SPECIAL AGENTS REQUIRED: CALLING A NEW GENERATION OF TRANSFER AGENCY SERVICES

WHITE PAPER INVESTMENT OPERATIONS SPECIAL AGENTS REQUIRED: CALLING A NEW GENERATION OF TRANSFER AGENCY SERVICES TONY WARREN HEAD OF STRATEGY AND SOLUTIONS MANAGEMENT, ASSET MANAGEMENT AND INSURANCE, FIS INSTITUTIONAL AND WHOLESALE BUSINESS

Contents 1 Introduction Efficiency versus complexity: The diversification dilemma 2 A function in flux: The changing face of the transfer agency market 3 A new world of demands 4 Mission critical: Redefining the transfer agency function 5 Conclusion At your service: The specialist industry utility

Special Agents Required: Calling a New Generation of Transfer Agency Services 1 Introduction Efficiency versus complexity: The diversification dilemma In the search for alpha, today s asset managers must constantly look for new ways to improve returns for investors and ease the mounting pressure on their margins. With competition fiercer than ever, investment strategies are evolving fast and mainstream firms are becoming notably less traditional in their approach. In short, diversification is now increasingly key to successful performance. Around the world, more asset managers are branching out and going global; broadening the scope of their investments to embrace a greater range of not only products, instruments and strategies but also geographic territories. In a recent survey, Aite Group found that moving from a country level to a global approach is important for 77 percent of asset managers and third-party administrators (TPAs), who see better support of their global client base as a critical near-term goal. 1 Operational challenges abound as a result and are only compounded by the growing need to achieve operational efficiency. In a fast-moving market, investment processes must now also move rapidly and deliver accurate, transparent data that is readily available for client reporting and regulatory compliance. The twin need to manage complexity and increase efficiency is, unsurprisingly, placing considerable strain on fund administration processes not least when it comes to shareholder record keeping. Like the rest of the back office, transfer agency is under pressure to improve efficiency, effectiveness and scale, especially in the context of a more complex investment landscape and shifting industry dynamics. But this critical function must also confront specific challenges of its own as it adapts to the demands of a diversifying market. For TPAs in particular, the new global playing field has introduced additional complexity and risk. As their asset manager clients continue to diversify, many of the more traditional TPAs have been driven to service products, instruments and vehicles that were once the remit of pure alternative asset servicers. Fact: With competition fiercer than ever, investment strategies are evolving fast and mainstream firms are becoming notably less traditional in their approach. 1 AITE GROUP, GLOBAL ASSET MANAGEMENT STUDY 2014, JULY 2014

2 Special Agents Required: Calling a New Generation of Transfer Agency Services A function in flux: The changing face of the transfer agency market Over the past decade, changes in the landscape of both the mutual fund industry and the wider world of financial services have had a profound effect on the transfer agency market reducing its responsibilities, margins and profitmaking potential. Shrinking volumes: The sub-accounting effect From the early 2000s, a shift towards intermediary subaccounting has progressively reduced the number of accounts managed directly by transfer agents. As Deloitte explains: Mutual fund shareholder servicing has been transformed dramatically as increasing numbers of intermediaries serving as fund distribution partners move to provide shareholder sub-accounting through an omnibus model. In this structure, intermediaries such as broker/ dealers and retirement plan recordkeepers maintain account information and transaction histories directly for their customers in sub-accounting systems. 2 By the start of the current decade, omnibus accounting arrangements were becoming standard. According to PwC: Omnibus accounts now prevail in the industry, and intermediaries are performing some or all of the investor servicing and recordkeeping functions that transfer agents would have previously handled under the direct model. As a result, a broker-dealer intermediary may seek, and receive, a portion of the shareholder servicing fees (that were traditionally paid to the transfer agent), either directly from the mutual fund or through its transfer agent, to offset the additional costs. 3 With only a condensed number of omnibus accounts to manage, transfer agents have lost not only earning power but also scale reducing the efficiencies and economies that a larger volume of individual accounts can deliver. Budgets under pressure: The regulatory effect The global financial crisis and its ongoing repercussions have only compounded the challenges faced by the transfer agency sector. Traditionally, the industry s main players have been large global banks, who once tended to offer shareholder recordkeeping as part of a full suite of services. Since the crisis, however, and particularly in the U.S., these organizations have gradually withdrawn or sold off their transfer agency functions. A main reason for this mass exodus is regulation. A welldocumented wave of complex compliance and risk management requirements has hit the too-big-to-fail banks where it hurts, placing enormous pressure on budgets and resources. Forced to pay the high costs of compliance, many top-tier financial institutions have also been driven to reassess the viability of their fund services and separate the low value from the lucrative. Core fund administration and accounting services have been safe from the threat of rationalization. Closely integrated as they are with businesses such as custody, prime brokerage and securities lending, these core competencies remain a potentially healthy source of additional revenue and competitive advantage for banks. Without the former, in fact, it can be difficult to sell the latter to institutional clients. The same cannot be said for the transfer agency function, whose end user the individual shareholder has no use for high margin, add-on fund services. Falling outside their core competencies, transfer agency also presents something of an operational challenge for banks: one they can no longer afford to surmount. Without the specialist skills, scale or indeed appetite to run an efficient operation, the large majority of top-tier institutions have bowed out of the market. With far lower volumes of accounts to manage as a result of sub-accounting, large asset managers and TPAs are also re-evaluating their need for an internal transfer agency system. 2 DELOITTE, THE OMNIBUS REVOLUTION: MANAGING RISK ACROSS AN INCREASINGLY COMPLEX SERVICE MODEL, 2012 3 PWC, EVOLUTION OF THE MUTUAL FUND TRANSFER AGENT: EMBRACING THE CHALLENGES AND OPPORTUNITIES, JULY 2015

Special Agents Required: Calling a New Generation of Transfer Agency Services 3 A new world of demands While account volumes may be shrinking, the need for effective transfer agency services is, paradoxically, more intense than ever thanks largely to the operational and regulatory demands of modern investment portfolios. The search for alpha: Operational issues The past decade has seen the progressive convergence of traditional and alternative investment approaches. Today, mainstream, previously long-only asset managers are just as likely to invest in complex derivatives products as hedge funds, and there has been almost a complete integration of the asset classes under management in firms. At the same time, new investment products and strategies are in frequent development, with innovative vehicles such as liquid alternatives and registered hedge funds recently rising to prominence. Typically, even a medium-sized asset manager will now need to handle a complicated combination of, for example, 40 Act fund, fund-of-funds, hedge fund and offshore investment structures and strategies. Compounding the complexity will be the multiple accounting, regulatory and tax requirements of different jurisdictions and the risk inherent in processing delays and inaccuracies. According to Cerulli Associates: Managers are focused on packaging multi-strategy and other non-traditional fixed-income investments to meet advisor demand for income-generating products 46 percent of asset managers plan to launch one to three new products during the next year; only 13 percent of firms reported that they plan to launch more than six in the next 12 months. 4 NICSA has acknowledged the operational impact of alternative instruments, commenting that: On its face, the interest in retail alternatives would appear to be the province of the product development department, but, perhaps more than any other product category, these funds require extensive support from operations and technology. Investment techniques used by these hedge fund-like vehicles place heavier demands on investment operations and compliance. Extensive use of derivatives, short sales and leverage requires sophisticated approaches to collateral management, while holdings of less liquid securities, swaps or options pose valuation challenges. At the same time, monitoring these complex strategies is more difficult from a compliance standpoint. 5 From a transfer agency perspective, many emerging investment products have different workflow requirements to those of traditional instruments, or must be processed on a same-day basis. With batch-based processing still prevalent across the transfer agency industry, the need for same-day processing and settlement has never been greater, and demand for intraday pricing requirements is sure to rise in the near future. A case in point is the recent reform of rules governing U.S. prime institutional money market funds. Along with new risk management, reporting and tax accounting obligations, the latest requirements include the introduction of a floating NAV regime and the application of liquidity fees and redemption gates, to prevent runs on a fund in times of stress. Overall, this is likely to cost the industry dearly. One leading transfer agency provider has estimated a spend of around $10 million on upgrading its current batch-based processing systems; for some money market funds themselves, the operational cost of responding to reform could be several times as high. Again, a flexible architecture and same-day pricing capabilities will prove critical to meeting modern demands. The flexibility of transfer agency technology is also key. Rather than relying on multiple, specialist solutions to meet the needs of specific products or strategies, it should be possible to configure new styles of instrument within one system without relying on technology cycles. The compliance challenge: Regulatory burdens With portfolios that increasingly span many territories and jurisdictions, firms must inevitably navigate multiple regulatory requirements and tax laws. So, as they extend their footprint in the search for alpha, and strive to improve returns to attract investors, they must also find new ways to manage the costs, risk and complexity of cross-border shareholder servicing. According to Aite Group 6, 72 percent of asset managers and 84 percent of TPAs currently operate in multiple jurisdictions, thereby having to manage the challenges of cross-border investment accounting. In their combined experience, the biggest obstacle to entering new territories, for 35 percent of survey respondents, is the wide variation between regulatory reporting requirements from country to country. 4 CERULLI ASSOCIATES, THE CERULLI EDGE: US ASSET MANAGEMENT, JANUARY 2014 5 MONEY MANAGEMENT EXECUTIVE, NICSA EXPERT VIEW: OPS, TECH IN SPOTLIGHT IN 2014, JANUARY 2014 6 AITE GROUP, GLOBAL ASSET MANAGEMENT STUDY 2014, JULY 2014

4 Special Agents Required: Calling a New Generation of Transfer Agency Services Mission critical: Redefining the transfer agency function Given the loss of scale created by omnibus accounting and the growing demands on its operations, transfer agency finds itself in something of a quandary. On the one hand the function no longer adds value for the global banks that once dominated the market. But on the other, the need for efficient, cost-effective shareholder servicing is increasingly critical. As the market redefines itself, three clear missions emerge for transfer agency services. Mission #1: Deliver efficiency and scale For sustainable growth, asset managers and TPAs need to increase the efficiency, speed, effectiveness and scale of their back- and middle-office operations, transfer agency included. According to NICSA: now that the outlines (if not all the details) of the post-credit crisis regulatory regime are in place, the industry can focus again on generating growth. And, this time around, it won t just be product development and marketing getting all the air time. Instead, operations and technology will share the spotlight. That s because, in an increasingly competitive industry, efficiency behind the scenes is essential to an effective front office-and will be a key contributor to industry profitability overall. 7 But as volumes diminish, and large institutions leave the market, who will provide the efficiencies and scale that transfer agency services require? One increasingly compelling answer lies beyond financial institutions themselves in the realm of the specialist technology provider, for whom back-office processes like shareholder recordkeeping represent a core competency. In recent years, both asset managers and TPAs have made efficiency gains by outsourcing a range of non-core yet critical operations and utility functions from the depths of their own back office, including transfer agency. In Aite Group s survey 8, 66 percent of asset managers and servicers say they outsource some form of operational activity to a third party. Asset managers, as would be expected, are highly active in this sense, with 57 percent currently outsourcing the transfer agency function to a third party and another 11 percent planning to do so in the next three years. Although less so, asset servicers are also reaping the benefits of outsourcing to meet diverse client requirements. According to the survey, nearly half (47 percent) currently outsource an operational activity. Through business process outsourcing, and by working in partnership with technology providers, firms can ultimately get more from technology than just a core solution they can also gain a trusted industry specialist. In research on technology trends, CEB TowerGroup notes that: Financial services institutions of all types are looking to reduce cost and reengineer their business operations; therefore outsourcers continue to add greater domain expertise and a majority of vendors are increasing their emphasis on vertical specialization across financial services. 9 Mission #2: Steer clear of competition Any bank, asset manager or TPA that exits the transfer agency market may be forced to rely on a direct competitor as its transfer agent. Again, the specialist technology firm provides an ideal solution. As well as expertise, efficiency and scale, it can offer customers a wholly independent transfer agency service that prices fairly and won t compete against their own core financial services. Mission #3: Invest in innovation To manage growing operational demands, today s transfer agency services need a robust technology backbone with a flexible modern architecture, able to cope with multiple products and all fund and security types. They should also deliver real-time access to account data, facilitate 24/7 processing and reporting of assets and support both same-day processing and intraday pricing. Perhaps even more crucially, they should never stand still. As the investment environment continues to evolve, asset managers will be keen to capitalize on its latest opportunities as and when they arise. Behind the scenes, it s the duty of the modern transfer agency to keep up with and even anticipate its clients ambitions and constantly meet new market requirements. And that means committing to ongoing innovation and continuous investment in hardware, infrastructure and technology. 7 MONEY MANAGEMENT EXECUTIVE, NICSA EXPERT VIEW: OPS, TECH IN SPOTLIGHT IN 2014, JANUARY 2014 8 AITE GROUP, GLOBAL ASSET MANAGEMENT STUDY 2014, JULY 2014 9 CEB TOWERGROUP, TOP TRENDS AND TECHNOLOGIES IN FINANCIAL SERVICES FOR 2012, APRIL 2012

Special Agents Required: Calling a New Generation of Transfer Agency Services 5 Conclusion At your service: The specialist industry utility In times of radical change for the financial services industry, transfer agency may be losing its place in the suite of fund services offered by global banks. But the function now has a champion in the form of specialist technology providers, who are progressively in a stronger position to deliver effective transfer agency services. As experts in the field, this new breed of firms can offer an independent utility that allows asset managers and TPAs to concentrate on their core competencies without trying to compete against them. But at the same time, they can ensure the pricing advantages, scale and efficiencies of a large, global service provider. With innovation an important part of its remit, the transfer agency utility is designed specifically to support the ever broadening portfolios, processing nuances and regulatory demands that create such major operational challenges for today s asset management industry. Special requirements, after all, deserve specialist attention. So, what better way to meet the needs of today s complex investment environment than through a dedicated industry utility? Fact: As the investment environment continues to evolve, asset managers will be keen to capitalize on its latest opportunities as and when they arise.

About FIS Investment Operations FIS Investment Operations is a global suite of products and services for asset managers, institutional investors, and traditional and alternative fund administrators. Investment Operations supports the entire investment process, from portfolio management, risk management and compliance to investment accounting, transfer agency and client reporting. Combining deep functionality with broad business process management capabilities, FIS helps investment firms manage complexity, increase efficiency, and respond quickly to changing business and regulatory requirements. About FIS FIS is a global leader in financial services technology, with a focus on retail and institutional banking, payments, asset and wealth management, risk and compliance, consulting and outsourcing solutions. Through the depth and breadth of our solutions portfolio, global capabilities and domain expertise, FIS serves more than 20,000 clients in over 130 countries. Headquartered in Jacksonville, Florida, FIS employs more than 55,000 people worldwide and holds leadership positions in payment processing, financial software and banking solutions. Providing software, services and outsourcing of the technology that empowers the financial world, FIS is a Fortune 500 company and is a member of Standard & Poor s 500 Index. For more information about FIS, visit www.fisglobal.com www.fisglobal.com twitter.com/fisglobal getinfo@fisglobal.com linkedin.com/company/fisglobal 2016 FIS FIS and the FIS logo are trademarks or registered trademarks of FIS or its subsidiaries in the U.S. and/or other countries. Other parties marks are the property of their respective owners. 1209