HFMWEEK

S P E C I A L R E P O R T

HOW TO START A HEDGE FUND IN THE EU 2013

REGULATION CAPITAL
Navigating growing legislative concerns with emerging managers

How difficulties raising day-one investment are driving innovation

TECHNOLOGY

The increasing importance of IT set-ups during the launch process

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UCITS IV 2011

ts fair to say that start-up funds are facing some of their most challenging times yet. With the hedge fund industry having undergone a raft of changes over the past few years including increasingly demanding investors and regulatory burdens hedge fund managers have had a lot to get accustomed to. Attracting early-stage capital in todays environment seems to be one of the biggest hurdles of all. Hedge fund austerity measures are crucial to reassuring investors about a funds survival, and this often means consolidating operational structures in order to have cost-effective operations. Setting up the required infrastructure can be more challenging for emerging managers, not just because of a lack of experience when it comes to outsourcing, but also because large amounts of initial investor capital can be sliced away on establishment costs. Across the board, reduced AuM means funds are tightening their belts in order to fulfil heightened technology, legal and admin requirements. And while establishing a track record takes time, the right risk management solutions need to be in place from day one to gain investor trust. When it comes to overheads, this trust is acquired through transparency, regulatory compliance and caution. This, in turn, will only be in place if managers fully understand the technology platforms available to them, make sure the right employees are hired, and choose outsourcing partners who provide effective and innovative solutions. With the EUs Alternative Investment Fund Managers Directive coming into play in 2013, it will prove to be a year of change. And while there will certainly be a number of challenges for emerging managers, signs point to increased investment in start-up funds. This HFMWeek How to Start a Hedge Fund in the EU 2013 report covers a wide range of topics that will be high on the agendas of emerging fund managers, and hopefully offers a guide for driving business and evolving with the times.

Roberto Barros
REPORT EDITOR

HFMWEEK
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REPORT EDITOR Roberto Barros T: +44 (0) 20 7832 6543 REPORT WRITER Jon Yarker T: +44 (0) 20 7832 6541 j.yarker@ pageantmedia.com HFMWEEK HEAD OF CONTENT Tony Grifths T: +44 (0) 20 7832 6622 t.grifths@hfmweek.com PRODUCTION EDITOR Claudia Honerjager SUB-EDITORS Rachel Kurzeld, Eleanor Stanley CEO Charlie Kerr GROUP COMMERCIAL MANAGER Lucy Guest T: +44 (0) 20 7832 6615 l.guest@hfmweek.com PUBLISHING ACCOUNT MANAGERS Edward Taylor +44 (0) 20 7832 6616 e.taylor@hfmweek.com, Tara Nolan +44 (0) 20 7832 6612 t.nolan@ hfmweek.com, Shona Lynch +44 (0) 20 7832 6614, s.lynch@hfmweek.com CONTENT SALES MANAGER Richard Freckelton T: +44 (0) 20 7832 6593 r.freckelton@hfmweek.com OFFICE MANAGER Fay Muddle T: +44 (0) 20 7832 6524 f.muddle@pageantmedia.com
HFMWeek is published weekly by Pageant Media Ltd ISSN 1748-5894 Printed by The Manson Group 2012 all rights reserved. No part of this publication may be reproduced or used without the prior permission from the publisher

H F M W E E K . CO M 3

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CONTENTS

06

MARKETING

POSITIVE RELATIONS THROUGH COMMUNICATION

17

FUND SERVICES

Henrietta Hirst of Parex PR explains why effective marketing from the outset will set hedge fund managers a league apart

08

FUND SERVICES

Ulf Svensson of Bloomberg LP talks to HFMWeek about what startup hedge fund managers should consider

HEDGING FROM THE START

Starting out as a new hedge fund management rm can be a daunting task with the industry constantly evolving and growing. So to get an idea of the challenges these start-ups face and how they can circumvent difculties, HFMWeek talked to Matthew Wilson of Hedgestart about the importance a consultancy service can have

HITTING THE GROUND RUNNING

20

PRIME BROKERAGE

11

FUND SERVICES

OUTSOURCING FOR SMALLER HEDGE FUNDS

Jerry Lees of Linear Investments explains the advantages of working with a mini prime broker in order to keep costs to a minimum in this challenging environment of greater regulatory burdens and increasing investor demand

Peter Hughes of Apex Fund Services talks to HFMWeek about the main points a start-up manager should keep in mind when setting up a hedge fund in the EU

ADAPTING TO CHANGE

14

RECRUITMENT

22

TECHNOLOGY

HIRING THE COO CAN BE THE HARDEST DECISION

CHECK YOUR PLAYBOOK EXPIR ATION DATE

COOs are playing an increasingly important role within start-ups, as investors want to have an individual in place with the background to handle the complexity of regulation and governance. Mush Ali of One Ten Associates explains the main factors that should be considered when hiring a COO

With cloud services becoming increasingly popular as a hedge fund IT solution, Nigel Kneafsey of Options IT provides an overview of the most important points to consider when selecting a technology platform

25

LEGAL

RISK MANAGEMENT IN SECURITIES FINANCING PROGR AMMES

Simon Borg Barthet of GVTH Advocates explains why, in the current regulatory environment, having a robust risk management system is crucial for managers - both from a legal and capital adequacy point of view

4 H F M W E E K . CO M

Integrated expertise for hedge fund start-ups

All successful hedge funds have a robust business infrastructure behind them. HedgeStart has the skills and experience you need to build yours. Our expertise covers a broad range of business requirements and we understand how they t together. Using these insights we provide our services in an integrated way working as part of your team to launch and grow your fund.

Tax

Regulatory compliance

A robust business infrastructure built around you.

Accountancy

IT and communications

HedgeStart is ready to talk to you please come to see us for an informal and condential conversation.

Contact Richard Jobling: +44 (0)20 7484 3945 rjobling@hedgestart.com

HedgeStart Partners LLP, St Albans House, 57/59 Haymarket, London SW1Y 4QX T. +44 (0)20 7484 3900 www.hedgestart.com

H O W T O S TA R T A H E D G E F U N D I N T H E E U 2 0 1 3

POSITIVE RELATIONS THROUGH COMMUNICATION

HENRIETTA HIRST OF PAREX PR EXPLAINS WHY EFFECTIVE MARKETING FROM THE OUTSET WILL SET HEDGE FUND MANAGERS A LEAGUE APART

H
Henrietta Hirst
is a seasoned PR industry leader with over 25 years experience advising companies on their international media relations activities, profile raising, stakeholder communications and issues management. She founded specialist investment management sector PR firm Parex PR in 2005, having previously worked for UPC across Europe and Ludgate Communications in the Americas.

edge funds, once the darlings of the nancial markets, have taken a beating over the past few years. With their performance records and reputations severely dented, many funds have had to re-establish themselves. is re-establishment, or evolution, has meant that many hedge fund rms have made signi cant investments in compliance and legal as well as their operations and technical functions. Historically, marketing has not enjoyed the same recognition as a critical market support function. However, with an arid fund raising environment and ever-intensifying competition for investor assets, e ective marketing and PR is, at last, becoming elevated to the top table as a requisite discipline for fund managers. Despite intense competition within the industry, emerging managers have good reason to be optimistic. Con dence in the hedge fund sector has been returning this year. According to Hedge Fund Research, by the end of Q3 of 2012, asset levels had bounced back up and hedge fund capital increased $183bn to a record $2.19trn. And now that the rules of marketing hedge funds are becoming clearer through the AIFMD (and the JOBS Act in the US) hedge funds will be able to integrate a marketing and communications strategy from the outset. ere is, of course, no geographical constraint in looking for investors, but the changes in the regulatory landscape will a ect the marketing of funds in the EU and o shore. When looking to target investors, emerging hedge fund managers should do extensive research on their investor pro le: many investors prefer to remain o shore and use unregulated hedge fund structures while others, in particular European investors, are increasingly investing through Ucits and other similar EU-based structures. erefore, investor interest will ultimately depend on the structure of the fund. Nevertheless, one growing trend as a result of the AIFMD is towards re-domiciling funds onshore in Europe. e AIFMD applies to hedge funds with over 100m

DESPITE INTENSE COMPETITION WITHIN THE INDUSTRY, EMERGING MANAGERS HAVE GOOD REASON TO BE OPTIMISTIC

under management, but the advice to any start-up hedge fund with less than that is to structure the fund in such a way as to comply with these rules. Even now, a er several years and many versions, the AIFMD continues to cause controversy, with much of the debate played out in the press. But as the Directive starts to be implemented by EU member states, the opportunities are emerging too. Firstly, a clear bene t is that under these new regulations, promoting a fund onshore in the EU will mean that investors have some protection. Secondly, the EU market for hedge fund investments is big and ge ing bigger: there are already plenty of European investors prepared to invest in onshore hedge funds (unlike UK investors, many European institutional investors face penalties if they invest in o shore hedge funds). ere are also many pension funds that are in the process of expanding their investment strategies to include hedge funds or increase their existing hedge fund allocations. But with global hedge fund industry assets concentrated in the largest rms (HFR data shows that 65% of total industry AuM is with the 5% of rms that each individually manage $5bn or more), the smaller funds are losing out. What this means in practice is that since the nancial crisis there has been a polarisation of hedge fund investors. SIZE MATTERS As the situation stands in 2012, institutional investors tend to allocate assets to the larger and longer established hedge funds (those with AuM of over $5bn). is is not only because those have a large asset base, but also because the investors require strong liquidity and o en more mainstream strategies in order to comply with the restrictions of their investment mandates. At the other end of the spectrum, many medium to small size investors including family o ces and high-net-worth individuals are more open to investing with smaller managers; those niche and emerging managers that o er more distinctive strategies. Since the nancial crisis, it seems that accessing the second group has become more di cult.

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MARKETING

e reality is that generating capital is di cult without a proven track record of either independent performance or in raising assets. And once a hedge fund has tapped into family, friends and personal contacts, they need to venture further a eld for more substantial assets. is can be a signi cant stumbling block as the high-net-worth individuals, family o ces and seeders that should be the next port of call for managers to market their funds are bombarded with marketing proposals every day. So, it will only be the well-planned marketing strategy with appropriate well thought out support collateraltogether with the managers ability to communicate a consistent, clear and concise message that will catch the investors eye. In order to market a fund e ectively, from the beginning managers should ascertain their position in the marketplace, build market awareness of the funds and prove to potential investors how their strategies di erentiate from others. is should be integrated across all business activities in order to reinforce the message and market positioning. Emerging hedge fund managers need to research each target investor and work out if the characteristics of the strategies they run t with the asset allocation pa erns of their target investors. Once this has been done, the external marketing can begin. And this involves a panoply of possibilities: regular update le ers to a wide but relevant distribution list; a comprehensive website that includes useful information on the investment focus, the team, and uploads of up-todate multimedia factsheets. Concise and high quality pre-

QUALIFIED INVESTORS AND THEIR WEALTH ADVISERS, AS WELL AS OTHER INSTITUTIONAL ASSET ALLOCATORS ARE MORE LIKELY TO TAKE NOTICE IF THEY HAVE MET THE MANAGER

sentation documents with relevant data (including calculations where necessary) and an excellent pitch by a well-trained, authoritative and articulate spokesperson will be equally essential in raising the managers pro le. e recently created JOBS Act in the US means that SEC-registered managers will have greater freedom in communicating with potential investors and providing access to fund information. Managers should take advantage of this. en, its all about the networking. Quali ed investors and their wealth advisers, as well as other institutional asset allocators, are more likely to take notice if they have met the manager and this means ge ing out there. Hosting seminars, a ending and speaking at family o ce gatherings, investor conferences and other platforms can be part of the mix. Becoming a member of AIMA and signing up to the best practice standards of the Hedge Fund Matrix, (a joint initiative of AIMA, HFSB, IOSCO, MFA and the Asset Managers Committee of the US PWG). Even speed dating for hedge funds is becoming a popular option. Undoubtedly, raising capital has never been harder in this harsh economic climate, and for managers who have only a short or li le known track record for the foreseeable future there will be signi cantly fewer opportunities for raising capital. e message for all start-up hedge fund managers is to realise that marketing and communications is no longer a bolt-on function. It has to be an integral part of the business model and regardless of track record, managers must continue to build positive relationships through the many channels of communication available to them. n
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HEDGING FROM THE START

ULF SVENSSON OF BLOOMBERG LP TALKS TO HFMWEEK ABOUT WHAT ISSUES START-UP HEDGE FUND MANAGERS SHOULD CONSIDER

T
Ulf Svensson
is head of business development for Bloombergs Enterprise Products and Solutions (EPS) business where he focuses on developing and implementing technology solutions for the hedge fund sector. He is based in Bloombergs London office.

he launch of a hedge fund is an exciting time, with entrepreneurial energy in the air. However, the fund launch space is incredibly difcult for start-up managers, with a lack of available capital, heightened regulation and crowded marketplace to all take account for. erefore, the need for technology solutions and support is key, as Bloombergs Ulf Svensson explained to HFMWeek. HFMWeek (HFM): e hedge fund industry has experienced rapid changes in recent years, with tighter regulation, increasing operational costs and more demanding investors. What are the key elements of advice you would give a start-up manager in this environment? Ulf Svensson (US): e hedge funds industry is more structured and regulated today, so while hedge fund managers continue to launch new business ventures, they have to do so with these considerations in mind. An excel spreadsheet, an o ce and several million dollars in AuM are not enough to open a new fund, much less ensure its long-term success. Fund managers have no choice but to keep abreast of new regulations and guidelines. Before managers can accept outside investment and raise money, due diligence needs to be conducted, business continuity plans need to be developed, and a compliance process implemented. In todays challenging investment market, hedge funds need to di erentiate themselves from the thousands of others seeking new capital. Ongoing success depends on a hedge fund managers ability to articulate and defend the funds investment strategy, explain its risk pro le, and ensure transparent detailed, consistent communication with investors. e hedge fund manager is not just a trader or a portfolio manager - he or she is managing business operations, IT infrastructure, risk, investor relations and compliance. HFM: What products and services can Bloomberg provide hedge funds? US: e products and services Bloomberg provides hedge

HEDGE FUND MANAGERS KNOW THAT IT DOESNT REQUIRE MUCH TO HAVE THE BLOOMBERG PROFESSIONAL SERVICE SET UP AND RUNNING

funds are categorised in three groups: e Bloomberg Professional service (or the terminal), which includes real-time and historical market data, news and analytics; market data solutions, which can be licensed and integrated into the rms existing systems; and enterprise trading, risk and compliance systems. Our data solutions, for the desktop and enterprise systems, provide reliable, fast and exible solutions, which support hedge fund trading strategies across all asset classes. Bloomberg also o ers multi-asset class electronic trading capabilities, order management platforms, portfolio and risk analytics, asset valuation tools for complex nancial instruments, and price discovery platforms for non-exchange traded instruments. Hedge fund managers know that it doesnt require much to have the Bloomberg Professional service set up and running; its a simple implementation. When it comes to the data backbone or what feeds every desk across the hedge fund organisation Bloomberg can deliver reference and premium data as a data licence arrangement or as a real-time feed. HFM: Why should hedge funds consider Bloomberg a trusted market data provider and technology partner?

US: Founded in 1982, the Bloomberg Professional service is licensed by 310,000 business and nancial professionals globally. Bloomberg provides the hedge fund community with reliable, real-time and historical data, market-moving news and analytics, and trading tools that support investment decisions and activities. Bloomberg also o ers execution and order management platforms for multiple asset-classes, instant communications tools, industry research and news. Bloomberg applies rigour to standardising and cleansing its data sets, which is one of the reasons Bloomberg is trusted to provide timely, accurate, consistent and comprehensive data products to hedge funds and other investment professionals. e breadth and depth of our data library, the exible way that Bloomberg products can be adapted and integrated into a global infrastructure and the companys decades of industry experience are major differentiating factors.

8 H F M W E E K . CO M

FUND SERVICES

One of the reasons hedge funds choose to implement Bloomberg technology in the front, middle and back o ce is because hedge fund managers are generally already familiar with the Bloomberg Professional service from having used it as an institutional trader or analyst. Choosing a trusted market data provider and front-end trading platform has to be a simple and painless process for hedge fund managers. Bloomberg o ers a simple, e cient and comprehensive suite of products and services that make the job of se ing up a hedge fund easier. HFM: What types of information and information delivery system are available to Bloomberg clients and how can the way a start-up manager chooses to consume information help/hinder their business development?

BLOOMBERG OFFERS A SIMPLE, EFFICIENT AND COMPREHENSIVE SUITE OF PRODUCTS AND SERVICES THAT MAKE THE JOB OF SETTING UP A HEDGE FUND EASIER

US: Bloomberg is capable of delivering data from the front o ce to the back o ce, in real-time or periodically to alleviate some of the pressures on hedge fund managers. If traders are using Bloomberg on their desks, then it makes a lot of sense to use Bloomberg data in the middle and back o ce as well. When all systems in the food chain inside a hedge fund, or other buy-side rm, are using the same data, managers avoid discrepancies and unnecessary reconciliation between the trading oor, middle o ce and back o ce. HFM: How do Bloombergs hedge fund solutions apply to the wide range of hedge fund professionals (independent asset managers/family o ces, private equity rms, prime brokers) who are potentially interested in se ing up a business? US: Hedge funds generally invest in multiple asset classes. Even if a fund is an equity shop, it still needs to know whats going on with eurozone bonds, for example. Bloombergs vast database of content and data coverage, across asset classes, is critical to a hedge funds business. In 2011, Bloomberg released a technology package designed for start-up hedge fund managers that need to manage fund strategy, risk and compliance, STP trade se lement, portfolio analysis, order management and electronic trading connections. Bloombergs Hedge Fund Tool Box called HBOX enables users to access Bloombergs global, multi-asset, brokerneutral execution management system (EMSX) platform, as well as Bloomberg Tradebook, Bloombergs agency broker. HBOX connects to all major prime brokers and fund administrators, provides compliance and audit reporting, pre-integrated data and execution tools and realtime P&L and exposures. Bloomberg also updates technical capabilities, processes and analytics in anticipation of market changes and customer

needs. We are able to roll out product enhancements virtually overnight on a global scale. For example, to support the new European short-selling regulations that took e ect in November, Bloomberg worked with regulators to produce a de nitive industry benchmark, which classi es whether certain assets should be considered liquid or illiquid. Previously, prime brokers only had to organise assets as general collateral or hard-to-borrow collateral. Bloomberg caters to the variety of active and discretionary managers se ing up businesses. For such an established product, Bloombergs ability to be nimble and react to changing markets is a key strength. Although Bloomberg is standardised in cost and content, it is highly customisable based on approach.

HFM: How successful are Bloombergs hedge fund conferences and events? What topics are discussed and what impression and bene t would you hope delegates leave with? US: e annual Bloomberg LINK Hedge Funds Summit convenes managers and investors in New York for what has become one of the most important annual gatherings of the hedge fund community. e most recent event covered the impact of the European debt crisis on the global markets and deconstructed the drivers of equity market volatility. Panel discussions at the Summit also discussed how the new regulatory environment and US election would impact the market place and hedge fund success. Bloomberg also hosts an invitation-only start-up hedge fund event in London where 400 prime brokers, fund administrators, lawyers, hedge fund investors gather to addresses the concerns of new and existing managers. In addition to o ering access to the top industry in uencers and informative panel discussions, the event also enables sectorfocused networking opportunities and resources. n

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FUND SERVICES

ADAPTING TO CHANGE
PETER HUGHES OF APEX FUND SERVICES TALKS TO HFMWEEK ABOUT THE MAIN POINTS A START-UP MANAGER SHOULD KEEP IN MIND WHEN SETTING UP A HEDGE FUND IN THE EU

T
Peter Hughes
is group managing director at Apex Fund Services Ltd. He founded Apex in 2003 and it is now one of the worlds largest independent fund and private equity administration companies. The success of its Global Reach, Local Presence strategy has led to the opening of 28 Apex offices around the world.

he hedge fund industry has undergone signi cant changes in the past couple of years, with tighter regulation, increased investor demand and higher operational costs now all factors that start-up managers need to take into account when se ing up a hedge fund. Peter Hughes, founding and group managing director of Apex Fund Services explains why emerging managers need set-up solutions that are global reaching, but have local know-how. HFMWEEK (HFM): What are the key points a manager should have in mind when starting a hedge fund? Peter Hughes (PH): e key point is to make sure you have enough seed capital to launch. A lot of people go through expenses by heading up structures and then, in the current environment, encounter the fact that capital never arrives or gets delayed. Making sure there really is an amount of capital available, and for managers to be realistic about how much that might be, is crucial. Also, the di erent fund structures available should be studied so as to mitigate risks of possibly not being successful. HFM: What are the biggest challenges when starting a hedge fund speci cally in the EU?

THE BIGGEST CHALLENGES REVOLVE AROUND ESTABLISHING A COSTEFFECTIVE WAY OF SETTING UP THE STRUCTURES NEEDED AND MEETING THE REGULATORY REQUIREMENTS IN THE EU

agers should create the most cost-e ective way of se ing up, through fund platforms, hosting vehicles, and through compliance. At Apex we want to make sure that we are the rst point of contact for these new asset managers so we can drive them through all of the steps in an unbiased way to make sure they set up in the right way, and to give them as much opportunity to raise the capital and be successful. As we are present in several domiciles, we can point people down a particular path. We try and create the right solutions for them and it is not just from a fund structure point of view, or fund administration point of view. It is also about nding the right so ware to do their trading, nding middle-o ce solutions, providing them with cloud hosting for their own IT infrastructure, and so forth. e way we phrase it to managers is: you look a er hiring an ofce that you want to be in and a er managing portfolios and raising money for your strategy, we will do the rest to help set up in a coste ective, yet robust way. HFM: With increasing demands from investors and regulators, the hedge fund industry is in a di erent place than it was 10 years ago. What are investors today looking for when it comes to choosing a start-up?

PH: e biggest challenges revolve around establishing a cost-e ective way of se ing up the structures needed and meeting the regulatory requirements in the EU. It is more expensive se ing up EU structures compared to the traditional Cayman, Bermuda, or BVI structures. ere is also a question of having a regulated asset manager and the compliance demands around that, which are only going to become more onerous. When se ing up in the EU, managers need advice on the best structure and domicile in order to make them attractive in capital raising terms. Once that is de ned, man-

PH: Investors want to make sure corners arent cut. Given the fact that managers have increasingly been looking for capital for several years, investors have so much to choose from nowadays. When you are starting out as a new manager, it is important to make sure that you tick all of the boxes for allocators. You need risk management solutions, proper order management systems, and a portfolio management system. Also, you need to outsource administration and use a credible broker because otherwise people wont look at you as a manager, as there is so much to choose from. You cant expect people to allocate to you as a manager if short cuts have been taken.
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FUND SERVICES

Investors want transparency and liquidity. e be er liquidity a fund manager can provide to investors, the be er it is. We dont o en see a one- or two-year lock-up on a fund nowadays, as we may have done historically. If a strategy is liquid, why not give weekly dealings, or daily dealings? Why make it monthly, or quarterly? is is being driven by investors and what we do at Apex is make sure our portals will be able to provide fund managers as well as investors with a real-time snapshot of the risks associated with their portfolios. Investors are asking for more, and they are ge ing more delivered by rms like Apex. HFM: What are the biggest regulatory challenges facing start-up hedge funds in the EU?

you still have to provide the same quality that investors expect, or you will not get allocations.

THE CHALLENGES WILL ALWAYS BE HAVING IN PLACE THE RIGHT STRUCTURES TO BE ABLE TO ATTRACT INVESTORS, WITHOUT SPENDING HUGE AMOUNTS OF MONEY

HFM: In terms of trading opportunities, which markets are proving to be the most successful for nimble start-up managers and why?

PH: e biggest challenge is making sure that regulatory demands are being met, which is expensive in terms of compliance. With the AIFMD coming into force, it is going to be more expensive for managers to meet nancial requirements. ey need to have good initiative to make sure the requirements can be met, without crippling them in terms of costs. at is the world we live in, and we need to be able to adapt to that. HFM: What trends do you expect to de ne the start-up sector in the next three to ve years? PH: It is di cult to say, but I think start-ups will run leaner businesses in the next year. In three to ve years, we have to make sure managers have exible models in place. e hedge fund world is driven largely by the allocators now and what they expect. Start-ups need to meet those demands. Whether you have $10m AuM or $10bn AuM,
1 2 H F M W E E K . CO M

PH: It is all very cyclical. We are seeing a large demand for credit funds at the moment. Emerging markets credit is a very popular strategy. Managers are moving slightly away from the classic long/short equity model and there is a growing demand for uncorrelated strategies more private equity strategies, plantation funds and agricultural land funds, student property funds, or insurance linked security funds, for example. People are looking at uncorrelated returns, and at diversifying away from just following the stock market. ey are building portfolios that give good returns, but that arent linked to how the markets are doing. HFM: What can you see the next twelve months holding for start-ups in terms of challenges and opportunities? PH: e challenges will always be having in place the right structures to be able to a ract investors, without spending huge amounts of money. Certainly this is an area which we, as a business, are looking at. Apex provides the solutions in an intelligent and sophisticated way that is not expensive, but which meet demands from investors and regulators. Apex looks a er funds of any size, any structure, and in any domicile and do the work locally. We have teams located close to where any of these start-ups will be. n

| FOCUSED EXPERTISE |

European and international media engagement & stakeholder communications for investment management sector firms Hedge funds, fund of funds, wealth managers, private equity, property funds, end investors, intermediaries & sector service providers

Parex PR Limited 20 Fouberts Place, London W1F 7PL telephone: +44 20 3195 9500 website: www.parexpr.com | email: info@parexpr.com

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HIRING THE COO CAN BE THE HARDEST DECISION

COOS ARE PLAYING AN INCREASINGLY IMPORTANT ROLE WITHIN START-UPS, AS INVESTORS WANT TO HAVE AN INDIVIDUAL IN PLACE WITH THE BACKGROUND TO HANDLE THE COMPLEXITY OF REGULATION AND GOVERNANCE. MUSH ALI OF ONE TEN ASSOCIATES EXPLAINS THE MAIN FACTORS THAT SHOULD BE CONSIDERED WHEN HIRING A COO

T
Mush Ali
is director at One Ten Associates a specialist hedge fund recruitment firm. He qualified as a chartered accountant before starting his career in recruitment nearly 10 years ago. A specialist in the sector, his expertise lies in finding non-investment talent for the hedge fund industry and service providers

he chief operating o cer (COO) hire in any start-up hedge fund is typically the rst noninvestment hire the rm will need to make. We have seen the evolution of the importance of this hire change from it simply being a need to now being just as essential as having a high quality investment team. e track record and pedigree of the COO will be the rst thing investors will question, once they are aware of the investment team and strategy of the business. While the need for a well-regarded COO is key for a hedge fund launch, the accessibility to them is greater than it has ever been from the traditional head-hunter approach to introductions through various networks/suppliers that exist in the sector. We recognise this hire can be difcult to make, since the person responsible for assessing the skillsets of the COO has invariably always hired investment professionals but has rarely been involved in hiring a non-investment individual. erefore, assessing the relevant skill-set of the individual can come with challenges. e purpose of this article is to provide some speci c guidance on the thought process required when considering a COO while recognising that this hire is ultimately individual to the situation of the startup; so there is no one right answer to the hiring of a COO. e following are three key areas to consider when thinking about hiring the COO: 1. SIZE OF THE FUND LAUNCH is will determine the nature of the COO required Less than a $100m launch needs more of a head of operations/COO that can roll up the sleeves and multi-task in the role Greater then a $100m launch is more likely to need someone with a track record in managing relationships and people Greater than a $250m launch will typically want to attract someone from a larger hedge fund, as the launch

will need that type of pedigree to cope with the complexities of this size of launch 2. WHAT SKILLS ARE REQUIRED? e COO will typically need knowledge in nance, tax, operations, compliance, technology and legal. ere is a perception that the COO needs to be a qualied accountant, the rationale being that investors feel comfortable with a COO who is professionally quali ed to create a strong control environment. e validity of this is split across the industry, and in essence there is no wrong or right answer to this view. We always advise fund managers to think about the skills/knowledge that can be missing in the current team typically the answer is to cover everything on the non-investment side. However, this makes it hard to narrow down on the type of background that is required. Some good questions to address in order to narrow down the type of employees a start-up fund manager should look at: Do I need to set up complex systems? If yes, a more technology-savvy COO is needed Is middle o ce across operations and NAV production the biggest worry? If yes, someone with pedigree in dealing with middle o ce is needed Is there a strong need for in-house knowledge on the legal, compliance, as well as tax & nance side, without having to outsource this advice? If yes, a quali ed accountant/lawyer is the best place to nd this broad skill-set. Addressing some of these key issues upfront will help in assessing how relevant the background of the COO is to the start-up. e upside is that the talent pool for COO skills has matured over the past 10 years to ensure start-up fund managers now have the ability to be more speci c about what they want.

THE TRACK RECORD AND PEDIGREE OF THE COO WILL BE THE FIRST THING INVESTORS WILL QUESTION, ONCE THEY ARE AWARE OF THE INVESTMENT TEAM AND STRATEGY OF THE BUSINESS

14 H F M W E E K . CO M

RECRUITMENT

Our advice has always been: the more speci c the fund manager can be about this need, the easier it is narrow down the potential employees, ultimately saving time and reducing the confusion around what the right hire for the business is. 3. USING SPECIFIC BENCHMARKS TO ASSESS THE QUALITY OF THE COO Academics/quali cations is does not always tell the full picture but it can be used as a di erentiator if you are up against a close decision between individuals. However, in our experience it should never be the only factor to consider. Previous institutions e companies individuals have worked for in the rst ve years a er university invariably dene their mind-set and approach as they progress through their career. On top of this, assessing their current roles and organisations is a natural place to create judgements on the skill-set of an individual.

COOS WILL ALWAYS NEED A SMALL TEAM AROUND THEM TO ENSURE ALL CORE AREAS ARE APPROPRIATELY CONTROLLED

CONCLUSION It should be stressed that when thinking of this hire it is unrealistic to expect it to solve all the needs on the noninvestment side invariably, COOs will always need a

small team around them to ensure all core areas are appropriately controlled and managed. e hiring of a COO of a start-up fund can be the hardest hire to make, because a unique mixture of skillsets is needed, which will always be individual to that particular start up. We have tried to provide some advice around how to structure the thinking and approach to assessing COOs backgrounds, but the aspect which cannot be measured is personality. As opposed to the hiring of investment talent which is a more straight-forward and clear decision process the COO hire can be long and tedious because the personality aspect is something which can only be assessed when you have met the person. In our time of specialising in this sector, we have seen di erent tools being employed to assess the quality of individuals. It could also be argued that time can be saved by utilising the skills of a headhunter to help shortlist candidates based on the personality matches and relevance of his or her skills. As this hire will also be critically assessed by the investors, it is imperative that the fund manager spends time structuring the thoughts around what factors they want to focus on when considering this hire for the rm a er all, a lot of time will be spent working very closely with this individual! n
H F M W E E K . C O M 15

a multi-jurisdictional group of companies, providing investment fund formation, administration & valuation services.

Sales & Marketing:

Derek Adler dadler@ifina.com

Group Headquarters:
Sam Bratchie sbratchie@ifina.com

http://www.ifina.com

UK BVI Cayman Malta Hong Kong Singapore USA Switzerland Austria Panama

H O W T O S TA R T A H E D G E F U N D I N T H E E U 2 0 1 3

FUND SERVICES

HITTING THE GROUND RUNNING

STARTING OUT AS A NEW HEDGE FUND MANAGEMENT FIRM CAN BE A DAUNTING TASK WITH THE INDUSTRY CONSTANTLY EVOLVING AND GROWING. SO TO GET AN IDEA OF THE CHALLENGES THESE START-UPS FACE AND HOW THEY CAN CIRCUMVENT DIFFICULTIES, HFMWEEK TALKED TO MATTHEW WILSON OF HEDGESTART ABOUT THE IMPORTANCE A CONSULTANCY SERVICE CAN HAVE
s the hedge fund industry has evolved, so has the complexity of launching a fund. What was once a relatively simple process now faces some very high entry barriers. Capital raising has become incredibly di cult, competition between managers more intense and as a result investors are faced with a lot more choice. So how can a edgling fund get started and overcome these hurdles? HFMWeek sat down with Ma hew Wilson, managing partner of alternative investment consultancy rm HedgeStart, to nd out more. HFMWeek (HFM): How do you perceive the start-up hedge fund climate in the UK? What are the biggest obstacles? Ma hew Wilson (MW): e absolute, number one challenge is raising capital. Its probably always been the biggest obstacle. Even a decade ago I used to say that the three most difcult aspects to cover when starting a rm were raising the capital, nding the right o shore directors and choosing a name. While the la er two havent become any easier in the past few years, undoubtedly raising money has become exponentially harder. I think what is also really important to note is that the majority of fund failures are actually down to operational issues. So, building and maintaining a robust business infrastructure is also absolutely key. What usually happens with the fund managers who fail is that they dont approach their new venture as a business. Someone will walk away from a prop trading desk to set up a hedge fund for the rst time and will be con dent about the one thing in their mind that needs to be done; managing the portfolio. So what the trader needs to do is to make sure they have the robust business infrastructure around them to properly support the activity they do best. Regardless of the conditions you face, you need to be smart about how you set up your operation and ensure your model is scalable for what you want to achieve. With this in mind, we generally advise our clients to keep things as simple as possible in the beginning. However, in doing

Matthew Wilson

managing partner, founded HedgeStart in 2000. Previously he was CFO/COO at a $1bn long-short spinout from Soros, where he ran finance and operations in London. He qualified as a chartered accountant with PwC in 1984 after reading Chemistry at Oxford University.

REGARDLESS OF THE CONDITIONS YOU FACE, YOU NEED TO BE SMART ABOUT HOW YOU SET UP YOUR OPERATION

so, we also have to be mindful of how a client might want to develop the business as well as the constantly changing tax and regulatory environment. We therefore always focus on the exibility that our clients need. Our preferred management structure is generally a limited liability partnership, probably with a UK company as a member of the partnership. is is very simple and straightforward, and importantly creates li le excitement with the tax authorities. As the business grows, we can create more tax advantageous structures alongside, at a time when they are needed and by reference to what still works at that time. Possibly o shore elements to the structure are warranted from day one, but only if there are clear indications that the circumstances under which it is bene cial are there from the start or actually likely to occur and even then it is o en only necessary to put in place the framework elements as opposed to the full works. Dont try and build the empire before you build the city. Some start-up managers are concerned about the impending Alternative Investment Fund Managers Directive (AIFMD). Im of the view that the AIFMDs bark will end up worse than its bite, especially when we look back on it in a few years time. Our approach has been, watch this space while supporting lobbying initiatives such as those of the Alternative Investment Management Association. But what is the AIFMD trying to do? Leaving aside the original political agenda, it is principally trying to ensure that what has become an increasingly important subsector of investment management operates properly. In respect of this, most hedge fund regulation tends to be just codi ed good business practice. With the right pragmatic and practical advice, all of these things no ma er how terrifying they may seem can be dealt with. e industry will nd its solutions to the AIFMD. HFM: What are the operational options for hedge fund start-ups? Why is there a need for outsourcing to start-up hedge funds? MW: Unless youve done it before, it is a lot easier to launch if you talk to someone who has done it before. Nevertheless,
H F M W E E K . C O M 17

H O W T O S TA R T A H E D G E F U N D I N T H E E U 2 0 1 3

FUND SERVICES

some people will still endeavour to go it alone without consultancy assistance. ere is a lot of support out there from prime brokers and they are doing a lot of the things now that we were doing 10 years ago in terms of the overall consulting support. So we have now focused around those parts of the process the primebrokers dont handle. For example, take an Financial Services Authority (FSA) application. Anyone can do an FSA application themselves, as the forms are publicly available and easy to download from the FSAs website. However, just because you have the form, doesnt necessarily mean you will understand the questions being asked. You could write a 16page answer for a particular question, which could very well contain the very information the FSA needs except that it is wrapped in 15 pages of information that they dont need to know. is then makes the whole process unnecessarily longer for both parties involved. Another area start-ups absolutely need help with is tax. One thing for sure is that tax is not going to get any easier or simpler as time goes on; indeed it will be the opposite. Quite frankly, no tax inspector is likely to lose his job because he busted the tabloid-vili ed hedge fund manager who didnt get the right tax advice and made some honest mistakes. Even where the rules dont change, understanding how the tax man interprets and enforces is absolutely crucial. We also adopt the mind-set of what we think the tax man will be asking in two to ve years time since those are the questions you will eventually have to answer, not todays. In the end, managers need to be able to concentrate on what they do best. So, they either need to create an infrastructure within their organisation to handle all of the peripheral functions or they keep their business more lean and outsource these roles. Building a hedge fund operation is largely an issue of taking standard industry components, and pu ing them together in an integrated fashion to create a business. We have the perspective to know how these pieces t together. HFM: Has this need changed as a result of the evolving regulatory, market and investor conditions?

MW: e industry has grown exponentially, although more recently at least the rate of growth has been more subdued but nevertheless with healthy new activity. e investor community has matched this and itself become much broader, as there is now a larger range of investors and organisations trying to get into hedge funds. is itself has introduced more rigorous due diligence and higher operational standards as a given, as well as perhaps some degree of bureaucracy. e barriers to entry have also been raised through the minimum amount of assets that investors want to deploy. If Im an investor, I might say my minimum ticket is $10m and I dont want to be more than 10% of the fund I invest in. So that means immediately Im not going to look for any funds unless they are at least $100m. If youre a hedge fund manager who is starting with nothing, it can be much harder to achieve that primary level of investment. As a result of that, we are seeing a lot more in terms of seeding deals. HFM: How do your start-up hedge fund clients come to you? And what services are you typically required to provide for start-ups initially? MW: Clients almost exclusively come to us via personal referral and word-of-mouth activity in our existing client base. ey know we are interested in building relationships within the industry and aiding start-ups is a means to an end and allows us to develop a long-running relationship. e service we do for most start-ups is the FSA application, closely followed by various elements of tax structuring. As we are interested in building long-term relationships, we have a vested interest in whether the fund succeeds or not. Operational factors aside, if they deliver performance they will succeed and if they dont, they wont. But if they are smart, ensure they have the right operational model and outsourced infrastructure in place, this binary conclusion becomes signi cantly less startling. n

18 H F M W E E K . CO M

BLOOMBERG FOR HEDGE FUNDS

GET THE SUPPORT YOU NEED EVERY STEP OF THE WAY. Bloomberg can help you start and build a successful hedge fund. Along with industry-leading technology, data and analytics, we can connect you to experts in compliance, seeding, fund administration, legal, prime brokerage and operations. From industry best practices and market insights to world-class news and trading solutions, we provide access to everything you need. Find out more about the complete, end-to-end solution for starting a hedge fund. Contact us at getconnected@bloomberg.net

2012 Bloomberg L.P. All rights reserved. 51362041 1212

H O W T O S TA R T A H E D G E F U N D I N T H E E U 2 0 1 3

OUTSOURCING FOR SMALLER HEDGE FUNDS

JERRY LEES OF LINEAR INVESTMENTS EXPLAINS THE ADVANTAGES OF WORKING WITH A MINI PRIME BROKER IN ORDER TO KEEP COSTS TO A MINIMUM IN THIS CHALLENGING ENVIRONMENT OF GREATER REGULATORY BURDENS AND INCREASING INVESTOR DEMAND

Jerry Lees

is CEO of Quant and chairman of Linear Investments. As global head of Alternative Execution at Cheuvreux, Jerry grew the Electronic DMA, Synthetic Prime Brokerage business from the beginning, starting the first AES service for the group in Japan in 1998.

dont know what I want but I want it now! said Sir Henry at Rawlinsons end, a great character from an 80s radio show. ese are very di cult times for smaller or start-up hedge funds and we o en face this dilemma. We are frequently approached by new funds se ing up for the rst time, or even mid-sized funds being squeezed at both ends under current market conditions who are looking for new homes. Investors have di erent expectations nowadays caution and suspicion are the leading in uences on how investors look at a new or smaller fund. ey have been burned and do not wish to experience the same again. For emerging funds, the days of ashy o ces in the heart of Mayfair are more likely to put o investors than impress them. ey would prefer to feel the investment is going into the fund austerity and a serious outlook, reassuring clients about the funds survival are crucial. e issues are almost wholly the same how can we build a track record, or even stay a oat with reduced AuM and having to incur signi cant costs to maintain a hedge fund under current regulations (with increasing supervisory demands and reporting requirements)? Fixed costs and overheads can quickly overwhelm the earnings potential of even quite successful smaller funds. Simply put: costs are too high to sustain the level of investment. You need time to build or prove a track record, and resources and skills outside of the fund advisory function are costly. In terms of what needs to be in place, there is FSA registration and ongoing reporting and management, as well as middle- and back-o ce se lement and operational issues that need a ention (and cannot be ignored). Also, technology is expensive but essential (using Bloomberg data, for example), websites and marketing

materials need building and signing o , and rents in London are high. On top of all this, raising capital for smaller funds is impossibly di cult in current market conditions. ere are ways of addressing all of these issues to keep costs down and manageable. ere is a tendency for groups of smaller funds to get together with boutique industry experts to create innovative and e ective solutions. is has been the case for a long time in the US, where mini prime brokers are very prevalent: there were 42, at last count, operating in the country but hardly any in Europe. is approach avoids many of the costs, expensive learning curves and pitfalls of se ing up and running a smaller fund. By sharing resources you can radically reduce overheads to increase your chance of success or survival, and maybe even more signi cantly open up doors to capital introduction by working with others. e importance of working with mini prime brokers who o er consolidated services (including o ce space,

BY SHARING RESOURCES, YOU CAN RADICALLY REDUCE OVERHEADS TO INCREASE YOUR CHANCE OF SUCCESS OR SURVIVAL
20 H F M W E E K . CO M

PRIME BROKER AGE

shared legal and other advisory services) and are focussed on raising seed capital is that they are focussed entirely on this area of the business. e smaller fund is very important you are not relegated to the back of the queue as you would be with a global prime broker (even if you make it through the door!). What happens, for example, when your investors withdraw funds (often for reasons entirely unrelated to your fund performance) and at the same time your prime broker or custodian tells you they no longer want to look after a fund of your size as it is too small, there is not enough turnover, and not enough return to make it worthwhile for them? To add to the pain, your service providers and fixed costs are eating up your management and performance fees. What are you going to do? A start-up or emerging fund has all the same issues, with maybe a few more headaches piled on. It is very easy to erode signi cant chunks of the initial set-up capital on establishment costs, legal fees, admin, back o ce and premises. But, in both circumstances, there are now better ways of radically reducing those overheads and xed costs at the same time as pulling in appropriate knowledge and infrastructure. Virtually all of your non-core cost can be turned into some form of outsourced variable cost. e whole issue of raising new capital is a complete nightmare at the moment. Its especially difcult for the smaller funds, as they are ghting the multiple issues of investor con dence (or lack of): indecision, fear, uncertainty, downturn exhaustion and complete risk aversion. Whatever your

RESEARCH AND OTHER SUPPORT SERVICES CAN ALSO BE TIED IN AND YOUR EXECUTION CAN BE FULLY OUTSOURCED UNDER THE SAME UMBRELLA

strategy, the investor will have a disaster anecdote to relate that is directly comparable to yours. An organisation such as Linear Investments is speci cally geared up to help you through the stages of growth; from early days to second- or third-stage seeding. Our aim, and that of our partners, is to nd managers with talent and ideas, helping them get on with the process of building value while we deal with the detail and the cost. e approach can manifest itself in many ways and each individual situation involves a selection of options, which are speci cally suited to each environment and level of development. As a mini primebroker, we work with smaller funds and, by tying up with a number of industry experts in several elds, we become enablers at all levels. Tie-ins with technology companies, administration and operational support businesses, set-up specialists, compliance outsource and legal means we can help you select the best and most appropriate solutions. Operationally, we use these services ourselves, running back/middle o ce functions, providing o ce space and trading facilities, and FSA registration and compliance services all of which we can supply wrapped into commission. Research and other support services can also be tied in and your execution can be fully outsourced under the same umbrella. In addition, we have inhouse capital introduction experts who are completely focussed on the smaller funds and working constantly on relationships with specialist family o ces and other investors interested in earlier stage involvement in hedge fund growth strategies. To do this we are in the process of adding a feeder fund to manage diversi ed investments on behalf of our investors from seed capital to next stage growth. In some cases, we will partner with ventures where synergies are greatest and there are mutually clear objectives. But overall, we are working in partnership with our funds and it is up to you or them to select what suits your model and at what stage. e concept is one which is a racting a great deal of a ention. We expect to build relationships with 60 or more hedge funds over the next two years, building on the multiple relationships we have in place and expanding the network of funds and investors into a signi cant force for growth in the industry. In summary, it is vital that you streamline your costs and operational structures to minimise outgoings and optimise the return from your AuM and performance fees, which themselves are lower than they used to be. Investors are more impressed by how you are managing costs and how austere your o ces are than expecting to see marble and glass in the heart of Mayfair. It is now possible to set up very cost-e ective operations by sharing expertise and working with prime brokers who focus on smaller funds. Everything can be shared: o ces, FSA licence, o shore entities (SPC structure), advice, admin and even capital introduction all without giving away your ownership or independence. Its worth exploring what could be done to radically reduce your costs, especially if you (like many others) have seen a withdrawal of investor capital or are in start-up mode. n
H F M W E E K . C O M 21

H O W T O S TA R T A H E D G E F U N D I N T H E E U 2 0 1 3

CHECK YOUR PLAYBOOK EXPIRATION DATE

WITH CLOUD SERVICES BECOMING INCREASINGLY POPULAR AS A HEDGE FUND IT SOLUTION, NIGEL KNEAFSEY OF OPTIONS IT PROVIDES AN OVERVIEW OF THE MOST IMPORTANT POINTS TO CONSIDER WHEN SELECTING A TECHNOLOGY PLATFORM
erhaps youre launching a new hedge fund, spinning out or spinning up a new book, or expanding your business in a direction that calls for a fresh look at your technology platform. If that is the case, then stop and take a look at the date on that playbook you intend to use to make your choices; the fact is, if its more than a few quarters old, its of limited value. Investor, business and regulatory-driven requirements evolve from one reporting period to the next. Yet the emergence of the cloud business model possesses a new source of disruption that presents new means of addressing these requirements and of changing the economics of your business something which may be less than obvious. SCEPTICS WELCOME One can hardly be blamed for more than a modicum of scepticism towards the hype and hyperbole associated with the cloud, so lets endeavor to separate fact from fancy. At Options, we nd ourselves uniquely positioned to shed light on the ma er given our heritage. We have 20 years of experience in providing managed technology solutions to the capital markets, and we were the rst provider to o er a hosted, managed and multi-tenant technology platform (in other words, a cloud) speci cally for the alternative investment community in 2002. Over those 10 years of operating a private nancial cloud, weve developed a number of deeply held convictions on the subject.

Nigel Kneafsey

is founder and CEO of Options IT, a provider of private financial cloud services to the global capital markets community. Kneafsey launched Options in 1993 as a provider of outsourced IT services to the investment banking industry. Options IT now provides market data and execution connectivity to all major markets, supporting more than 130 firms globally.

HIGH QUALITY PROVIDERS WILL CERTAINLY DEMONSTRATE SUPERIOR DESIGN IN TECHNICAL ARCHITECTURE

BUSINESS IMPER ATIVES & IMPAC T Lets get back to basics, then, and ask ourselves what the most critical business imperatives governing technology platform selection are, and consider how cloud providers impact them. 1. Build investor con dence: Investors are looking for assurances to the operational stability and soundness of the managers they entrust. Cloud providers with mature, proven and professionally audited procedures a ested to by way of a Type 2 SOC 3 report not only instill con dence in their customers, but
22 H F M W E E K . CO M

also enhance the pro le of the customers to their investors by allowing them to enjoy and assert their possessions of those same SOC 3 accreditations. is can be leveraged as a competitive advantage among ones peers with discerning investors. 2. Minimise business risks: In the context of a rms technology platforms and operations, resiliency and availability pose signi cant risks both in terms of systems and, most critically, sta . High quality providers will certainly demonstrate superior design in technical architecture, which enables the high availability so vital to a solid operational platform. But equally importantly, these providers can hire and motivate talented sta in all the key disciplines involved in todays highly evolved technology systems and focus them on a single cohesive platform. Be it through expertise in Linux, Windows, or network, storage and database administration, leading providers can wield the critical mass of resources necessary to withstand turnover and routine sta absences, all within a single set of hardened repeatable business processes and a uni ed platform proven over years of production cycles and a broad customer base. 3. Address regulatory & due diligence requirements: Regulatory authorities and investors alike present challenging and not uncommonly changing and expanding expectations concerning the maintenance and availability of the rms data, be it correspondence, positions and transactions, books and records or otherwise. Best in class providers can clearly articulate a data management platform capable of exceeding todays requirements to ensure the rm is prepared to respond no ma er how stringent future expectations might be. 4. Optimise expense control: Market volatility and the many external forces a ecting the fate of any fund managers assets under management threaten the stability of the rms pro tability, unless they can manage their costs in line with revenues. Cloud service providers can provide capacity on demand as an operational expense, allowing for more dynamic scal-

TECHNOLOGY

ing of technology infrastructure in line with prevailing conditions and business demands.

DE TER MINANTS OF SUCCESS While cloud adoption o ers such bene ts, choosing the right provider calls for a discerning review across a number of dimensions. 1. Provider & platform maturity: Experienced infrastructure managers know all too well that its only with hard-earned experience that a given platform can achieve high quality, given the complexity and continuing evolution of modern computing architectures. Hence, when weighing the quality of a cloud hosting platform, there can be no substitute for the production miles of a uni ed system and the processes supporting it. Progressive service providers will continually seek to adopt innovative technologies and techniques, but only as enhancements to a time-tested proven system and with great care to manage the change process. Furthermore, they will have a track record of pro table and reputable business operations to earn your trust in their long term viability. 2. Capital markets expertise & applications: As homogenous as many of the IT components we leverage may be, the capital markets industry presents a myriad of niche requirements, which cannot be properly supported without subject ma er knowledge and experience. Be it market data quality and exchange reporting obligations, FIX connectivity, or regulation-driven storage requirements, service providers must provide industry focus and a seasoned team equipped to provide a comprehensive service experience. Be er yet, providers should present a broad array of supported partner applications and content to address the front-to-back needs of the client under one service provider umbrella, and o er direct access to trading destinations in market co-location centres. 3. Architectural and systems quality & uniformity: System availability and resiliency is a ma er of critical concern to all customers and yet all too easily underinvested in or poorly designed by the provider. Service provider offerings must be validated to ensure all critical systems are deployed in geographically distributed resilient pairs with detailed backup and recovery systems and procedures. Just as important, the providers platform should be uni ed and coherent, and therefore capable of being properly administered at scale. 4. Privacy: Regulators and investor expectations, as well as intellectual property protection concerns, call for rigorous measures to isolate and protect client data be it stored or in transit. Beyond taking obvious measures such as operating a private network and implementing the rewalls and access control policies one would expect, discerning customers will again look for audited assertions of data privacy enforcement measures.

EXPERIENCED INFRASTRUCTURE MANAGERS KNOW ALL TOO WELL THAT ITS ONLY WITH HARD-EARNED EXPERIENCE THAT A GIVEN PLATFORM CAN ACHIEVE HIGH QUALITY

In addition, they will expect a more rigid data protection model than the one o ered by public cloud providers such as Amazon Web Services, and will require data segregation techniques and dedicated hardware operating in the speci c data centre countries they desire. 5. Price predictability: All managed service arrangements call for a delicate balance of capabilities and associated costs between customer and provider, and its all too common to see commercial models that expose customers to the undue risk of an uncapped consultancy charge model. Best-in-class providers will o er customers a high degree of price transparency and predictability in the form of xed service pricing. By removing the threat of nickel and diming, these set service providers adopt simple xed subscription pricing and assume the risk of cost volatility themselves, and rightly so given that the service provider is be er positioned to manage those costs. 6. Performance incentive alignment: Beyond being able to properly articulate and demonstrate a set of processes and systems that position a service provider to meet a clients expectations, they must be nancially incented to perform as well. Clients should expect rigorous, quanti able service level agreements which ensure any pain they endure is shared by the service provider where they feel it most: in their wallets.

OPTIONS AT YOUR DISPOSAL e fact is, cloud service providers are capable of ge ing investment rms up and running more quickly, cost e ectively and con dently than was previously possible. With a contemporary understanding of the choices available to you, you will be be er placed to execute your playbook than ever before. n

H F M W E E K . C O M 23

Compliance Expertise For Asset Management Firms

Complyport is a leading regulatory compliance consultancy which provides bespoke, practical solutions to the asset management industry. FSA authorisation assistance Ongoing compliance support Special projects including s166 Skilled Persons Reports Whether you are a boutique adviser or a global asset manager, our job is to help you understand and meet your compliance and regulatory obligations. Our experienced team includes many former regulators and industry practitioners who have a proven track record of delivering pro-active solutions to asset management rms. With the regulatory landscape constantly evolving in Europe, the US and Asia, Complyport ensures you are prepared for the challenges ahead. CONTACTS UK Jon Wedgbury Email: jon.wedgbury@complyport.co.uk Tel: +44 (0)20 7399 4133 Martin Herriot Email: martin.herriot@complyport.co.uk Tel: +44 (0)20 7399 4980 Jersey John Pallot Email: john.pallot@complyport.co.uk Tel: +44 (0)1534 626 144 www.complyport.com

H O W T O S TA R T A H E D G E F U N D I N T H E E U 2 0 1 3

LEGAL

RISK MANAGEMENT IN SECURITIES FINANCING PROGRAMMES

SIMON BORG BARTHET OF GVTH ADVOCATES EXPLAINS WHY, IN THE CURRENT REGULATORY ENVIRONMENT, HAVING A ROBUST RISK MANAGEMENT SYSTEM IS CRUCIAL FOR MANAGERS-BOTH FROM A LEGAL AND CAPITAL ADEQUACY POINT OF VIEW
ndoubtedly, the name of the game over the next year is going to be managing expectations the scope of regulatory changes on a European level will leave many asset managers jumping through hoops to try and satisfy a ra of regulations rather than focussing on maximising returns. e AIFMD, EMIR, MIFID II/MIFIR and CRD are just some of the regulations which will have an impact on asset managers. To boot, a spotlight has been shined on the so-called shadow banking sector (the unregulated system which provides funding to almost half of the nancial system through a number of risk transformation nancial market techniques, including repurchase agreements, securities lending and securitisation) due to the liquidity shock that can be sustained in runs on the system. ese may be exacerbated by margin calls, defaults and the pursuant appropriation of collateral. Many hedge funds operating a long/short strategy use securities lending as an arbitrage tool,

Simon Borg Barthet,

LLD, MSc, is an associate at GVTH Advocates and is knowledgeable on financial market operations. Prior to joining the firm, Simon had been engaged in a number of positions in the financial services industry, particularly insurance, where he was exposed to MiFID and IMD business, UK FSA regulatory reporting, Anti-Money-Laundering, and pensions business.

A ROBUST RISK MANAGEMENT SYSTEM MUST BE EMPLOYED TO ENSURE THAT AN ASSET MANAGER IS NOT CAUGHT OUT

or simply to appropriate securities to sell short; other institutions use repurchase agreements (repo) as a secured nancing tool, especially now that unsecured credit lines have dried up. Either way, runs on the system could trigger mass recall of securities out on loans, resulting in managers either having a position that becomes uncovered, which garners unfavourable a ention from regulators, or having to close out positions by purchasing securities to cover the loan at considerable loss to themselves; or worse, placing them in default (as a consequence of unprecedentedly low interest rates, the consequences of failure to deliver have diminished, which could lead to strategic noninvoluntary defaults). In addition, the move to T+2 se lement means that funds have less time to source equivalent securities, which in illiquid market conditions and particularly for illiquid securities, leaves li le margin for error. is means that a robust risk management system must be employed to ensure that an asset manager is not caught out, both from a legal and regulatory point of view, as well as from a capital adequacy viewpoint. Typically, securities lending and repos are transacted under the Global Master Securities Lending Agreement (GMSLA produced by the International Securities Lending Association) and the Global Master Repurchase Agreement (GM produced by the International Capital Markets Association), respectively. ese agreements and the various relevant annexes have been cra ed and tweaked over a number of years by industry proponents, taking into account a number of nuances speci c to those transactions. is provides a great deal of operational certainty as to the accepted legal mechanisms of the transaction. e importance of legal opinions supporting the nature of such a transaction so as to avoid re-characterisation as an outright sale into a secured nancing transaction is paramount in avoiding legal complications in the event of a default. e complex sets of rights and obligations must be examined in light of the provisions of the master agreeH F M W E E K . C O M 25

H O W T O S TA R T A H E D G E F U N D I N T H E E U 2 0 1 3

LEGAL

ments and speci c provisions relating to the counterparty relationship. Ne ing and set-o , for example, are an important part of this. Ne ing is not automatic under the master agreements and must be opted in this provides two main bene ts:

i) the grouping of transactions between counterparties in various transactions under a single legal document, which would allow for the transfer for net balances on re-margining, thereby leading to greater transactional e ciency; ii) e other is the bene t for the purpose of capital adequacy. By way of summary, exposures to counterparty credit risk under CRD/Basel is a orded the greatest collateral e ciency in trading book transactions and treated as single balances due to either partys capability of being ne ed through a legal document. Strict regulatory capital calculations arising from CRD III now requires that an investment services provider must hold capital at 10-day Value at Risk (VaR) 99% con dence level, meaning the importance of an appropriate collateral management infrastructure and collateral optimisation has become a cornerstone of sound risk management practice. Furthermore, the Financial Stability Board issued their comments on the shadow banking sector and is calling for liquidity cover ratios and net-stable-fundingratios similar to the requirements for credit institutions under Basel III. A way to further reduce the burden of regulatory capital is through mitigating counterparty risk by engaging a central counterparty clearinghouse (CCP). Since the nancial crisis, regulators have sought to bring over-thecounter (OTC) bilateral transactions out of the shadows in light of severe mispricing of risk and massive accumulations of counterparty credit positions, as was the case with Lehmans Brothers and MF Global. CCPs signi cantly reduce the extent of credit exposure in clearing and se lement by e ectively acting as the buy-

A PRUDENT APPROACH TO RISK MANAGEMENT WILL PROVIDE ADDED REASSURANCES TO BOTH FUND MANAGERS AND THEIR RESPECTIVE INVESTORS

er to the seller and vice versa. Operationally, this means that the network of transactions between counterparties would all be transacted with a single party. For example: Counterparty A owes a net balance of 100 to counterparty B Counterparty A owes a net balance of 200 to counterparty C Counterparty A is owed a net balance of 250 from counterparty D Counterparty A owes CCP: 100 + 200 - 250 = 50

When transacted through a CCP, the above balances due would be ne ed out to Counterparty A owing a single balance of 50 to the CCP, as opposed to having to account for each set of transactions with individual counterparties separately. Multilateral ne ing allows us to maximise the e ectiveness of collateral posted by singularly eliminating the need for separate accounts, reducing back o ce costs and potentially reducing the need for collateral by up to 75%. To boot, CCPs are heavily backed up by a collective default pot, which would indemnify the participant of its losses in case of a default of the counterparty. A market participant can also reduce concentration risk by engaging a number of di erent CCPs to avoid the default of a single CCP, albeit very unlikely. e full extent of EU regulation is yet to be felt and undoubtedly will provide challenges in the future. Nevertheless, a prudent approach to risk management, particularly in relation to regulatory capital, will provide added reassurances to both the fund managers and their respective investors as to liquidity of the fund and consequently ensure that it is protected to some extent from runs on the market. Ensuring that an adequate mix of legal documentation as well as relationship management with key service providers is in place will bolster managers positions as a beacon of prudence, especially in volatile and uncertain markets. n

26 H F M W E E K . CO M

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