As the year comes to an end, asset managers and custodians hire auditors for reconciliations, but in the loan space, which has been a hot asset class over the last two years, reconciliations can be difficult and time consuming due to their complexity and the large amount of manual processes.
“A lot of times both from a custodian’s standpoint or even the asset manager, in the year end audit process, they’re trying to dig through trade documents, assignment agreements, pay-down documents, etc., to try to string three or four pieces of activity together to say as of this date the position was ‘XYZ,’ whereas if you maintain this on a regular basis, then it’s going make the audit process at year-end significantly easier,” says Mark Schultis, managing director, managed services at Markit.
Most of the industry realizes there should be loan reconciliations with an agent bank or an independent third party throughout the year, particularly to verify positions since there’s no certificate or delivery versus payment like a typical security, making fraud easier. Yet the complexity has been a roadblock to making a change.
“Operationally, it’s always been a cumbersome thing,” says a global custodian, who’s a client of Markit’s platform in this space, Markit WSO for reconciliations. “You’re not doing a reconciliation against one or two entities. There’s dozens of agents banks, and their capabilities and formats differ, so it’s been a challenge.”
However, regulations such as the Alternative Investment Fund Managers Directive (AIFMD), while not specifically saying how frequently reconciliations need to occur, have given the industry the necessary push to adopt more automated processes, while at the same time, fund managers are coming to realize that they need custodians or fund administrators to verify loans.
“Even though loans aren’t securities, you’re seeing from regulators and investors that more and more will be pushed to this sort of model, and there hasn’t been a good solution for fund admins or custodians to do this. It’s very manual,” says Schultis.
“DTCC Loan/SERV has been out there for about 5 years, and people in the industry have been slow taking that up, but that’s getting us closer to one central repository for this information,” says the unnamed global custodian. “But it’s not all the way there yet. Really you need a solution that has the economies of scale that can reach out and connect with all of these agent banks.”
When looking at how to solve this problem, the anonymous custodian weighed building the connectivity in-house versus outsourcing it to another provider, which they ended up doing. “It requires a lot of time and somebody really devoted to it,” says the custodian, in explaining the decision to outsource. “It’s not something you can fit into an existing reconciliation role; there’s a fair amount of monitoring. It’s something that you want that elasticity to accommodate the demand for it, and it’s not something you can train somebody for in a short amount of time.”
Markit’s platform pushes feeds from agent banks, repositories, and other sources, creating significantly higher matching rates and automating reconicilations.
“In many cases, some of this was just never done, and it wasn’t very efficient to be done anyway with the disparate nature of multiple agent banks housing the data and not having a great central source,” says Schultis.
“The solution is going to be different for each organization,” adds the custodian. “For a smaller shop that has a couple portfolios…maybe outsourcing a reconciliation or looking for a partner to do that doesn’t make sense. But for a larger shop with multiple funds and a pretty big book of business, it might make more sense to do that.”
The Difficulties of Loan Reconciliations
As the year comes to an end, asset managers and custodians hire auditors for reconciliations, but in the loan space, which has been a hot asset class over the last two years, reconciliations can be difficult and time consuming due to their complexity and the large amount of manual processes.