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Banking on investor protection
Banking on investor protection

Banking on investor protection


Andrew Dougherty

Andrew Dougherty

Americas Head of Asset Managers and Alternative Investors

BNP Paribas Securities Services

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Given the exceedingly high stakes and ongoing emphasis on investor protection, what factors should hedge funds consider when selecting an administrator

For the better part of a decade now, fund administrators have become increasingly responsible for ensuring their clients on the buy-side, particularly those in the less-regulated, but highly complex world of alternative investments, remain compliant with regulations. While demand for sophisticated and customised reporting among hedge fund investors has continued to rise, at the same time thinning margins have prompted some administrators to cut costs and/or commoditise services, potentially exposing gaps in the due-diligence process.

The consequences can be dire: over the past few years the SEC has targeted numerous service providers and various other gatekeepers for allowing (consciously or not) fraudulent or suspicious activity within its client funds. Among those recently cited was an independent administrator for failing to detect signs of fraud while handling accounting and administration services for two of its private-fund clients. In its decision, the SEC found that deficiencies in the administrator’s monitoring and recordkeeping system prevented the fraudulent transactions from being properly recorded.

What can managers do to ease investors’ concerns over vulnerable transfer agency processes facilitating – mostly unwittingly – fraudulent activity? And what kinds of challenges does this create for third-party providers?

Hedge helpers

While hedge funds, unlike their broader-market peers, remain on the plus side year-to-date according to Barclay’s Hedge Fund Index, the ongoing influx of institutional investors has not only boosted competition within the space, it has also ratcheted up funds’ due-diligence requirements, leading to higher costs and reduced margins. As a result, managers have been more willing to outsource certain administrative tasks to a seasoned third-party in an effort to focus on generating satisfactory returns.

Meanwhile, the SEC continues to advance its investor-protections agenda by focusing on managers’ valuation skills, in particular the ability for funds to accurately account for all assets held through broker-dealers, custodians and other counterparties. Going forward, the SEC’s Division of Investment Management is expected to continue its use of enhanced data analytics to more effectively monitor potential investment-company malfeasance. The commission’s message is clear: if things seem amiss, don’t be afraid to ask questions.

It’s a salient point, especially when one also considers the rapid uptick in web-based criminal activity affecting the world markets of late. Data repositories are particularly ripe targets for hackers, and accordingly banks that provide transfer agency services on behalf of clients must have in place robust authentication protocols for effectively monitoring data access, ensuring the legitimacy of payment requests, verifying bank details and more.

With breaches becoming increasingly commonplace, it is incumbent upon intermediaries to develop sound strategies and solutions for detecting potentially fraudulent behavior in a timely manner. At BNP Paribas, for instance, it is our duty to thoroughly screen all transactional activity within our banking network as well as those of our clients. From a cyber-security standpoint, investors need assurance that each provider within the value chain has sufficient security standards in place in order to prevent these types of incidents from occurring.

To ensure full compliance with newer transparency and efficiency standards, banks must continually maintain an extensive set of checks and balances on behalf of clients, using processes and controls that are specifically designed to meet regulators’ rigorous due-diligence demands.

For example, maintaining highly granular analytics, as well as independent messaging reports, can provide more reliable, quality data needed to support secure, straight-through payments processing on a global basis.

Indeed, technology remains central to success within the securities services segment—in particular, having the wherewithal to regularly invest in new solutions that can deliver adequate processing power as the markets ebb and flow. Such tools are not inexpensive, of course, and, accordingly, those with deeper pockets—such as institutional or bank-owned custodians—often lead the way in IT procurement, and therefore can offer clients systems and platforms that can keep pace with changing regulations, emerging investment strategies as well as malicious cyber activity.

Prioritising protections

Judging from recent activity, ensuring adequate investor protections remains high on the global regulatory agenda. Specific requirements aimed at closing transparency gaps throughout the investment chain are included within the EU’s revised Markets in Financial Instruments Directive (MiFID II), which took effect earlier this year.  These requirements help provide investors with fuller transparency into all assets across the entire investment lifecycle, covering all counterparties and across different jurisdictions.  

At the same time, the threat of cybercrime continues to command the attention of regulators, who have grown increasingly vigilant in their efforts to quell nefarious behavior within the financial industry. This has led to even greater oversight not only around fund managers’ cybersecurity protections, but also those of service providers within the value chain who may be privy to sensitive investor data. The climate doesn’t appear likely to change anytime soon.

Beginning in May, the EC-drafted General Data Protection Regulation (GDPR) takes effect, requiring that both EU-based businesses, as well as non-EU firms with ties to the region, follow a strict set of standards intended to safeguard consumers’ privacy and personal data.

As the markets grow even more diverse and interconnected, providers will need to continually make the necessary adjustments to ensure adequate fund transparency while also streamlining reconciliation, reporting and other integral functions on behalf of the client. Those with the right skills - and proper scale - are more likely to come out on top.

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