Hedge funds should protect themselves against fund admin default or failure

Fund AdministrationInvestorsOperational Risk
06 Mar, 2012

Hedge funds have been advised to protect themselves against a large-scale fund administrator default.

Fund administrators do not pose anywhere near the level of systemic risk as that of a prime broker although a default could lead to an operational nightmare for managers, particularly in a distressed market environment.

“A large-scale fund administrator default would lead to hundreds, if not thousands, of hedge funds being unable to calculate their net asset values (NAVs) or honour their investor redemption requests or subscriptions. Even though it is not the managers’ fault they cannot meet redemptions, investors are likely to pull out cash at the soonest point,” said Phillip Chapple, managing director at KB Associates.

Citco Fund Services is the largest provider with approximately $468 billion in assets under administration (AuA) followed by State Street ($281 billion) and BNY Mellon ($210 billion). GlobeOp, which is currently on the market, has an estimated $174 billion AuA.

“Were a small fund administrator to go under, the situation would not be as serious as their clients would be picked up by other administrators. If a bulge bracket bank’s fund administrator ran into trouble, it is highly probable the parent company would bail it out. However, it would be far more serious if a large independent administrator was to default. Nevertheless, a fund administrator default does not look like it's on the cards as things stand” commented Chapple.

Switching fund administrator in normal let-alone choppy market conditions is no easy or brief feat. It requires months of operational due diligence and negotiations. “It can take up to six to eight weeks for fund administrators to onboard hedge fund clients. Getting the systems in place for individual hedge funds is a challenge as no two fund administrators are alike,” said Chapple.

The prospect of a major fund administrator default was very real in 2008 and many hedge funds even got back-up administrators or at least looked at other providers. “Since 2008, the issue has taken a back seat. However, managers should consider all their options if they suspect their fund administrator is in jeopardy,” said Chapple.

Others believe a large-scale fund administrator default is unlikely, and at best, it is a manageable scenario providing managers have the right checks in place.

“Providing a manager uses shadow accounting and can calculate the investor-level NAV themselves, the situation would be manageable in the unlikely scenario that their fund administrator is no longer able to strike an official NAV. Some big-scale hedge funds use two administrators to minimise the risk although not all managers can afford that luxury or are interested in that model. As long as the manager has a shadow book, investors will have a higher comfort level with the manager in general and will also feel that adequate controls are in place until a new administrator can be found,” said Andrew Kaufmann, director of Europe, Middle East and Africa at Viteos Fund Services in London.


Written by Charles Gubert