The parties to any single trade, be it the fund manager, the custodian, the investor or the administrator, are incorporating a degree of estimation in the course of the transaction process. It is still difficult to operate otherwise. Each participant is using different parameters to view mission critical data and communications. Each still relies on paper-based processes and spread sheets to manage billions of dollars of alternative investments. But can any of them express with 100% confidence that a specific trade is at a specific location in the transaction trade at any given time of the day? And can they put a value to it when they do find it?
At this juncture in time we stand in an industry that is becoming increasingly institutional, with over 60% of the assets being managed by hedge funds now originating from institutional clients. The client complexion of the industry has changed while the legacy technology in use within many firms harks back to an earlier and simpler era.
Technology issues are becoming a bottle neck for institutional investors, particularly with regard to managing and reviewing hedge fund portfolios. This is creating a demand for a more proactive and integrated approach to client reporting using technology that has the ability to break down the different components of the hedge fund trade. By bridging these operational processes, institutional investors can manage and review accurate data with a higher degree of confidence.
The scale of the problem facing the industry has been highlighted by Swift’s SHARP (Swift Hedge Funds Harmonisation Project) initiative. Swift identified a number of key operational issues within the hedge fund transaction process. While custodians and administrators can handle the paper trail when transaction volumes are low, the largest service providers to hedge funds now process well over 1000 transactions every month. Each order may come with up to 50 pages of documentation attached. A typical team within a hedge fund administrator might be handling 600-700 orders with a dedicated staff of a dozen or so. Apart from reconciling data with their own records, they must also ensure investors are complying with KYC and other regulations.
Because subscriptions processing is time consuming and error prone, the entire cycle from the time when the order is taken to taken until confirmation is received and accounts are reconciled can be as much as a month. Faxes of subscription agreements must be sent to transfer agents, which in turn must be confirmed by phone, with final documents being sent over by courier.
For a fund with monthly liquidity, these transactions can prove costly, particularly if the market has moved. Missing a deadline for an order could lead to a fund holding unnecessary cash, while a missed redemption deadline would leave a fund exposed to an unwanted position for another month, quarter of a year or more.
If funds restrict liquidity, or extend their lock-in periods, or raise gates, the risks of moving transactions in and out of funds grows. It is still very hard for custodians to provide funds of funds with accurate status reports, particularly when they are bombarded by faxes from administrators and transfer agents at the end of the month. For larger custodians, with dozens of service providers to deal with, the problem is only magnified.