By Penny Davenport, managing director at Markit Document Exchange
In 2008, “credit crunch” has become part of the common vocabulary used across all types of media from business programmes to style magazines. According to Wikipedia, a credit crunch is a sudden reduction in the availability of loans or credit, or a sudden increase in the cost of obtaining a loan from banks. There are a number of reasons why banks may suddenly increase the costs of borrowing or make borrowing more difficult. This may be due to an anticipated decline in value of the collateral used by the banks when issuing loans, or even an increased perception of risk regarding the solvency of other banks within the banking system.
One of the results of this squeeze is a slowdown in new business in the financial system and this, in turn, impacts profitability on both the sell side and the buy side. As profits are hit, in order to maintain margins and returns to investors, costs are managed more tightly. However, at the top end hedge funds, investment managers and asset managers, there is very little appetite for compromising on quality, even in a cost cutting environment. Therefore, the buy side are looking for creative ways to take cost out of the business, using services that maintain the highest standards.
One area where buy side firms can improve the quality of their operations, but at a reduced cost, is in the area of performance reporting. Hedge funds distribute their price and performance information to a range of parties, including investors and fund administrators, on a regular basis. This type of reporting is typically handled bilaterally between the fund and the investors and it can be inefficient and slow.
Fund administrators often have to gather, validate and process information manually from a range of sources in different formats. However, services such as Insidehedge bring centralisation as they collect relevant pricing information from the funds, using specialist technology and dedicated teams, and deliver it to investors and administrators in a standardised manner. This facilitates operational efficiency and reduces operational risk. This platform and others like it are secure and ensure confidentiality for participants.
Another area where improvements are being made is with respect to the Know Your Customer (KYC) rules. The burden of the KYC process falls mainly on banks and broker-dealers and the regulatory environment has become increasingly intense. However, there is a significant knock-on effect on their customers in terms of the frequent provision of information and documentation.
This is heightened by the fact that the regulations are different across jurisdictions and in many cases are based on recommendations and best practice, as opposed to being prescriptive. The provision of bespoke information to different dealers, and multiple desks within dealers, is one of the great ‘intangibles’ of doing business and the buy side are looking at lower cost ways of meeting this need but at a higher quality.
Markit Document Exchange addresses this inefficiency by providing a centralised, secure hub which hosts documentation for the buy side. Users upload their relevant documentation into this electronic filing cabinet and then permission it to their sell side counterparties. The permissioning is done at the document level, which enables total control of these sensitive documents, by the buy side.
It is a very simple solution to an expensive problem. Part of the value derives from the fact that the platform replaces repetitive emailing. Not only are documents uploaded once, but there is also a detailed audit trail that tracks which documents have been provided to the sell side and who exactly has accessed them.
Further value derives from the fact that this is a ‘one to many’ solution, which saves considerable time over bilateral emailing. Although Markit Document Exchange was developed with a focus on the KYC process, it has become a significant part of the monthly credit reporting processes for participants who use the platform to distribute net asset value (NAV) and assets under management (AUM) statements. The benefits that accrue from the ability to distribute documents more efficiently and in a more organised manner are buoyed by considerable cost savings. One hedge fund with 12 funds estimates that it saves 1 FTE by using the platform.
Further cost savings can be generated by the buy side, without compromising on quality, by using a fund administrator. Fund administrators provide independent, flexible middle and back office, administration and risk measurement services to hedge funds, fund of funds and institutional investors.
Fund administrators, such as GlobeOp and JPMorgan Fund Services, enable fund managers to leverage their time and operating costs more effectively by outsourcing a variety of middle, back office and fund administration processes. Typically, fund administrators provide best of breed technology, which would be difficult for a fund to match internally without major financial investment. Standardisation, shared resources and talent, and scalable infrastructure allows for functions to be performed at a much higher standard but at reduced cost. Opportunities to offshore staff can be leveraged by fund administrators in a way that would be significantly more challenging for the funds themselves.
For the fund managers, there is limited opportunity to generate profit in managing the investment process after trades have been executed. There are costs that can be minimised and operational risk that can be mitigated. Fund administrators provide services that can lower and scale that cost and mitigate the risk of operational errors.
There is no doubt that 2008 will be remembered as a tough year in the financial markets and one where sales cycles have been extended for all types of service providers. However, there are still opportunities to be mined especially when the providers are able to offer cost savings to the buy side, whilst even improving efficiency and quality.
Penny Davenport is managing director at Markit Document Exchange