July 2010

ROUNDTABLE: Back of house (part 1)

As asset management plays an ever greater role in the Gulf states, asset servicers discuss the evolution of operational and regulatory processes. (part 1)
mena roundtable 2

Craig Roberts (CEO, Apex Fund Services)
Andrew Polley (senior executive officer, RBC Dexia)
James Martinson (senior vice president, Maples Finance)
Richard Street (director, head of Middle East securities and fund services, Citi)
Glyn Gibbs (head of business development, HSBC Securities Services Mena) Funds Global: What role can asset servicing play in terms of investor protection and of how much concern is investor protection to those operating in the region? Craig Roberts, Apex: All investors are concerned about protecting investments and are making stronger demands for more transparency. Asset servicing providers will give them some assurance that their interests are being looked after and are well defined. It helps the manager create appropriate products to cater to their needs and to make sure that the investors’ demands are being met. Andrew Polley, RBC Dexia: Investor protection is more important in the retail market. There’s this old saying that you judge the jewel by the jeweller, so when people in this area buy a product from a trusted local bank, they trust that bank to have done all the relevant due diligence. Where the asset service industry comes in is, before we take on a fund-sponsor client and agree to be their custodian and fund administrator, we all do our due diligence checking on that fund sponsor, so that a distributor of the fund, who is obviously on the front line for investor protection, or an investor as part of their own due diligence procedures, can look to see who the custodian is, and who the administrator is, giving them some assurance that well run and regulated custodians and administrators will have carried out their own checks. James Martinson, Maples: Traditionally, the investors that we worked with in the region were much more accustomed to in-house administration, but I think outsourcing, independent administration and external service providers are playing a much larger role after the financial crisis and Madoff, especially with institutional investors, by just giving them some additional comfort that investment products are operated in accordance with governing documents and making sure that there are certain checks and balances in place, and that the necessary know-your-customer (KYC) model requirements are met. Richard Street, Citi: Andrew [Polley] mentioned one word: trust. It is extremely important. Historically, in this part of the world, things have been done on trust. If you look at a retail investor who invests in the regional markets here, traditionally they’ve left their assets with their broker. Now custodian concepts are being put into place and are becoming regulated activities, so there’s a maturing of the market, there’s a slow realisation that best market practice is to have a segregation of duties between a broker and a custodian. But that takes time to evolve.
  Looking right across the board to perhaps the private equity environment, many of the investment houses and investment companies in this part of the world just seek coinvestment, so they’ll engage into an investment transaction and then they’ll proceed, almost on a syndicated basis, from capital providers who trust them. This is still how a lot of the business is done here, but as things mature and as more and more people from other parts of the world become interested in the Middle East, it’s our responsibility to drive best market practices. If you consider equity funds or even more advanced funds, perhaps alternative funds or private equity funds, it is important to make sure there’s true servicing and good disclosure and total transparency.
The Madoff example is very relevant too. A lot of people who perhaps have had a more syndicated structure and maybe had leverage or financing at the group level, and then used their own money to lever or to finance what’s going on below, are now looking for third-party financing.  In order to obtain this they need to put these best market practices in place. In order to secure it they need to make sure that they can pledge assets in an appropriate manner.
So adding a layer of professionalism to everything from the bottom up is what the asset servicing industry is doing here and that’s why you see all of the major players coming into this marketplace working together. Glyn Gibbs, HSBC: I think I’d break the market down into two. For international institutions, segregated assets and investor protection is an absolute prerequisite for them to put money into any market, so looking for a custodian and people who can provide that service for them was second nature.
For regional investors and local investors it’s a very different question. There has been a great deal of trust with the local players, but also perhaps misunderstandings. Some will say there is no risk but the way most markets are structured here, there is risk – risk on brokers and on how you are holding the assets. But it is an education process, it’s part of the maturing of the market.
In the United Arab Emirates (UAE), regulation will be introduced at the end of the year where the use of a custodian will become compulsory. We are already having dialogue with a number of regulators who are talking about this need to separate the role of a fund manager from a service provider to ensure there’s full independence and segregation of assets, and I think that’s all part of maturing as these markets within this region go from frontier status, hopefully through to emerging market status, and in due course into developed status. Funds Global: Is it too much of a simplification to say the regulatory landscape is all about bringing the Gulf region to an international standard? Or are there more intricate issues involved in the region? Can a more considered approach be taken to regulating the region that reflects local investors or is it all about trying to appease international investors coming to the region? Street: You have to consider regulation and the Gulf market from many different angles. If you consider the region as a region for capital raising, then there are plenty of products available elsewhere. There are Ucits products in Dublin and Luxembourg, there are other offshore jurisdictions which are creating funds, which then invest back into this region or elsewhere.  These products are readily sold to investors from the Middle East. It also depends which direction the investments are flowing. Are international investment managers creating sub-funds which are investing into this region? If they are do they feel compelled to domicile them in the region? Not typically – they’ve already looked for their distribution needs and have their products designed to address those needs.
Generically, you could say that regulators here are interested in creating markets that enjoy the right level of protection, both from the securities side, but also on the funds side, so some of the points that have already been made around segregation of duties between the fund manager and administrator are being addressed. In Bahrain, for example, the central bank (CBB) has already dictated that if you’re the fund manager you cannot be the administrator for that fund as well, which is consistent with other European jurisdictions, like the UK. But in Luxembourg you can still do it within your own family. So it’s a bit of a generalisation to say that everyone in the market is trying to do the same thing when it comes to regulation.
I think if you go back to why they’re developing these regulated environments it’s about diversifying the economy. Why are there so many financial centres in direct competition with each other? It’s because they’ve all got national agendas on the table. A market like Bahrain is looking to create jobs; it is looking to mature the funds business and is looking to compete with some of the smaller fund jurisdictions and maybe even the bigger ones in the future.
Why is the DIFC here in Dubai? Why is the QFC in Qatar? These centres are all about diversifying the economy and creating an infrastructure for commerce and trade and industry for entrepreneurs to come in and do their thing.
Will it work? I think given the short time these have been in place, it is very difficult for anyone to measure the success or failure. But these regulatory environments have been put in place not just for a day or week – they are here for the long term and they continue to mature.
There are a few things I would like to see. I’d like to see agreements between some of these jurisdictions and Saudi Arabia and Egypt, where there’s a greater population and perhaps a more natural movement from lower to middle class and then into a savings culture. But is it too late for new fund jurisdictions? Are the Ucits funds and other domiciles a more attractive environment? Whatever the answer is, we as asset servicers tend not to worry too much because we operate in an international environment. Citi specifically provides administrators of funds in over 20 domiciles. So if someone wants to domicile an MPF in Hong Kong that’s absolutely fine. If they’re managing the fund from the Middle East, Citi will provide the operational service support from here. It’s not necessarily the responsibility of the asset servicing community to advise where to domicile, that’s probably better from a lawyer’s perspective; we are there to educate on the differences and what the relative benefits are.
Funds Global: Richard, do you see more international fund managers looking to base physical operations on the ground out here, as long as they can get a distribution network? Street: Well it’s the same thing: what is the fund manager doing? What is a fund manager? Is it a distribution agent or is it someone who actually manages money? There’s more distribution activity here, albeit for high-net-worth individuals and institutional investors rather than retail investors. There are a handful of investment managers who the international community would recognise from a branding perspective that are domiciled here and managing money out of here.
I personally would say it makes sense to manage money from here if you’re going to invest into these markets. I don’t think you’re a better hedge fund manager if you’re based in Mayfair than if you’re based in Jersey. It’s to do with your strategy and making sure you’re there and open. Funds Global: As asset servicers, are you seeing more inquiries from international fund management companies that are looking to domicile here? Gibbs: Our experience is that there was a surge of interest, particularly in the markets through 2007 and the early part of 2008 when the world was going ‘great guns’ and the Middle East in particular was a stellar performer. Since then, as markets have turned down, that’s really slowed down. We are seeing a lot more ‘suitcase portfolio managers’ now coming to the region. My own personal opinion is that actually for this region, if you’re managing a Mena [Middle East & North Africa] fund you actually are better placed being in Mena, mainly because these markets are so volatile that you need to be close to what’s going on. I’m not sure you can actually do that as effectively from the US, Europe or Asia.
I think the second thing is, that prior to the financial crisis, rent and office space were very, very expensive. It’s only now that we’re beginning to see that type of ancillary cost come down, and therefore people may be able to look at the business cases as to whether or not it is actually cost effective to be based here. Certainly one regional manager I spoke to had a look at Dubai specifically back in 2008 and couldn’t recommend being located here, it was just simply too expensive.
You also have to consider that these are markets that are still very, very young. The DFM [Dubai Financial Market] celebrated its ten-year anniversary only in May. When you consider what’s happened in the past ten years, it’s an absolutely extraordinary achievement both here in Dubai and for elsewhere in the region. There is now so much competition in trying to attract managers and service providers to individual countries because it is an attractive industry to have domiciled in your nation.
So what does the future hold? I think if rents continue to come down then I think there could be more relocation of advisers and managers on the ground, but it will be a slow process and at the end of the day the markets now are not as large in this part of the world as they were two or three years ago. Polley: A good example of a Mena fund and fund management is the ING Mena fund. It chose to have investment management based in the same time zone as the markets invested in, which is the basis of a good fund management model, and yet the service providers are in Luxembourg because ING decided it wanted to have a Ucits structure as the fund was created to sell to their international investors worldwide. So you have two things: put your fund manager where the actual markets are and in the same zone as where all your knowledge is, but the location of the service provider is really dictated by where you’re going to sell the fund. Funds Global: What does that kind of model mean for you as asset servicing firms? Polley: For those of us that are in all of the fund centres, we’re almost agnostic as to where the administration takes place. Gibbs: It’s a global industry, simple as that, and whether it’s Hong Kong, Dublin or Luxembourg, we’ll service each of them from this location. What we’ve seen over this past year or so are more and more actual local banks setting up asset management divisions or asset management businesses, whether that’s on a fund-type basis or more about discretionary portfolio management. So that in itself is creating employment as they begin to expand their expertise in those areas and take on people to do the underlying work. I think we will see an expansion through that rather than internationally. Funds Global: And how does servicing local asset managers differ from international managers? Third-party outsourcing is still a relatively new concept for local asset managers. Gibbs: It depends on the experience of the people that are employed to run the asset management business. If the business has brought in people with prior experience then it becomes a lot smoother. If not then you tend to end up working with the legal teams and accounting teams and providing general advice, even down to trying to temper expectations of how quickly you can launch a fund, where everybody seems to want to do it in about four weeks and it just is not possible. Street: When it comes to the operational service side, I think local market knowledge is absolutely critical. For example, understanding how the equities markets work in this part of the world is disproportionately important, in my opinion, to local fund managers. There is an opportunity for more middle-office outsourcing activity too as a lot of the new investment managers are setting up from nothing, and like a new hedge, fund they tend to be very strong on the front office and relatively weak on the middle and back office. Accordingly, the demands on asset services are to provide true local market expertise as custodians, and middle office processing.
The issue is that middle office service offerings tend to work economically on a much higher scale than perhaps we would want to offer here, so while there is an opportunity in this area, a lot of time will be spent handholding the investment managers at the point of setting up, making sure they understand how the markets work and understand the market set up and concept of a custodian.
Prior to this many managers have been dealing with brokers only, so naturally administrators and custodians take on a bit more than perhaps they would in other markets because there’s less experience in the middle and back office of the fund manager. If a new manager could have a full turnkey solution I think most would prefer it, but they would consider it as relatively expensive compared to hiring a few people for a small amount of money and supplementing them with the experience of the international asset servicing community to educate and handhold them through the first few months.
Roberts: Also the relative diversity of the markets is very important. Information about these markets and how things are done can be  completely different from one market to the next, so putting a turnkey solution in place isn’t so easy. When we deal with managers investing into Europe and into the US it’s so much easier to coordinate; it’s much easier to provide a fuller range of services, but here we get more involved in the handholding, the advice and just pushing transactions through. Polley: I think one of the reasons a lot of people still do things in-house here is based on a confidentiality point of view. I think they view their client base as something special to them, and often they view a lot of the larger service providers as also having private banking operations and having retail operations. The fear is probably unjust – a well-run bank has Chinese walls and that should work; but it’s not a perfect world and they do fear that they’re giving the details of their client base to a competitor.
The second thing is, outsourcing can be done in small jumps, and I’m always surprised that I find people who are still doing their investment analytics internally and having to hire people or buy software. The production of fund fact sheets and investment analytics can be done so much cheaper by one of us externally than they could ever do it in house, but they just don’t buy into that concept, they don’t believe that we could do it cheaper than they would. But if they worked out how much is spent on the people and the systems and software to do that, they would be surprised. Street: On your point about privacy and keeping things in house, I think if you look at the private equity market here, which is huge, there’s a stark difference typically between Middle East providers and American and European providers. The greatest strength of the private equity provider here is the link between them and their access to capital – the relationships they have with their limited partners is absolutely critical.
The idea of outsourcing that relationship is pretty alien to the regional PE community, whereas in the US for example they assume that the most important aspect of their relationship as a private equity manager is the ability to get access to the investment bankers and the deal flow, and their performance will attract the capital automatically. So it’s absolutely critical to consider what you’re dealing with here.  To try to overlay what we all would perhaps consider to be normal in the US or in Europe into this part of the world is to miss the mark considerably. Martinson: Outsourcing is not necessarily a word that describes what we do in the industry here. As you say with private equity especially, it’s more of a partnership with the manager whereas in fund management, they would tend to want to deal with their investors directly. In the region we also find that it’s very important for us to be based here to get any sort of credibility with investors. They like to be able to call somebody in the same time zone and the same work week, so if the investor base is in the region, I think it’s key that the services are provided here.
We touched on education earlier and it’s really an education process for everybody involved and a natural evolution that stems from that interaction between service providers, the manager and in some cases
the investors. Funds Global: What is the selection criteria used by an international or local fund manager here to appoint an asset servicer? Is it based on existing relationships? Is it referrals? Is it cost? Gibbs: I think in this part of the world relationship is much more important, and I’m talking here not just about the business relationship but the personal relationship. But then, of course, you can’t win deals on the basis of relationship then be overcharging. So at the same time your price is a very, very important factor to people here, down to the last dollar and basis point. So you put those two combinations together, assuming nobody’s able to offer the same type of services, and those are the two features. Funds Global: And do you think that relationships are always going to be key to this market, or is it because the market is still developing? Roberts: It’s been a traditional factor and I think it’s going to still be a significant factor in five or ten years. But the relationship is not the be all and end all: we have still got to provide a service, and as more providers and a more wide range of assets become available too, these managers may be looking for more. End of part 1 ©2010 funds global

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