automation, standardisation, work practices, offshoring, outsourcing, staff development Managing regulatory change This survey considered only some of the regulatory issues that will impact Irish fund administrators in the years to come. The findings show that while regulatory change will create an additional compliance and operational burden, some regulation may also present opportunities for the Irish fund administrators. How fund administrators respond to regulatory change will have a significant impact not only on their operations but also on their market positioning and client perceptions. AIFMD opportunities but also challenges AIFMD will have significant strategic, compliance and cost impacts for the global hedge fund industry, however a majority of Irish fund administrators do see potential business opportunities. These include the setting up of regulated onshore product in Ireland and the provision of a new range of services as fund managers seek to outsource complex data and reporting requirements. Fund administrators are highly concerned by the AIFMD’s depositary liability regime and to a lesser extent by the valuation rules and operational requirements. FATCA compliance burden FATCA is generally viewed as a business threat due to the onerous reporting and withholding requirements that will come at significant cost and risk for funds and their service providers. For many respondents these implementation and compliance costs outweigh any potential benefits of FATCA from a service provider perspective. Administrators are concerned over the uncertainty surrounding the regulations and the impact FATCA will have on asset gathering and the distribution network. The application of withholding on investors is viewed as the single greatest challenge under FATCA. 5 Corporate governance – not a significant challenge for Irish fund service providers The majority of administrators did not consider meeting the Fitness and Probity regime to present a significant challenge. The aspect of the regime that causes most concern is the implementation of new due diligence procedures, which are very robust when benchmarked internationally. Respondents were overwhelmingly in favour of the adoption of a voluntary corporate governance code for fund administrators. Irish fund administrators clearly recognise the importance of corporate governance and embrace the concept of a voluntary code tailored to the industry. The ndings show that while regulatory change will create an additional compliance and operational burden, some regulation may also present opportunities for the Irish fund administrators. 6 Strategy and operations Overview Survey respondents were asked to identify the key strategic and operational issues facing fund administration CEOs today. This excludes regulatory change which is dealt with separately in the survey. The results can be grouped into three tiers of concerns weighted by their relative importance. The top tier of concerns relates to cost pressures and uncertainty. The second tier includes issues around service levels. The third tier encompasses a wide range of other important issues on the business agenda which are generally less critical for most Irish fund administrators. The survey also delves into fund administrators’ views on growth and revenue, human resources challenges, process and productivity initiatives and system development budgets. Strategy and operations Key issues facing CEOs Costs and market uncertainty Cost containment ranks as the strategic and operational issue of greatest concern, closely followed by market uncertainty and pressure on fees. Cost containment has consistently featured as one of the key issues facing fund service providers globally in recent years and its number one position in the current environment comes as no great surprise. The pressure on costs and fees is closely related to the ongoing market uncertainty as asset decline negatively impacts fee margins. Fee arrangements agreed some time ago were dependent on an expectation of AuM growth which may not have materialised. Smaller fund launches due to market uncertainty and scarcity of capital also exert pressure on service provider fees which become very significant for funds that launch under €100 million and do not achieve scale. With distribution, operational and compliance fees now typically accounting for 58% of the TER in Europe 4 , fund managers face increasing margin pressure as their costs have risen while investors simultaneously demand lower fees. Fund administrators have in turn been feeling pressure from asset managers to keep fees and subsequently costs down. The benefits of consolidation, economies of scale and automation have continued to intensify competition and exert pressure on costs and fees. This means that the scope for administrators to negotiate higher fees at the bid stage may be extremely limited. Fee models are considered in more detail on page 10. The high levels of debt and slow growth in Western economies, the protracted Euro crisis and the resulting financial instability mean that global markets are filled with uncertainty about growth prospects. Fund administrators are concerned by these events and are unsure how they will impact their clients’ business prospects over the medium to longer term. This uncertainty makes business planning more difficult and reinforces the need to keep costs in perspective. Service levels A second tier of key challenges facing fund administrators can be grouped around service scope creep and maintaining service quality. Over half of respondents found increasing client demands and managing the associated service scope creep to be a key issue for their business in the current environment. Since the poor fund performance in 2008 with associated gatings and suspension of redemptions, investors have demanded more frequent and detailed risk reporting. Ad hoc requests from clients can become permanent and more frequent without specifically being included in the service level agreement. Over time administrators can find themselves taking on ancillary activities which may require significant additional resources but for which the administrator is not remunerated. 4. EFAMA, ‘Fund Fees in Europe’ survey, Oct. 2011. No. 1 Costs and uncertainty Cost containment Market uncertainty Pressure on fees No. 2 Service levels Increasing client demands Service scope creep Maintaining service quality Managing growth No. 3 Various Distribution support Technology/systems Risk management Increased competition Process redesign 7 A third of respondents saw challenges in maintaining service quality, an issue that was also highlighted by over 40% of respondents in our global survey. The sharp reduction in staff turnover in recent years undoubtedly had a positive impact on service quality as experienced staff are retained. 5 Indeed only 13% of respondents saw resourcing as a key issue. However, recent years have also seen administrators reduce staff numbers, become leaner and implement offshoring and outsourcing programmes in a bid to reduce cost. This brings additional challenges on administrators who need to ensure their outsourced service providers deliver to a high standard. Bullish on revenue growth All survey respondents expected positive growth for the financial year ending 2011, with 46% projecting up to 10% growth and a further 15% projecting between 10 and 20%. Most surprising was that 39% of Irish fund administrators predicted that their revenue would grow by over 20% for the financial year 2011. While fund administrators face strong pressure to contain fees and costs, the take on of new clients, additional volumes from existing clients and the provision of new services continue to drive revenue growth. Strong revenue growth set against fee pressure and a drive to contain costs is also comparable with the findings of the Deloitte Fourth Annual Global Fund Administration Survey, although respondents to that survey were significantly less bullish about their revenue growth prospects in comparison with their Irish counterparts. Expected levels of revenue growth for financial year ending 2011 46% 39% 15% 0% - 10% >20% 10% -20% Percentage of respondents 0% 10% 20% 30% 40% 50% All respondents attribute the growth of their business to the take on of new clients while additional volume from existing clients also represents a major source of revenue growth. Half of respondents attributed growth to the rollout of new services, making it a significant but less important source of revenue growth. The fund administration business model is clearly focussed on new wins but set against the key issues of cost containment and pressure on fees there may be an increased need for greater focus on client profitability. A detailed assessment of client profitability can help to reveal “hidden” servicing costs and lead to more effective overall cost management and a subsequent increase in margin. Principal drivers of revenue growth 100% 86% 50% New clients Additional volume from existing clients New services 0% 20% 40% 60% 80% 100% Percentage of respondents Furthermore, the survey suggests that fund administrators may not be fully maximising the opportunities to provide additional, value-added services to investment managers. With both investors and regulatory authorities requiring additional oversight, controls and reporting, there clearly is scope for fund administrators to provide more middle office services. With the correct technology investment, middle office services can attract higher margins than back office administration. 5. See the human resources section on page 10. 39% of Irish fund administrators predicted that their revenue would grow by over 20% for the nancial year 2011. 8 Hedge funds and UCITS will both drive product growth Fund administrators expect hedge funds to be the fastest growing product over the next 12 months. This undoubtedly reflects Ireland’s position as the leading centre for hedge fund administration and the general trend towards regulated products. UCITS will also drive product growth. In light of strong demand for sophisticated UCITS in recent years, it is perhaps surprising that fund administrators now expect traditional UCITS to contribute more to growth. Could the findings mark a shift for some hedge fund managers away from sophisticated UCITS towards more flexible regulated products such as the Qualifying Investor Fund (QIF)? Statistics from the Central Bank of Ireland confirm that the QIF is the fastest growing product in Ireland, with assets now exceeding €181 billion. 6 The uncertainty surrounding the Alternative Investment Fund Managers Directive (AIFMD) that pushed many fund managers towards UCITS may now be dissipating. Or perhaps managers may now have concerns about the potential impact of UCITS V and the ongoing discussions about complex UCITS. Fastest growing products over the next 12 months 20% 11% 17% 23% 29% 0% 5% 10% 15% 20% 25% 30% Other ETFs Sophisticated UCITS Traditional UCITS Hedge funds Percentage of total responses Respondents were asked to explain what their business is doing to capture this growth. The results revealed an increased focus on marketing and business development, building new service offerings and investing in new technology. Several respondents planned to recruit additional relationship management staff and to focus on profile and brand building. Traditional marketing and business development activities such as conferences, face-to-face meetings and targeting gatekeepers were mentioned, as well as more innovative techniques such as social media. 6. The net assets of QIFs grew by over 20% between January and December 2011. Source: Central Bank of Ireland. Front office Back officeMiddle office Trade support Risk management Cash management Trading systems Fund (in-house) Fund administrators Custodians Activity can be performed completely or in-part by the party Value added services - untapped growth potential? 9 Are fee models set to change? With pressure on fees highlighted as one of the key issues facing the industry, it is somewhat surprising that 43% of respondents foresee no change in fee models. However, this implies that 57% of respondents do in fact foresee some change in the way fees are charged. With the level of competition in the market it may be difficult to introduce an innovative fee model, but de-coupling the administration fee from the level of assets has to be the way forward for fund administration. Respondents who anticipated change to fee models most frequently cited the charging of individual fees for “non-core” services. This reflects the concern fund administrators have over service scope creep and if value added services are provided these can be billed separately. Do you expect to see a different fee model for fund administration in the future? 7% 7% 14% 29% 43% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Transaction based fees Other Higher minimum fees Individual fees for "non core" services No change Percentage of respondents Human resources Staff turnover has reached an all-time low of 6%, based on the average of survey responses. Staff turnover has fallen dramatically in recent years from a peak of 29% in January 2007 7 before the Irish economy entered recession. The sharp reduction in staff turnover has positive impacts not only on recruitment and training costs but also in terms of minimising disruption and building experience within the client service teams. While recruitment of staff is no longer the challenge it once was, recruiting suitably qualified specialist staff can be difficult. In fact, experienced hire recruitment is the key HR issue for the industry, with 69% of respondents identifying this as their main challenge. The need to service increasingly complex client requirements and manage regulatory and business change are also factors driving demand for experienced, senior hires. One of the main responses to this challenge is to focus on the provision of training and upskilling staff internally to meet the requirements of more senior or specialist roles. Encouraging internal mobility, recruitment within the group and advance hiring are frequently used to address the challenge in finding experienced and skilled staff. Just over half of respondents identified compensation as a key challenge, making it the second most frequently mentioned HR issue. There are undoubtedly two stands to the compensation challenge. Firstly, as companies continually seek to reduce costs it becomes harder to maintain, let alone raise salaries. Staff are effectively being asked to do more for the same or less salary. This has led companies to focus on wider benefits packages, work/life balance policies and leadership programmes to incentivise, develop and maintain the right employees. Secondly, the challenge of recruiting experienced specialist staff means that certain employees can use industry wide competition for their skills to request higher salaries. Salaries for hard- to-fill positions requiring experienced people with the right skills (e.g. business analysts, risk and compliance specialists, project and change managers, senior fund accounting and TA roles) could be prone to increases as a result of demand. 7. IFIA Investment Fund Industry Employment & Staffing Survey 2011. 57% of respondents foresee some change in fund administration fee models. 10 [...]... The survey was carried out in December 2011/ January 2012 and all companies providing fund administration services in Ireland were invited to participate We received responses from 17 fund administrators, accounting for 80% of assets serviced in Ireland. 10 Respondents service both traditional and alternative investment funds and include both large scale and smaller fund administrators Number of sub funds... of Irish fund administrators see the Alternative Investment Fund Managers Directive (AIFMD) as a business opportunity This positive view of AIFMD is undoubtedly rooted in Ireland s position as an EU regulated fund administration centre and the global leader in the servicing of alternative investments Ireland has a strong track record in regulating hedge funds through the Qualifying Investor Fund (QIF)... It’s a balancing act Fund administration in Ireland is thriving due to a growing client base and new volumes from additional business The move to onshore, regulated product will continue to drive business in future, as will increasing demand for new services Yet fund administrators also face a range of challenges in the current environment from cost and fee pressures to market uncertainty, regulation... outsourcing requirements apply to the administration of both UCITS and non-UCITS funds and Irish domiciled and non-Irish domiciled funds Under the regime “core administration activities” involving oversight and control cannot be outsourced while the fund administration company retains ultimate responsibility for any outsourced activities A resounding 100% of respondents indicated that the new outsourcing... Ireland or relocated more activities to Ireland Business process re-engineering initiatives IT system development budget for 2012 Percentage of respondents that have implemented or intend to implement business process re-engineering initiatives 100% Workflow / automation of manual tasks Increase 60% 93% Staff training and development 64% improved work practices 27% Offshoring Decrease 57% Relocation onshore... largest fund administrators.8 Economies of scale are a key competitive factor in fund administration yet the number of administrators operating in Ireland has remained static over the past number of years This is because any reductions in the overall number of administrators due to mergers are offset by new market entrants following the trend towards onshore, regulated funds.9 As cost pressures increase,... Looking to the future Given the extent of efficiency initiatives already underway and with ongoing margin pressures, administrators may look to consolidation as a way to build scale, further reduce costs and increase margin A series of scale-driven mergers has taken place across the Irish funds industry since the mid 2000’s, with 71% of assets serviced in Ireland now concentrated in the five largest fund. .. This survey focuses on selected regulatory changes affecting fund administrators in Ireland, including the Alternative Investment Fund Managers Directive (AIFMD), the Foreign Account Tax Compliance Act (FATCA) and various corporate governance changes AIFMD and FATCA are undoubtedly the two key pieces of regulation nearing implementation that will have the greatest impact on the Irish funds industry in. .. and productivity initiatives A majority of fund administrators have already implemented or plan to implement various business process re-engineering activities Workflow stands out as the key area of focus, where 100% of respondents have implemented or intend to implement automation processes The vast majority of fund administrators have also focussed on business process reengineering initiatives related... requirements including valuation independence should encourage hedge fund managers to use third party administrators New controls in relation to the valuation of complex or illiquid assets could present an opportunity for fund administrators to provide complex valuation validation services AIFMD – a business threat? On the other hand, a sizeable minority of fund administrators view AIFMD as a business threat . Leading business advisors Fund administration in Ireland survey 2012 Managing uncertainty Fund administration is one of the great. Annual Global Fund Administration Survey. 2 In our Fund Administration in Ireland Survey we aim to drill down into these findings and gain further insights