The Troubles With Transfer Agency

My first material experience of funds’ transfer agency (TA) came in the early 2000s when the problems of transfer agency could be summed up as paper, people and communication, to which could be added a high degree of risk. A decade or so on, the problems appear to continue.
My first material experience of funds’ transfer agency (TA) came in the early 2000s when, through acquisition, we found ourselves a small player in that then poor relation of the fund administration sector. Staff turnover was astronomical, premises and environment were lacking, and staff quality was poor to even poorer. I looked at different fund sector transfer agencies in the market at the time with an open mind on whether to outsource, partner or expand. Those operations were generally willing to discuss all options because they were looking for critical mass, not so much to improve the quality and depth of their offerings but more to reduce unit costs, through economies of scale, to a sensible proportion of available revenues. I realized that, whether based in Luxembourg, Dublin or more exotic locations, they all suffered from the same problems I myself had acquired. And I realized quickly that if the problem was unit cost and staff quality, the answer was cost and skill arbitrage offshore, as long as regulators could be persuaded to allow the basic transfer operation to be run from a remote location.

The problems of transfer agency back then could be summed up as paper, people and communication, to which could be added a high degree of risk. A decade or so on, the problems appear to continue, although there are some moves to alleviate parts of the problem through agencies such as Fundsettle and Vestima.

The paper challenge of a transfer agent is all down to regulation. The KYC requirements have led to two phenomena. The first is the growing importance of the nominee holder in retail funds, which has the advantage of down-streaming all that KYC work. And that is no bad thing as the volume of information needed in the KYC process, from utility bills to passports and other apparently trusted proof-of-identity sources, increases year on year. Without doubt the advent of FATCA, both in its original form but also in the likely emergence of Global FATCA with country-specific unique features, will further exacerbate the information garnering process around any new fund investor. But the volume of information needed, the potential need to ensure that it is current, and the need to store that data—in many countries still in paper rather than electronic form—is like an antediluvian nightmare come true. The task is somewhat simpler in the alternative funds market as they have a lesser number of investors per fund than the retail market. But new legislative initiatives such as the JOBS Act in the U.S. or the emergence of more retail-style hybrid funds embracing long-only and alternative features could change the landscape in that sector.

The people issue is structural. The business is labor intensive, in part, because it fails to make maximum use of available technologies and, in part, because it, like so many old market structures, fails to lobby effectively to bring about the change that is possible, given that would spell its own material downsizing if not its actual demise. The people are tied to paper and the collection, collation, storage and retrieval of that paper. And much of that paper is KYC linked. Markets must migrate this data collection and storage process to electronic utilities, just as they moved from physical certificates in investors’ hands to dematerialized environments.

I have long argued that just as we are moving to trade repositories, we need KYC repositories. It is pointless for an investor in multiple funds to be obliged to provide almost identical information to each of the funds to satisfy an identical need, namely evidence of the investor’s status. This is not only a ridiculous and profligate tax on investors, but it is also a restrictive practice. Although the U.K. and the U.S. have powerful independent fund groups and quite open distribution channels, KYC allows simple cross-selling by banks to their client base and thus, in many markets, as they also control distribution, creates a huge barrier to entry for the independents.

The communication problem opens up the Pandora’s Box of challenges. There is a dichotomy between the critical importance of TA to investor communications and the challenge of training quality staff in a relatively mundane set of duties, especially in an industry where fees per capita are sub-optimal.

And TA is about recordkeeping. The record of fund investors must be accurate and reliable. AIFMD and the new UCITS regulations create an obligation for fiduciaries (including custodians) to ensure the safety of their client assets, although there is that classical “get out of jail” clause in respect of events that are beyond their reasonable control. However, TAs are stated to be within their control orbit as far as can be seen, and TAs historically have several blots in their record books around the accuracy of their investor data. And it is not always easy to evidence that data as many TAs, especially in tax havens, have shown themselves to be allergic to any kind of due diligence exercise other than from the direct investor in their funds. And too many transfer agents are part of the issuer group when best practice would have them (and indeed all fund administration) operated at arm’s length from the originator.

All this adds risk to the market place. There is a high risk of operational error in this labor-intensive and paper-based environment. The internalization of functions within fund groups eliminates independent oversight. TAs are often not transparent to their stakeholders, especially to fiduciaries whom they do not view as their clients. There are commercial risks in poor performance at the TA for it is an important part of the sale execution process. And there are quality risks, which are always evident in areas of business that operate in such a manual environment; machines would be much more efficient and cost effective.

For the future, some key changes are needed—namely an acceptance of electronic data to establish the bona fides of an investor; the creation of KYC data utilities through trusted intermediaries; mandating by regulation the independence and obligations of the TA function; and better quality training for the TAs who act as a business-critical point-of-entry and service for the clients of the funds in their books. The cost of achieving quality could most likely be more than funded from the economies of a move to automation and, of course, standardization of data. But for many TAs that is tantamount to the proverbial turkey voting for two Christmases a year!