GAIA points the way to the automation of hedge fund subscriptions and redemptions

Buy-Side FeaturesFeature
21 Jan, 2016

Bill Gourlay, who previously ran the fund management strategy group at RBC in London, arrived at investment management industry technology consultants Idea Group as CEO in December 2013. The speed with which they have created the GAIA standards to automate subscriptions and redemptions is a reminder that few were better qualified to fix that obvious and longstanding source of cost and complaints in the hedge fund industry.

On 28 September last year the Global Alternative Investment Automation initiative (GAIA) published a new set of messaging structures for the alternative investment management industry. The ambition of GAIA, set up in August 2014 by a group of seven central securities depositaries (CSDs) and fund administrators, is to address and solve a complaint of longstanding among the private banks that distribute hedge funds and the hedge administrators that process the orders of those distributors.

Unlike the mutual fund industry, where automated order routing networks (Calastone, FundSettle and Vestima) and settlement services (Clearstream and Euroclear) now intermediate a growing  proportion of the order flow, the opening of investor accounts and the processing of subscriptions and redemptions in the hedge fund industry are still characterised by extensive use of faxes and repeated manual re-keying of data. It is one reason why hedge fund administration sustains far more providers and proportionately more jobs per million dollars of assets under management than its mutual fund counterpart.

It was to address this gap in services that Clearstream - owners of the Vestima order routing network - acquired Citco Global Securities Services, the Cork-based hedge fund order processing business of Citco, in April 2014. However, an order-routing network and a group of people with knowledge of how to process hedge fund orders manually, cannot automate an industry. That requires agreement between all participants to adopt standard market practices by which to exchange information about account-opening, subscriptions and redemptions across any network. 

This is the purpose of the GAIA group.  The group is supported not just by Clearstream but by its rival across the Ardennes with a comparable service offering (Euroclear) and the American central securities depositary (CSD), the Depository Trust and Clearing Corporation (DTCC), that dominates fund order routing in its domestic market. Four hedge fund administrators are also supporting GAIA, though only J.P. Morgan and Northern Trust have openly published their support. They are paying the Idea Group, a technology consulting firm which expanded its horizons in 2012 having previously predominantly worked as an in-house technology group of Legal and General Investment Management (LGIM), to create the message structures.

The interest in greater operational efficiency of all the members of the GAIA group is well attested. But Idea Group CEO Bill Gourlay rejects the notion that the decision of other supporters to remain anonymous, and of three more administrators to postpone their commitment, is indicative of an underlying hostility to automation. “There is a concern about creating too great an expectation,” he explains. “Some administrators are concerned that announcing this prematurely will create pressure to meet demands from hedge fund clients that they are not able to fulfil in the sort of time-frame their clients have in mind. We have to carefully manage these client expectations.”

That said, Gourlay accepts that automation will not necessarily be welcomed by every administrator. “It is a well-known feature of our industry that there is money to be made from inefficiency,” he says. “Organisations have to be brave enough to recognise that, even if the revenue line will be lower in the short term, they will have to do something eventually, or risk sharing the fate of the dinosaurs. The fax machine cannot last forever, even in this industry. And the cost savings from automation in this area means that these messages will pay for themselves very quickly indeed.” 

Unfortunately, few hedge fund administrators collect the data that would enable that claim to be authenticated and quantified. Much the same is true, adds Gourlay, of hedge fund managers who believe that their operational flexibility is essential to commercial success. “Operations obviously cannot be allowed to drive investor relations any more than they can drive investment strategy,” he says. “But managers need to accept that creating inconsistencies in the process is not necessarily in their interests, because it leads to operational problems, which result in costs and risks which might outweigh the benefits of accommodating a particular investor.”

Gourlay has encountered an assertive (as opposed to quantified) addiction to the status quo in this area before. As global head of sales for funds at SWIFT, where he worked from 2003 to 2009, Gourlay was involved with Project SHarP. This initiative, which aimed to automate hedge fund subscription and redemption orders through adoption of SWIFT messages couched in the ISO 20022 format, had the misfortune of being planned for launch in the very period the financial crisis entered its acute phase.

“We were at the point of launching Project SHarP at the Sibos conference in Vienna in September 2008,” recalls Gourlay. “Lehman Brothers failed on the first day of the conference. We are very conscious that many firms consider Project SHarP a failure, but that is unfair. It failed to take off for a number of reasons, but the biggest reason is there was a financial crisis. When the crisis began, people were more concerned about whether their firm would continue to exist, than whether it made sense to replace a fax with an electronic message. ”

Seven years on, replacing faxes with standardised electronic messages remains a good idea. So it is not surprising that, when Gourlay arrived at the Idea Group as CEO in December 2013, it was one of the first axes of growth he identified. In February 2014 he went to Dublin to check with the leading hedge fund administrators whether the demise of Project SHarP had poisoned the concept forever.  It had not. By August 2014, Gourlay had assembled his seven founding members.

They spent the next 12 months devising a set of ISO 20022-compliant subscription and redemption order messages. These are now being tested. Once they work, new messages to cover initial subscriptions and especially account opening - a highly legalistic process which Gourlay describes as the “holy grail” of the GAIA group - will follow. Though the relatively low proportion of mutual fund messages couched in SWIFT message standards, and carried by the order-routing networks, is a discouraging precedent from the mutual fund industry, Gourlay is confident the tests will spark a process of widespread adoption in the hedge fund industry.

“We already see the line between hedge and mutual fund messages blurring, as some hedge fund managers make use of mutual fund message types,” he says. “There is a greying of the line between the mutual and alternative investment management industries anyway.” He adds that the Securities Market Practice Group (SMPG), which drives adoption of market practices such as messaging standards, has already agreed to merge mutual and hedge fund message standards by 2018. “We have already achieved that,” says Gourlay. “On the assumption the SMPG adopts what we have done, we have saved the industry at least two years.”

That said, investments in hedge funds are more complicated than their mutual fund equivalents because of the size of the investments (most are from institutional investors), variations in the terms on which different investors buy into a fund, and oddities such as side-pockets, gates and lack of ISIN numbers for the underlying funds. But Gourlay dismisses the idea that these peculiarities place a natural limit on the impact of the GAIA message set.

“Take ISIN numbers,” he says. “Mutual funds use them, but why force hedge funds to adopt ISINs, and incur the additional cost of adopting them, when they do not use them today? We want to use information they have already, not force them into areas where they do not want to be. Transfer agents are already applying identifiers to funds when they are created, and it is easy to pass those down the chain from that point onwards. Why force two counterparties who are happily speaking ‘German’ to each other to use another language?”

This pragmatic approach is characteristic of the emphasis the GAIA group puts on using what works, as opposed to chasing after the ideal, and so making excessive demands of users. The group rejected establishing a processing hub, or a paid-for service, on the same grounds. “It is so easy to create barriers to adoption,” says Gourlay. “When the important question is what proportion of these supposedly complicated messages we can bring within the messaging structures we have created. People have in the past argued that the hedge fund space is too complicated to address. Project SHarP began to dispel that myth, and we have now dispelled it completely.”

One reason GAIA has dispelled the question of complexity is the disciplined approach of the group. The founding members committed to produce meaningful output within a year, and they managed exactly that. They have also absorbed two important lessons from Project SHarP. The first is to keep their numbers low. “When SHarP was being run, there were 40 odd people around the table from lots of different firms,” recalls Gourlay. “Not everyone round the table had the mandate to make the changes. Some were also motivated by the knowledge that progress on the issue was not necessarily in the interest of their organisation.”

The second lesson from Project SHarP is to keep it simple. “The SHarP Project was really no more than a set of SWIFT messages, but the meetings provided an opportunity for showboating, with people competing to come up with the most complex examples  of a problem, so they could then  come up with an equally complex way of resolving it,” explains Gourlay.  “It is admirable in a way, but it certainly does not lead to a quick and easily adoptable solution.”

As he points out, the problem to be solved – automating the routine exchange of business information between counterparties – is easily stated. The users do not need to understand the intricacies of the message standard, or the underlying computer code, any more than a car driver needs to understand how an internal combustion engine works. “The important questions are how to get information from point A to point B, and what that information is,” says Gourlay. “So we have concentrated on the practical business elements rather than the message standard.” That means funds, share classes, amounts, dates, counterparties and currencies.

Once the business elements were agreed, Idea Group reverse-engineered them into the ISO 20022 message standard.  Their work was reviewed by the standards group at SWIFT, which will help to facilitate endorsement by the SMPG. The seven founding members of GAIA have also agreed to use the new messages. Though it is worth noting that replacement of ISO 15022 by the new standard is rather higher among members of GAIA than in the funds industry as a whole, this will further encourage the SMPG to endorse the work of the GAIA group.

Besides, the standards are published on the GAIA web site ( so anyone, including technology vendors as well as hedge fund managers and administrators, can use them. To help potential users build a business case to senior management, and accelerate the construction of their own platform to use the new standards, Idea Group has also released a  testing tool alongside the published message standards. “We just want people to get the messages up and running, and start using them,” says Gourlay.

It is obviously important to the widespread adoption of the standards that they can be used on any of the vendor systems used by administrators (Advent, Koger, MultiFonds, Oracle, SimCorp and SS&C) and any of the messaging and order-routing networks (Calastone, FundSettle, SWIFT and Vestima). Though the GAIA group is not working directly with any vendors in particular, the ability for vendors to easily use the new message standards was a fundamental principle from the outset, so the group is confident they can all translate the published standards into their existing systems. This will insulate users of those systems from the complexities of adopting the GAIA message set.

There is another reason why adoption should spread rapidly. This is that, once account opening and subscription and redemption orders are automated, data about investors and cash flows will be captured in an easily retrievable way.  This will make it easier for hedge fund managers and their depositaries to fulfil their obligations to report to regulators under measures such as the Alternative Investment Fund Management Directive (AIFMD).

In fact, says Gourlay, a major contribution to automated regulatory reporting is the first of the benefits that GAIA expects to deliver. “I have spoken to a number of hedge fund managers,” he explains. “They understand that, in the long run, this is going to help them in terms of costs, but in the short run the focus needs to be on risk reduction, transparency and reporting, and not on fee reduction. All parties need to respect the fact that this initiative requires investment by administrators, and they have got to be given a window in which to recoup that spend.”

It is a refreshingly commonsensical approach. But then Gourlay has experienced at first hand the effects of an over-enthusiastic approach to message standards. “It is easy to make the mistake of forcing more cake into the mouths of people who have yet to swallow the last slice and the ineffectiveness of so many working groups where initiatives can easily descend into a self-perpetuating academic exercise in which people forget they are actually supposed to get some practical things done.” This year he is looking for no more than steady adoption of the first set of messages, and their extension into adjacent areas, including the “holy grail” of account opening. 

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