The investment management industry operates in a constant state of change resulting from challenges driven by regulators, competitors, and clients. Managers are stretched to meet the demands presented by these challenges which manifest in threats to bottom line profitability. Operational functions often suffer the initial assault from these challenges as managers face pressure to balance their ability to deliver increased services relative to their existing resource pool.
Although tactical outsourcing of certain operational functions can relieve some of the pressure, all operational functions are managed with a laser focus to find and implement a greater level of operational efficiency. The Cecere Group helps investment managers successfully navigate these challenges and find efficiencies.
Outsourcing
Strategic outsourcing of investment operational functions has become the norm in the industry. Partnering with the right outsource provider brings access to their deep resources and allows the manager to execute internal operating model changes. It also brings challenges in managing the provider.
Pros: Reduction in direct staff and related day-to-day management oversight. Access to provider’s resources: (i) trained professionals and the latest technical knowledge base, (ii) current state technology systems, (iii) global work force: “pass the book” or “follow the sun”.
Cons: Addition of peripheral staff to maintain provider oversight governance; KPIs and Service Level Agreement. Quality control give up while retaining liability. Wider disconnect with front office. High hurdles to provider rotation.
Case Study
Middle Office Outsource
Global investment manager outsourced its US and Canadian middle and back office platform to a US bank, which is a leading provider with expertise in middle and back office. The result allowed the manager to consolidate operations and refocus activities on outsource oversight.
Risk & Control
Operational risk arises from failed or inadequate internal processes, actions of individuals, or adverse external events. Nearly all aspects of asset management carry inherent operational risk. Operational risk presents itself in any number of forms. The most obvious are those that occur through human error or oversight and are associated with a specific event, such as a transaction processing error or communication of incorrect information. Less obvious operational risk can be imbedded within a process that is not immediately tied to monetary or data issues. Other areas such as product development or delivery of products may bring risk that may lie dormant until it is realized upon a triggering event. External activities such as outsourced operations bring unique risks that the manager may not be aware of.
In all cases, these risks have to be considered and procedures must be built into the processes that control these events, such as training and transaction review, adherence to pre-established criteria, and oversight of third party activities.
Case Study
Transition Risk Score Card
An investment manager had poor control over the onboarding process and had little visibility into the risks associated with each new client account. Investment manager strengthen process around client intake transitions through added risk controls and financial metrics. This project required a redesign of process to incorporate new controls and metrics
Tax & Regulatory
Global investment managers with multi-jurisdictional operations face challenges to adhere to rigorous tax and securities regulatory requirements. This is the most technically complex area that an investment manager can face. Quite often, these requirements can be difficult to implement in a cross-border setting and at times they may conflict with each other.
International transactions among affiliates are governed by tax rules mandating that business activity be conducted on an arm’s length basis. Failure to demonstrate compliance can lead to punitive tax consequences including subjecting foreign affiliates to US taxation, which is to be avoided at all costs.
Any entity, regardless of its domicile, providing investment advisory services to US domiciled investors is generally subject to registration under US securities law. Although there are special case regulatory exceptions for non-registered entities that provide advisory services, those advisory services must be provided subject to the supervision/direction of a US registered investment advisor and the non-registered entity is limited in the scope of advisory service it may provide. Where the non-registered entity oversteps its permitted scope, it will be considered to be providing advisory services without proper registration which is a serious violation of US securities law and brings stiff penalties.
Case Study
Investment Advisor Deregistration
A global investment manager consolidated its corporate structure by transferring all investment advisory business from their US SEC registered advisor to an affiliated UK SEC registered advisor. The transfer allowed the manager to eliminate regulatory risk in its US entity. This complex project required a fine balance of tax and regulatory requirements
International
International aspects of investments extend to operations and may include unique features not seen in domestic securities markets:
Foreign Tax on Dividends: The US has entered into tax treaties with many foreign countries that outline the agreed tax treatment of transactions that apply to taxpayers of each. In the case of dividend income earned on foreign securities, although the non-resident tax withholding rate may be 25%, the treaty rate may reduce this to 15%. Countries that provide “relief at source” will apply the treaty rate at the time of payment while others will require the non-resident to file a reclaim to recover the excess tax. The tax reclaim process can be complicated and lengthy.
Foreign Exchange: Foreign securities are transacted in their local currencies, which can be funded either through the manager’s execution of an fx contract or the common practice of the custodian’s fx standing instructions. Where the custodian sets the fx rate they do so in the capacity of an independent market participant rather than a client’s fiduciary. This capacity allows the custodian to charge fx rates that can significantly vary from market rates such as those received via the manager’s execution of an fx contract. There can be very little in the way of price transparency where custodian fx is used. Custodian fx is also obscured because the manager isn’t advised of the fx rate until after the transaction has settled.
Case Study
FX Best Practice
A global manager’s clients were experiencing significant markups on fx rates from their global custodians on standing instructions settlements. Clients turned to the manager for a solution who introduced a set of best practices for custodians to adopt.
Private Investment Funds
Private funds are a broad category of investment vehicles used by investment managers to offer a wide range of investment strategies. One of the advantages of offering a private fund for both manager and investor is that it provides scale through the pooling of investor assets. This scale results in a lower cost for both the manager and investor. If the fund meets certain regulatory criteria it can avoid registration under federal securities law and significant costs can be avoided where funds meet a regulatory exemption.
From an operational perspective, private funds operate similarly to mutual funds. Funds will normally have a custodian, if holding depository securities, a transfer agent, and an investment manager. It is quite common for a manager to offer investment strategies via private funds side by side with segregated mandates with the determining factor being account AUM.
Case Study
Private Funds Transfer Agent Outsource
An investment manager had a convoluted and confusing process in place for processing private fund subscriptions and redemptions. The TA function was outsourced to the fund administrator which streamlined the process and added tighter control.