Smaller fund admins will struggle to act as third party collateral managers, warns Citi Fund Services
Smaller, non-bank backed fund administrators will struggle to act as third party collateral managers for hedge funds, Citi Fund Services has said.
Several non-bank backed fund administrators are already in the game as the transition to mandatory clearing of over-the-counter derivatives, as mandated under EMIR and Dodd-Frank, has made third party collateral management an attractive option for hedge funds and their administrators. BNY Mellon, BNP Paribas, Citi and HSBC are some of the larger players active in the collateral management space.
“Third party collateral management is a service smaller or non-bank backed fund administrators could struggle with. While there is no regulatory impediment to smaller fund administrators acting as third party collateral managers, there are question marks about whether they have the capability to invest in the required infrastructure to make it work,” said Mike Sleightholme, head of global hedge fund services at Citi’s Transaction Services business.
“Bank-backed administrators also have the luxury of offering custody and prime custody, while managers are likely to prefer the balance sheet safety at banks. I don’t think many hedge funds will feel comfortable with a small counterparty or fund administrator managing their collateral requirements,” he added.
It is not just third party collateral management where bank-backed administrators stand to trump their smaller rivals. Smaller administrators are at an added disadvantage because of AIFMD depositary liability requirements. Some standalone administrators do not possess banking licenses which is a prerequisite to becoming a depositary and therefore will be forced to find depositary partners. This could be a challenge given that some banks and larger administrators will be reluctant to act as depositary partners to their competitors, a point reinforced by BNP Paribas earlier this year.
These regulatory requirements, coupled with the increasingly complex demands of managers, and falling revenues, is going to accelerate closures and M&A activity in the fund administration space, particularly at the sub $150 billion AuA level. “There are approximately 60 fund administrators in the market but in the next three years, I believe that number could decline by half,” said Sleightholme. His predictions, are however, more optimistic than those of Ron Tannenbaum, managing director at SS&C GlobeOp, who prophesised just 10 administrators would remain in business within a few years.
It is not just the independent fund administrators which are merging. Goldman Sachs Administration Services was sold to State Street AIS for $550 million creating a combined entity servicing more than $700 billion in AuA. Goldman’s desire to streamline costs and raise assets amid a drop in overall revenue is believed to be the main factor behind the sale of its administration arm. Others have said some institutional investors complained they did not like Goldman acting as both prime broker and administrator to certain hedge fund clients.
Nonetheless, Citi confirmed it did not intend to follow in Goldman’s footsteps and sell off its fund administration business, which currently has $198 billion in AuA. In fact, Citi just completed its implementation of the Man Umbrella SICAV, Man Group’s Luxembourg fund business, whereby the bank will provide custody, depositary functions, fund administration and transfer agency functions for the $52.7 billion hedge fund.
“We do not intend to sell our fund administration business as fund administration is essential to our strategy and for creating key relationships with clients. We are growing business and we are one of the fastest growing players in the space,” commented Sleightholme.