Outsourcing in a New Normal for Alternative Funds

While the financial market stress resulting from the coronavirus pandemic has not hit the alternative investment fund industry to the same extent as the financial crisis of 2008, in terms of evaporating liquidity and a rush for redemptions, the investment fund sector is certainly not immune to the fallout of COVID-19.  Volatile swings in global equity markets, a dramatic slide in energy prices, supply chain disruption and a severe knock to corporate earnings going forward all have the potential to depress markets for an extended period, while the global economy looks to be heading for a difficult period.

Not all managers are feeling the same pain and some funds in the credit space or those utilising arbitrage might be doing very well in the current situation.  For other strategies, such as long only equity, however, or private equity managers with distressed portfolio companies to prop up, it’s quite a different story.

One thing that is clear from discussions with investment managers across the alternatives spectrum is that the COVID-19 pandemic and related uptick in remote working – whereby managers have already had to implement the systems and infrastructure necessary to support out of office operations – should help simplify and further accelerate the trend towards outsourcing of non-investment management functions.  It has been well recognised in the alternative investment industry for many years that by outsourcing key functions to an agile specialist service partner who understands your underlying strategy and firm culture, with the necessary technology, cyber and information security systems in place and the requisite scale and expertise, managers can derive significant benefits. Outsourcing allows managers to leave the heavy lifting of the myriad regulatory compliance and reporting duties to experts, thereby gaining greater time and flexibility to focus on the core business of generating returns for investors.  In addition to the assurance that important deadlines and regulatory filings will not be missed, the manager can also benefit from a service partner’s scale.  In more recent years, this trend has been exacerbated by the cumulative effect of more layers of new regulatory compliance obligations for funds and, given that difficult markets going forward may require funds to operate with fewer resources, there is greater weight to the argument in favour of outsourcing a broader range of services.

Under the Microscope

For Cayman Islands domiciled investment funds, there are a number of key areas where increased anti-money laundering (“AML”) regulation and market developments have sharpened the focus on the outsourcing debate.  Notably, the requirement for investment funds to register with the Cayman Islands Monetary Authority has placed increased focus on the individuals who are appointed as Anti-Money Laundering Compliance Officers and Money Laundering Reporting Officer or Deputy Money Laundering Reporting Officer (the “AML Officers”) as AML Officer information must now be provided.  It is therefore vital that AML Officer appointments are considered carefully as the natural persons who discharge them must have sufficient expertise and in-depth knowledge of the Cayman Islands’ AML requirements and a strong understanding of the investment fund industry both in the Cayman Islands and globally to perform the roles effectively.  In practice, therefore, fulfilling these obligations goes beyond simply naming individuals to specific positions, given the ongoing obligation to keep abreast of all relevant changes to Cayman Islands AML laws, regulations and related regulatory guidance. With serious financial penalties in place for any breaches of AML legislation, not to mention the possibility of reputational damage and personal liability, significant efficiencies can be drawn from outsourcing the AML Officer roles to suitably qualified professionals.

Additionally, the global trend towards tax transparency and the automatic exchange of tax information has driven the implementation of key pieces of legislation, including the Foreign Account Tax Compliance Act (“FATCA”) and the Common Reporting Standard (“CRS”) which require managers to satisfy a number of obligations including registering and liaising with the IRS and local authorities, working with account holders to capture the required data, performing the necessary due diligence for on-boarding and classifying account holders, in addition to preparing and filing fully compliant FATCA and CRS annual reports.  These requirements continue to evolve.  A case in point being the new CRS Compliance Form, introduced by the Cayman Islands Department for International Tax Cooperation in April 2020, which seeks extensive additional information with respect to the Reporting Financial Institutions and Trustee Documented Trusts.   While there has been some movement in the FATCA and CRS reporting deadlines due to COVID-19, the relevant disclosures will still need to be made and, with other new obligations to be concerned with this year, fund managers are taking the opportunity to streamline their operations and put a greater share of the reporting burden in the hands of a professional service partner that can provide a flexible and cost-effective compliance solution for FATCA and CRS obligations.

Automatic information exchange is just one aspect of the swathe of legislative enhancements introduced in international financial centres in recent years, which can distract fund managers from their core activities. Country-by-Country Reporting, Form PF in the US, and the Alternative Investment Fund Managers Directive (“AIFMD”) and, more recently, DAC6 which introduces an obligation on taxpayers and advisers to disclose certain cross border arrangements between EU Member States and third countries, come with a heavy compliance burden.  However, with the right technology and approach, the compliance process can be simplified.  The complexities of Annex IV reporting under AIFMD, for example, can be dealt with through an outsourcing solution that captures accounting and portfolio data and drives secure reporting output with a full audit trail in a highly efficient process.

A further area where greater interest in outsourcing is set to continue is closed end fund administration. Although outsourced administration in the hedge fund space has been standard practice for quite some time, it is only in recent years that private equity funds in the US have adopted a similar model on the back of increased investor and regulatory scrutiny.  In addition to alleviating operational burdens, many private equity funds are outsourcing to gain additional operational and regulatory expertise that is supported by robust and scalable technology.  This provides an infrastructure that not only withstands regulatory and investor focus but also provides managers with holistic data sets, reporting and analytics to assist in running their business.

Bridging the Gap

With a global network spanning 18 offices across the world’s major international financial centres, the Maples Group offers a suite of regulatory and compliance, fiduciary, fund and entity formation and management services, all backed by market-leading legal expertise.  The effect of this combined depth of expertise provides a level of assurance to managers and investors that AML matters and a broad range of regulatory compliance requirements will be dealt with efficiently and to the highest standards.  This allows managers to focus on their core competencies and take advantage of the economies of scale of a vertically integrated institutional class service partner.  In addition, the Maples Group’s unique model and extensive geographic footprint affords managers and investors comprehensive support and expertise for matters related to economic substance and corporate governance, among others.

The highest quality of work is delivered by employees of the Maples Group and not outsourced. These professionals bring experience and expertise in regulatory compliance and reporting, constantly keeping up-to-date with changes in relevant legalisation and regulation. They are further supported by best of breed technology, including bespoke in-house systems.

As the current environment has highlighted, there has never been greater demand on the limited resources of managers to not only produce superior returns for investors but to do so in compliance with an ever growing and increasingly complex and evolving international regulatory framework. In such circumstances, it is imperative for managers to reassess their current operating models and determine whether they are fit for purpose as we enter a new normal for the asset management industry.