GC Interview: Scott Price of TMF Custom House on Fund Admin Changes

The hedge fund service provider has undergone significant change of late, across the fund administration, prime brokerage, and audit space. Last year, for example, KPMG acquired Rothstein Kass, prime brokers such as Goldman Sachs and Bank of America started asking clients to take their business elsewhere, and most recently, Citi decided to exit the hedge fund administration space. All of this amounts to a changing model, or a reversal to one from 10 years ago, where hedge funds segregate their service providers’ responsibilities, as opposed to bundling everything at a bulge bracket bank, says Scott Price, regional director and head of sales, Americas, at TMF Custom House Global Fund Services.

GC: What direction do you see big banks moving in the fund administration space?

SP: It’s a very interesting time for banking. We’re in a very low interest rate environment, and because of that, banks have traditionally been trying to diversify their services, so not necessarily focused solely on the banking wing. But, and there is a big “but”, fund administration specifically is a very different business than banking, not just from a service delivery perspective, but also just as a core basic service it’s very different from how banks tend to have grown their business from the traditional investment banking means. So what we’re seeing is this shift in the market, where 10 years ago, investment banks getting into the fund admin business were somewhat bundling services together such as prime brokerage, banking and admin services, and that trend has now shifted for a few reasons. I think one reason is headline risk. Obviously some hedge funds are not as successful as they originally thought, and banks are not in a position anymore to tolerate that type of risk from a headline perspective, because it affects other parts of their bank. There’s also the regulatory pressures of segregation of duties and independence, whereby fund administration isn’t necessarily fit into that business model. So especially now we’re seeing clients being exited if they’re under a certain revenue threshold, and now we’re seeing Citi put their fund admin business on the market. What it tells us is that banks don’t necessarily have the appetite for this business.

Fund management companies are very conscious about relationships and are very conscious that the service providers that they engage with will be there indefinitely for their firm, and they have to prove the commitment to the business. Banks have a tendency not to commit to business lines over the long term that are outside their traditional business. I think we’re going back to the model where funds have to know that all of the service providers with whom they engage are independent of each other, whether that’s the auditor being completely independent from the broker, the broker being completely independent from the fund admin, and the bank who’s responsible for the operating bank account is also independent from the broker. So we’re now going back to the old way of doing things from about 10 years ago, where we would see multiple service providers being engaged and not necessarily a few with bundled services, so separate risk management, separate admin, separate prime broker, etc.

GC: How closely linked are the changes going on in the fund administration industry to what’s happening with prime brokerage?

SP: There may be internal drivers within an investment bank, and therefore different benchmarks that both the prime brokerage and fund administration side of the business need to look at – which means they may not be able to commit to small or mid-tier managers to support them in their growth efforts. It takes a long time to ramp up from a capital and sophistication perspective to get institutional allocations, and a lot of the firms that are not banks work with startup managers and add services and grow with them and really see a relationship, which doesn’t really pan out until three to five years from that initial launch, just from an AuM perspective. So we have to commit to that time period, and that mindset doesn’t necessarily fit investment banks. So what we’re going to find, especially going into this year, is a lot of changes, where investment banks will focus on the top 10% of managers.

GC: For standalone administrators, there’s still a lot of consolidation, so as they become bigger doesn’t P&L become more important for them too?

SP: Absolutely. It does, but I think independent firms not affiliated with a bank understand the business in terms of the commitment with clients taking longer to grow. You just have to simply have a portfolio of clients from a macro perspective that are in different stages in their lifecycle and not simply focused on the largest sector.

GC: You mentioned earlier that there will be more segregation of duties. Will that raise costs for managers if they can’t go to an all-in-one shop?

SP: No, I don’t think so at all. The bundled model is going away, and clients are prepared to pay what the market is.

GC: What if it’s a custodian bundling admin services, versus a more diversified investment bank? Does that make a difference?

SP: I think it’s the same. Management companies want today, now so more than ever before, because of the amount of consolidation that’s going on, whether it’s on the PB side, the admin side or the audit side, they want all of the players to be independent of each other. I think that model is becoming more affluent now than ever before, not just from a best practice standpoint, but also from a counterparty perspective as well. If a client is bundling two services or more into one provider, it’s not a cost play anymore. As we go into 2016, we’ll see more segregation of duties and more focus on due diligence from the management companies.