Financial Journalist

Finance Week, Gerry O’Kane, 23 May 2008

Harry, my FD mate who has moved on to talking to his red cabbage, told me it was the most stressful three weeks of his life. “And I’ve been through two divorces,” he emphasised.

It wasn’t a merger, or pay review or job interview or a new baby; it was getting BT to transfer his phone line and broadband to a new home. “And it wasn’t cheap,” he hissed.

You see, he has my sympathies since I’m going through a similar process myself: no communication, bills without explanatory notes, wrong equipment delivered, help-lines and web-pages that don’t exist, even the registration page that refused to recognise my (BT) landline number and stopped the registration process dead. Then there were the shirty and ignorant technical people in Bangalore.

Ms Shirty

I had followed Ms Shirty’s technical advice precisely (Outlook was objecting about connecting to BT Broadband in spite of numerous hours installing and reinstalling BT’s software) but the particular button she required was not there. Somehow that was my fault but please bear in mind that I started as computer journalist in 1984 even met Bill Gates that year and have been working with PCs ever since. I even started using the internet in 1994 and worked for an internet company!

The final straw for her was my refusal to allow her take control of my computer from India. Yeah, right and I fully trust you, especially since you’re trying to pretend that you’re in Birmingham. I don’t even trust BT.

Scottish burr

Eventually I complained to Helen, the UK complaints telephonist, who had that soothing Scottish burr and said I shouldn’t put up with it and agreed that BT had cocked up my equipment.

When I told Harry about my progress he snorted, said something to his leek and just bought me another house vodka and coke.

Well since then a delivery that I had no idea was coming turned up with no letter, a bin-liner for the existing router (no letter), nor has there been progress on the Lightweight Directory Access Protocol (LDAP) issue which has to be authorised manually before I can get email or any of the other numerous esoteric problems that spring out at me and my two computers like Tigger greeting Pooh.

Baseball bat to wireless router

I’ve now given up ever expecting it to work smoothly and realise why the CD wouldn’t run on the laptop or anything operate correctly: I’d signed an 18 month contract and they have been immune to screwing me on my landline rental for years, so why expect anything new? The only thing is my girlfriend is fed up with me swearing at the computer so much.

Now what makes all this worse is that Hanif Lalani recently won finance director of the year from a FTSE 100 company in a CBI co-sponsored competition. Nauseatingly Lalani is the FD of BT and was commended for making “a considerable impact on the company”.

I’ll have to start talking to Harry’s cabbage otherwise the only “considerable impact” I’ll have with BT will be baseball bat to my wireless router.

Gerry O’Kane Finance Week 7 July 2008

Just as I started to write this Avon and Somerset police announced that another pensioner had been the victim of a distraction burglary by someone pretending he was from British Telecom.

My heart goes out to the 83-year old, but she must only remember telephone companies being owned by the Post Office because if anyone approached my doorstep and says they’re from BT, I’m reaching for the SRAW/Eryx (my personal anti-tank weapon) stashed behind the door.

There are a couple of reasons for this. Firstly, BT actually trying to approach you personally is so rare that you figure there’s something wrong. Secondly, since my transfer to their broadband my life has been less than smooth.

The latest has been yet another demand for money with absolutely no clarification for what exactly they were charging. They expected me to cough up £95 with no breakdown of the expenses: is this a style of accounting that Hanif Lalani the firm’s CFO believes is a good one? This is not the first time this has happened: last time it was some direct debit but didn’t again say exactly what they were billing for.

Harry, my FD mate who likens dealing with BT to going through the pain of divorce, is rubbing his hands at the idea of a consultancy on implementing financial tracking systems at BT. “I could invoice them without telling them what it was for, that’d pay for replacing the brassicas!” he trumpets. (He hasn’t quite got over the Great Brassica Slaughter of 2008 when a concerted attack of commando rabbits took out over 2000 various members of the genus known collectively as cabbages, in two fields in 24 hours. We’re sending them to the States to train up Delta Force.)

I had tried to call BT before the latest bill, but it was a maze of phone options that took 15 minutes before you were put in a queue and told how valuable you were as a customer. By this stage your brain is hurting because if you were a valued customer they’d answer the bloody phone.

This time I persevered. Success, someone answers. Headache goes. Headache returns: I was back in a Bangalore.

This irritates me because (a) the money for my over-priced bills is paying to take jobs out of the UK, (b) they have no idea of why we all hate BT and (c) you know that it is pointless venting your spleen on these clueless victims of outsourcing gone mad, who continue to dream of taking their double-first in Brain Surgery to somewhere sensible.

Anyway I was told that part of the bill was from my BT Option 75a, which I don’t use because I get better rates from my third party call supplier who is forced to use the BT landline.

But he had no idea what the “fine” of £2.75 was for, nor what was going on with the broadband charges, oh yes it was on there. I had to talk to the broadband department which was either in Delhi or three desks away. I then went through the palaver of phone numbers, customer billing numbers, post code, inside leg measurements, all over again.

This time I was told to go online and get a break-down of my bill, because she couldn’t be bothered to tell me. Well she didn’t say this, but did tell me to look it up for myself.

My voice did go up an octave at this point, with me arguing that since I was expected to pay them money they could at least break down what it was for and sod their paperless billing since they’re about as interested in the environment as telling me what they’re billing me for.

She put me on hold and went to speak to her supervisor because evidently she didn’t know either.

It appears I was now paying three months in advance for something-broadband and apparently I was meant to know this, the half price offer too, the fine (still don’t know what for), VAT and something towards African national debt, but it was me who had to add up what was happening on the landline side too…

The last time I had something like this was a week before I got thrown out off the National Union Of Journalists for having the temerity of asking what I had on account with the union and into which charge band they had now put me, since I had just joined the BBC. When they didn’t tell me, I refused to pay. Then they told me I was blacklisted.

That saved me a fortune over the years.

What staggers me is that BT pretends to be technology company - yet two departments can’t communicate. It espouses good value: yet it keeps hiking prices including charging me for not allowing a multinational corporation with monopolistic tendencies to have access to my bank account and remove whatever cash it sees fit. It certainly sees no need to tell me what I’m paying for.

Is this how a company retains customers, is this what is meant by improved reporting, is this good corporate governance?

If they didn’t have an effective monopoly I’d be one less customer.

No wonder the company’s preliminary pre-tax fourth quarter results were up 3% at £715 million. Oh no, my brain is melting, my brain is melting…

FT Mandate, March 2009

The dire economic situation towards the end of 2008 saw asset-servicers battening down the hatches, but now the institutions have to convince their clients that they provide a safe haven in these troubled times. By Gerry O’Kane.

If 2007 was a relatively low-key year for the asset servicing industry, with the merger of Bank of New York and Mellon Financial Corporation a rare highlight, 2008 was more a year that market players want to remain low-key in discussing, save to say there has been no flight of clients.

It is what happened in the last quarter of 2008 that most preoccupies the sector, with few asset-servicers trumpeting mandates they have won, although major players report clients re-examining the ranges of services they have and how they will stand up in the post-apocalyptic financial world.

“I think it was the speed with which the economic situation deteriorated throughout last year - no one quite expected it,” admits Mark Austin, head of multinational client relationships at Northern Trust.

“The industry will certainly be looking at a new landscape in the coming years, expectations on services like cash management, transparency and risk assessment have all changed because of what has happened,” says Jay Hooley, head of the global investor services business at State Street. Such viewpoints were less common at the beginning of the year.

As the fallout from the sub-prime crisis continued, institutions were more interested in examining their portfolios and trying to discover if they could have better assessed their risk. The search for new asset valuation procedures was on.

“I think it’s true to say there was little action on gaining new custodial clients during most of 2008, however we did see renewed interest in examining portfolios and trying to reassess the risk of these investments,” says Chris Adams, head of product alternatives for BNP Paribas Securities Services.

It is a view that Jim Palermo, co-chief executive officer, BNY Mellon Asset Servicing agrees with: “Prior to October last year, pension funds were being obligated to comply with new accounting rules and that triggered much more attention on getting a full valuation of the portfolio. It was a case of know your exposures globally.”

Transaction revenues up

And while custodians saw their assets shrink alarmingly, market volatility brought increased transaction revenues, at least in the short term. Across the board the issue of increased pressure for transparency and costs reduction compelled clients to outsource certain elements of the value chain that they had not outsourced in the past.

“The net result is that the top service providers could look at increased business because of increased servicing even though the whole market was shrinking,” observes Neeraj Sahai, global head of securities and funds services at Citi.

However by the time Lehman Brothers collapsed in September and the Madoff crisis hit the headlines, investors’ preoccupations had become more focused. “Recent events have brought more to the forefront the risk of a service-provider going out of business, especially for hedge funds, and what we’ve seen is a flight to quality service,” argues Mr Hooley.

Mr Palermo calls it a “dash to strength” and says that BNY Mellon’s win of the federal government’s $700bn (€549bn) troubled asset relief programme (Tarp) helped boost the institutions’ profile of a safe haven. Similarly State Street’s slice helped too. Nobody would accept that being the recipient of federal funds was a bad thing for your reputation; everyone was doing it.

While the asset servicing industry accepts that all institutions including pension funds, looked at reassessing their risk and how reliable their valuations were, the biggest movers in the custodial and administration stakes were the hedge funds. “In order to mitigate risk, hedge funds in particular have considered moving to multiple providers solutions, but are also faced with the need to reduce costs and administrative overheads, they’ve sought out new solutions,” says Mr Sahai.

Counterparty risk

While for some time custodians grumbled that prime brokers had been muscling into their business, the problems caused by the buyout of Bears Stearns and Merrill Lynch and the failure of Lehman Brothers have caused all institutions to review their counterparty risk. Indeed, according to Colin Rainbow of consultants Watson Wyatt, UK pension funds like many other global institutions continued in the market but this time placing assets with six or seven counterparties to further reduce risk.

For hedge funds, assets that were supposedly held safely by Lehman’s prime brokers were not held in their own name and could not be quickly recovered. The rehypothecating of clients’ collateral and assets by prime brokers, by switching the assets into the prime broker’s name so they could be lent out in the repo market to raise cash, brought risk that the investors did not want.

And the response has been swift. Both institutional and private clients to hedge funds have demanded greater transparency of both the assets held and their valuations. It is similar story from most institutions. In an effort to reassure their clients, hedge funds have been seeking safe harbour, usually with the traditional custodians.

“We’ve seen a trend whereby hedge funds are trying to ring fence their assets they’re not using for leverage and we’re seeing an uptake in demand for those sort of services,” says Mr Sahai.

Utilising escrow accounts has become a more common request in the European market accoring to BNP Paribas’ Mr Adams. And as they fled prime brokers in search of security of assets and increased transparency, they brought cash, in spite of record withdrawals. “We saw massive cash inflows in the third quarter,” says State Street’s Mr Hooley.

While the yield offered on cash by the custodians has been nowhere near the levels found from traditional prime broker lending, the quest for generating alpha on these assets is now less important. Perhaps paradoxically these events have led to an increase in over-the-counter trading, making the last few years of investment in handling alternative assets for the biggest custodians a worthwhile exercise.

“Traditionally a pension fund would call the money manager and say I need $20m for an investment call. They can’t do that any more because there is not enough liquidity. At the same time they don’t want to sell into such a down market, so what they are doing to maintain their exposure is to go the derivative road,” explains Dan Wywoda, head of products at BNY Mellon Asset Servicing.

Another consequence of this concern about counterparty risk has been a downturn in securities lending. While Dutch pension funds were early and vociferous on halting all securities lending, other markets have simply reduced it, demanding much higher levels of counterparty risk assessment, usually from custodians. “I’d expect securities lending to continue on a reduced level but on the other side of the coin we’ve seen other collateral vehicles used such as overnight repurchase and government backed loans,” says Mr Hooley.

Other areas of security servicing have seen a definite downturn. “Transition management has fallen away because you’re not seeing institutional investors change managers to the same degree,” highlights Mr Austin. “The last half of 2008 was very much a case of battening down the hatches before the storm broke; now is a period of trying to evaluate the damage and what the long-term environment is going to be.”

As the markets recover so too is there anticipation of the re-emergence of the importance of a transition manager; even so the current crisis has seen Citi close its transition management arm in London.

As for the future of the business? Technology investment spend is likely to be reduced, although BNY Mellon reports an increase this year as the final stages of its merger goes through, but there will be an increased focus on areas such as valuations and risk. As for industry consolidation, the large players have neither the cash nor appetite to digest new companies, but pressures on smaller administrators to both the private equity and hedge fund industry are likely to Increase.

“If you consider that its height the hedge fund industry was worth about $2000bn and this has shrunk to $1400bn today, that reduction is likely to lead to some degree of consolidation among smaller players,” says State Street’s Mr Hooley. With 2000 specialist administrators in off-shore and hedge fund sectors still existing, the loss of one third of your customers’ asset base is likely to have a knock-on effect.

TOP 10 GLOBAL CUSTODIANS (FIGURES AS AT END-2008)

1) Bank of New York Mellon $20,200bn

2) JPMorgan Worldwide Securities Services $13,205bn

3) State Street $12,000bn

4) Citigroup Global Transaction Services $10,700bn

5) BNP Paribas Securities Services $4650bn

6) Societe Generale Securities Services $3563bn

7) HSBC Securities Services $3500bn

8) Northern Trust $3000bn

9) Caceis Investor Services $2780bn

10) RBC Dexia Investor Services $1896bn

TOP 10 GLOBAL CUSTODIANS (FIGURES AS AT END-2007)

1) Bank of New York Mellon $23,100bn

2) JPMorgan Worldwide Securities Services $15,900bn

3) State Street $15,300bn

4) Citigroup Global Transaction Services $13,100bn

5) HSBC Securities Services $6100bn

6) Northern Trust $4100bn

7) BNP Paribas Securities Services $3800bn

8) Caceis Investor Services $3358bn

9) RBC Dexia Investor Services $2900bn

10) Societe Generale Securities Services $2585bn

Source: FT Mandate Research. Ranked by total volume of assets under custody worldwide ($bn)

REGULATING FACTORS

Those companies playing in the securities and capital markets are simultaneously being faced with a downturn in earnings and the need to improve efficiencies and cut costs. On top of that, the hoary old subject of increased regulation is expected to further pressure operations.

“Asset managers are going to be faced with the issue of overcoming increased regulation, reducing risk while tackling issues of cost and that means they’ll take a deeper interest in electronic dealing automation,” advises Christy Bremner, global managing director of Thomson Portia, a systems supplier for the back office of buy-side asset managers.

Apparently, these systems are no longer referred to as straight-through processing (STP) in Asia or North America, but the search for the seamless electronic trading holy grail continues. It has gradually moved down the trading chain, reaching the middle and back office, the less glamorous links and the poorer cousins when it comes to technology investment.

According to Ms Bremner, those on the sell side trading face the biggest hole in their electronic systems, often having issues with settlement and reconciliation with custodians. But, she adds, size doesn’t matter as even the larger houses which may have bigger pockets, were faced with real obstacles in handling their more complex asset mix. “There are no standardised solutions out there, and while firms like Omgeo and SunGuard and custodians have their own answers, none are standard and none seem likely to become so.”

While rates in exchange traded equities are nearly fully regarded as being processed electronically from purchase to settlement, other investable assets are not so far advanced. “It must be said that there has been progress in electronically trading OTC products but there remains much to be done,” adds Ms Bremner.

FT Mandate, March 2009

There are huge opportunities in private equity, but can boutique houses offer the services and security that are in demand? By Gerry O’Kane.

You can almost hear the increasing pitter-patter of the administrators’ heartbeat when they speak about private equity prospects in 2009. While much is made of a grinding down of the sector, fund administrators are rubbing their hands in glee – at least if they are one of the bigger players.

Some of the larger custodians saw private equity administration business grow by as much as 60 per cent in 2008. Many are hoping to realise increases in business of 20 per cent this year. “Best industry estimates say that only about 15 per cent of private equity funds outsource the administrative function,” reveals James Hutter, global business executive, JP Morgan Private Equity Fund Services.

“In these uncertain times, private equity firms may want to hire a strong, global administrator, so they have more time to focus on their core business,” he adds.

“Post-Madoff, regulators and clients are seeking a greater separation of duties and as so many private equity funds do all forms of administration internally, this applies to a lot of companies,” says Jack Klinck, State Street’s head of global investment product services. But the statistics for this sector are nearly as depressing as those for the global banking industry: financial sponsor teams at investment banks reported that the total global revenues generated fell by 79 per cent between the collapse of Lehman’s in September and February this year, according to data provider Dealogic.

In February research from Nottingham University and Barclays Private Equity showed that buyouts hit their lowest level since 1994, while a research paper by Spain’s IESE Business School and management consultancy Boston forecasts that half of them will default on their debt and only one third of buyout firms will survive.

Mr Hutter accepts that the private equity sector may contract, but the need for new services, perceived transparency, and increased efficiency in order to save money will push many of them into the arms of fund administrators for the first time. In terms of systems that provide transparency and a clear line of audit work, most do not have them.

16 December 2008 — Gerry O’Kane, Finance Week

Here we go again, ‘there shall be a weeping and gnashing of teeth’ heard globally as pension funds, charities and banks lament the loss of billions of pounds because Madoff was a crook.

Sorry ‘alleged’ crook.

While the Securities and Exchange Commission will certainly be puckering up because no matter how fast its excuses are spewed out of the press office, it fundamentally failed in its role. But it wasn’t the only one.

Questions must be asked of investment managers, CEOs, auditors, compliance officers, those responsible for corporate governance, risk analysts, the list could continue.

It shows yet again that only lip service has been paid to corporate governance in the investing companies and risk management across the spectrum of what that entails.

Indeed it should come as no surprise that in this humble editor’s opinion, many directors may face litigation under the Companies Act for failing to use reasonable skills to defend the interest of their shareholders.

Does the risk of holding this form of security fit in with the profile of risk across the portfolio or does it skew it? Are liabilities covered? Indeed does the type of investment fall within the parameters of the legal licensing of your own fund?

Secondly, you have to assess the risk profile of the company itself and those along the critical supply chain; the service providers, those executing critical parts of the process. While Madoff may have been the former chairman of the Nasdaq Stock Market, it is not enough as an assurance, after all Jeffrey Archer is a peer of the realm.

What is worse is that only a little digging has shown critical flaws in his corporate structure that even the mildest form of due diligence would have revealed.

The head of compliance was his brother. This is not in itself illegal but should raise a question.

As an investment company I should also be concerned that the fund’s administration and custodial services will make sure I get paid my dividends, is aware of the size of my holdings, move on corporate actions, make sure the shares Madoff’s company has bought arrive in the account and counterparties settle.

It is unheard of for a company of the size of Madoff’s to do its own custody. The largest players in the custodial market: JP Morgan, Bank of New York Mellon, State Street, Northern Trust, Citi are dominated by trust banks rather than retail (Citi) and investment (JP Morgan) banks and even within their own hallowed halls many custodial contracts go to their competitors.

It goes further. A prime broker has transparency into the books of hedge funds, contributing valuations that enable administrators to calculate net asset value (NAV). They also have to assess counterparty risk: in other words should the fund default on loans or purchases or paying margins on over-the-counter securities, prime brokers have to step up and pay up.

Madoff had no independent prime broker. It was his own firm.

And all of this was audited by a three-man sun-lounging team who went for their McDonalds in golf carts somewhere around Disney World. Mickey Mouse - you bet!

Just one of these issues should have raised eyebrows for even the most junior paralegal in the due diligence team or the secretary to the head of risk analysis. The fact that so many were caught for so long, proffers the question (as did the subprime debacle), do any firms carry out any intelligent risk analysis, does governance truly reach the boardroom?

compliance+risk+governance+Madoff

FT Mandate December 2008

The idea that Asia and China might be immune to a sneeze in the US economy has been proved incorrect and cross-border asset flows continue to run like a raging torrent.

Paradoxically this fact has strengthened the will of large asset servicing houses to parade themselves as a global one-stop shop for fund managers: the outflow of money from emerging markets in recent months has been more a case of Western institutions bringing money home, than a failure in the local investment economies.

“Our clients want to access the growing wealth in the Middle East and Asia and they see these markets as doing relatively better in the coming years than Europe or the US,” agrees Tim Keaney, head of asset servicing at BNY Mellon.

But can the fund administrators, large or small, be all things to all people globally? While global reach has long been a message of Neeraj Sahai, global head of securities and fund services at Citi, it has little presence in the Middle East, for example, where fund managers are panting to get a look-in.

Lock down any of the major securities servicing houses to answering whether they can provide this all-encompassing global answer for fund administration and you’ll get comments ranging from how blue the sky is to a semantic debate on what fund administration is.

The reality is that no house can provide all the services often demanded as part of an administration package in every jurisdiction in the world. But some are more pragmatic in facing up to limitations.

“You can’t be everywhere but you can position yourself to take advantage of growing trends,” explains Mr Keaney. “The larger business of fund administration involves economies of scale – no-one will make money in Vietnam and the small guys will dominate the market until there is a macro-economic push into the wider market.”

There is no doubt, however, that the industry is getting there. As John Campbell, senior managing director of investor management services at State Street points out, the sector has come a long way since the 1970s and 1980s when fund administration was almost exclusively a domestic-only affair. “By 2001 we were looking at a shake-out, losing fragmentation and inefficiencies and funds were beginning to look for regional players,” he says.

Custody came first

It has also to be remembered that for the players with the larger reach fund administration often came with custody: if there was no custody contract, they didn’t want to know about the administration. And it was custody that took the first global role.

But like custody (and this is where the global one-stop shop model becomes hazy)to compete in these markets, add-on services both became desired by fund managers and offered as incentives by the administration firms. Should the international fund manager want to move from a regional presence to more global, the desire in taking along the global custodian was one of confidence and other services often followed.

“When you’ve got a close client-relationship you go where the client goes, domestic to regional to global,” observes Mr Campbell. He points to Pimco emerging from the Californian marketplace to take a more global position.

In some circumstances these clients may demand services that attach to administration and custody including transfer agency and everything from securities lending to collateral management. Local suppliers can rarely meet these demands.

“You can have a global contract on funds, but in one country or another operate with a local partner,” explains Toby Glaysher, head of global fund services, EMEA for Northern Trust.

This step-by-step approach is one undertaken by all administrators whether they admit it or not. Mr Keaney agrees expansion follows or predicts demand. “Over the last few years we’ve done it organically, through partnerships or takeovers.”

“It’s a series of moves as clients become more open about their own product development and if you’re not there and they have a requirement, they’ll find someone who can fulfil it and that may be a risk to your longer-term business,” adds Mr Keaney.

One way providers have found in playing the global fund administration card is by following the sun, multiple centres each passing on the work that needs to be done, although this is dependent on a single platform.

“Technology is the first pre-requisite of being in business, you need it to support your clients and your costs,” agrees Mr Campbell.

Moving around the world

Offshoring also helps to keep costs low in order to remain competitive (although frequently the fund administration business is seen as a loss-leader to sell other services). GlobeOp, a specialist in hedge fund administration uses an operation in India where they have trained people in OTC administration and argues that with 80 per cent of hedge funds registered in the Cayman Islands and institutional in sales, it too can be a global one-stop shop.

“It’s a global operating model but a single platform based in different centres. Clients of UK funds investing in the Far East can have the net asset value following Asian close and for the UK morning by moving the processing around the world,” says Mr Glaysher at Northern Trust.

What does put the kibosh on both this model and any claim to global presence, is that many markets still demand fund administration, including valuations, be done within the jurisdiction it is registered or sold.

The success of Luxembourg and Dublin in becoming financial centres is not that they have any size of fund management or investment bank business, but in that they prepared for Ucits III and hedge funds, allowing funds to easily domicile while demanding that all administration functions must be done where the fund is domiciled. In other emerging markets these restrictions are even greater.

Ucits global reach

But the Ucits III label has its advantages too, especially in Asia. While Ucits III was originally focused on EU opportunities, it is having knock-on effects elsewhere boosting the need for international reach.

“The reality is that a Ucits III product has a perceived stamp of quality, especially in markets where the local regulatory regime does not always inspire confidence,” observes Toby Glaysher. It is fulfilling that pan-Asian role by default.

The result of that single factor has pushed fund managers to sell their offerings there, broadening the reach and demanding support from the administrators and securities servicing companies they know best.

And once the eye was on Asia, other opportunities emerged. The problem for the fund administrator there is that there can be many idiosyncrasies in Asian markets, from tax legislation to the fact that many processes remain manual. Often the fastest way to hit the ground running is to partner locally, eventually leading to takeover or buyout: again a global model serviced locally when needed.

The new investment landscape of the past few months also impacts administration, presenting growing opportunities. “We’re seeing a lot of activity and a lot of nervousness in the last few months with clients wondering what the shape of the new map might look like and simply wanting consistency and low risk,” observes Mr Campbell.

Indeed for those investment banks whose prime brokerage arms reached into the administration market, customers don’t like all their eggs in one basket. Pricing and validation is separating.

“It’s certainly true in the hedge fund sector,” says Hans Hufschmid, CEO at GlobeOp. “They don’t want their administration exposed to illiquid assets and they’re taking another look at their counterparties.”

“Now funds are looking to rationalise, looking to save costs. There are lots of big RFPs [requests for proposals] out there as they look to move from fixed costs to variable,” adds Mr Glaysher. While it should be no surprise that both the hedge fund and mutual fund landscape is shrinking, a desire to again cut costs and find new markets means the opportunities for new fund administration business is high and not only in traditional markets.

INVESTMENT OPERATIONS OUTSOURCING

Seeking outsourcing solutions is back on the map. The question is what form is it going to take?

Tim Keaney, head of asset servicing at BNY Mellon, admits that while it’s neither his desire to have administration without custody or provide parts of an administration service, it’s a route he’d take if future business was a possibility or maintaining relations with an existing client. “We’re seeing an uptick in in interest in outsourcing the middle office (for those under $10bn (€7.8bn)) from clients who have so far only used us for transfer agency,” he says. He sees the sector going through a similar process of consolidation as did custody years ago.

As the larger securities servicing businesses, especially the trust banks, seek a global position they’re happy to start with component outsourcing and wait for the big contract.

But it seems in the search to become the global all things to all people, one-stop shop, lift-out is not dead, at least in the Asian market. “Lift-outs as a method of transitioning business is not viable…. unless you get something else, expertise or systems and I’m specifically thinking about Asia,” says Mr Glaysher.

Global+Fund+Administration

27 November 2008 — Gerry O’Kane, Finance Week

Although factoring has become more important to the cash flow of British business, it still has its pitfalls. Here Gerry O’Kane looks at how to truly value your deal and points to other pitfalls and benefits.

The first thing to remember about factoring companies is that they don’t offer the same thing; there are always differences.

This is the considered opinion of Ian Johnston who has been in the business for over 30 years and runs Factoring Solutions, a broker for the sector. Although companies may only now be coming around to understanding the potential of how factoring can help in stabilising cash flow, they have also picked the worst time in 10 years to dip their collective toe in the water.

Even so, some SMEs have been forced to take this route over the past eight years as banks have pushed the business of lending from their company account overdrafts to higher charging factoring.New research from software house, KashFlow, revealed that SMEs in the business services sector are spending an average of five hours every week chasing overdue invoices to maintain their cashflow. Late payment of monies owed - including the time and resources taken to chase late debtors - is a large contributory factor to the failure of many smaller businesses.

Kashflow, a winner of Finance Week’s Software Satisfaction Awards, fielded more than 55 phone calls in one week from customers with clients who have gone out of business owing them money. Duane Jackson from the company said, “I’ve never know anything like it. We’re all aware of the economic downturn, but our small business customers are very concerned. And many are frankly scared.”

But can factoring offer a solution? Many of the largest in the business of factoring or invoice lending, are arms of the banks and we all know how cash flush they are. There are other companies in the business, but Johnston warns that both the big boys and the independents have drawbacks and customers need to be even more canny.

As it stands currently deals of anything under £100,000 are snubbed; the cost of money is too high and the factor’s fixed costs need to be serviced.

One major warning he makes, is to truly cost your deal. While one company may offer a lower interest charge on the invoice, their capability to turn your invoices into payments efficiently, may be much worse then their competitor. The result is that the company may end up paying more in charges.

For factoring companies their biggest expense after the cost of money [to be lent out] is staffing. As risk increases many factoring companies may take on more and more customers to spread this risk, this stretches staff and may affect how good they are at credit control.

The banks have become far more choosy in their customer base and Johnston comments that while Lloyds TSB would have taken “any business” months ago, now even well-heeled customers were under pressure as charges have been ramped up.

“I’m receiving a lot more enquiries from existing factoring clients partly because many of the major bank-owned factors that have spent the last couple of years just buying turnover at any cost who are now reassessing their portfolio a little more closely and pruning those that don’t meet this year’s criteria and upping the rates on some of the others,” says Johnston.

The highest rate on invoices from factors now stands at 90% at the very top end.

But these are not the only issues facing company customers. To protect themselves against unpaid invoices on which the factor has paid against, companies have tied up non-recourse factoring deals.

This structure means the factoring company takes on the risk of non-payment and you pay a fee for the privilege. However as times have got tougher so have the terms on non-recourse deals and in some cases they are no longer offered. Generally companies would be looking at a 2% charge over base rate for non-recourse factoring in addition to the charge of up to 3% to provide factoring.

Two sectors in particular have always been hand-in-hand with the factors (the company that provides the finance), the building industry and recruitment. “While construction is unloved by some factors there are those who will accept business and in my view it means they’re desperate for work, while the recruitment industry might take up nearly 50% of the business,” outlines Johnston.

The sector that does not benefit from the magic of factoring is retail; in part the Consumer Act prevents deals with those who rely on receipts from private individuals.

It is always worth taking legal advice when entering any factoring or invoice lending deal.

Factoring+UK business

12 November 2008, Finance Week

Working capital specialist, Brian Shanahan tells Gerry O’Kane that Tesco’s move to improve its own working capital by taking longer to pay its suppliers, is wrong.

Long accused of pushing suppliers into tough deals, Tesco has ratcheted up its squeeze on them as it searches for improved cashflow.

While it may be asset- or cash-rich, so important is improving the vast amounts of working capital Tesco needs for day-to-day business that it is trying to shore up cashflow by extending payment terms to its suppliers.

In other words it is using its purchasing muscle in a shrinking market to demand that companies allow Tesco to hold onto cash longer while cash-strapped suppliers struggle to handle longer debt periods. Drinks suppliers, amongst other firms, have been given ‘take it or leave it’ ultimatums demanding drops in prices by up to 10%, cough up extra cash for advertising and a moratorium on price increases.

It has also claimed that some of its suppliers have benefited from falling commodity prices so they could afford to pass on improved cashflows. Suppliers deny this.

“The fact that Tesco and others are trying to extend terms to 60 days is no surprise - we already have Argos extending terms to 105 days and other retailers are attempting similar strategies - what is surprising is the speed at which Tesco are trying to implement these measures,” observes Brian Shanahan, senior director at REL, a company with over a decade history in surveying British and European working capital practice.

He believes it reflects poor supply chain planning amongst retailers as the speed of these actions indicates that large retailers are desperate to rebalance the working capital strain that will come with large quantities of unsold stock. Tesco, in particular is under increasing pressure from perceived low-cost chains like Lidl and Aldi.

However the way in which companies like Tesco are trying to improve cashflow, by squeezing payment terms in their suppliers, will have a bad effect on the UK economy over the longer period. “It is pretty standard practice for larger companies to strong-arm suppliers, particularly when times are tough. But Tesco’s decision is bad business plain and simple. At best, they’ll damage their relationship with these smaller suppliers. Some may even walk away from the relationship. At worst, Tesco’s actions could even put some of their suppliers out of business,” says Shanahan.

He, like others, believes this type of tactic will cause businesses to fold creating short-term supply issues and possibly force up consumer prices at a time when the market place is ultra competitive.

“There’s no question that the current economic environment is very challenging. But rather than resort to these types of desperation moves, the most forward-thinking large companies will do almost exactly the opposite of what Tesco and others have done,” says Shanahan. “They’ll work more closely with their suppliers and collaborate with them, creating a situation where both companies share key data on manufacturing capabilities, inventory and demand forecasts. It is possible to create a win-win situation here, with buyers more easily able to find the products they need, when they need them, at the best possible prices, and suppliers able to count on their best customers and still make a reasonable profit.”

Tesco+working capital

31 October 2008 — Gerry O’Kane, Finance Week

Many British businesses are ignorant of working capital and need to understand forecasting, cashflow and the financial supply chain. But there are solutions to both ignorance and problematic working capital. Gerry O’Kane talks to working capital expert John Mardle.

If British business people do not learn how to handle working capital more professionally, the current recession will last much longer than it need do. This is the viewpoint of John Mardle, an expert in how to make working capital perform efficiently and managing director at Develin & Partners. He also warns simply delaying payments or cutting suppliers’ margins is not the solution.

“I’ve got a pessimistic outlook and groups like CIMA and the ACT have got to get finance directors up to speed on working capital,” he says. He estimates it’ll take at least nine months of education but should business people become more aware of handling their working capital, the supply chain finance and their forecasting, the impact on nationwide free cash flow could have a beneficial dramatic effect on UK business.

The down side, in his view, is that it will take 18 months to work.

As access to alternative finance for companies, whether from private equity companies or from banks, has been shrinking for nearly a year, finding money for new equipment or even paying wages is proving difficult and companies’ working capital needs to be handled more efficiently.“Companies are desperate for every penny of that £10,000 invoice, and think they can manage it well, but few do so,” he argues. Mardle lectures for CIMA in their Mastercourse qualifications, mentors at Cranfield Business School and will be lecturing at the ACT’s seminar on working capital in Reading in November.

He points out that British industry is often led by those with strict accounting backgrounds and their grasp of working capital was slim. “They haven’t been taught what it is or top 10 tips to reducing working capital. When the economy was moving along well they sat back on their laurels and didn’t look at it properly,” explains Mardle.

There was an ability to analyse debt but not how to practically improve working capital.

While every case will have its own characteristics, Mardle argues that there are several steps all companies can take to (a) assess their future liabilities and (b) cut the pain to the company.

While he agrees there are methods like factoring and asset-based lending to increase working capital, these are much less available in the current market. “In terms of factoring who is going to want to fund invoicing efficiently?” he asks.

He points out that companies in Europe and the UK do not collect monies owed very efficiently. “And they also do not look at the financial supply chain any further than who they are directly dealing,” says Mardle. In the US it is not uncommon for the supply chain to be analysed seven companies down the line, in order to reduce risk or find ways to solve any glitches in the system (see ‘How to boost working capital with a broader view of supply chain finance’).

Another side of the same coin is examining how your other suppliers will be able to pay. Cutting what you’re prepared to pay by 10% might simply put your supplier out of business.

Go and talk to that supplier: it might be that you’re getting something that is completely over-engineered for what you require,” says Mardle. You might be getting benefits of economies of scale but paying a price for a premium product. With a few adjustments perhaps the product could give the same performance but save money to both you and the maker.

He gave the example of Rolls Royce requiring bolts for aeroplane engines. By dropping the specification from the over-engineered supplier, it saved 50% per bolt – or $500.

He warns that unreasonableness in cutting payments are lazy and sometimes self-damaging. “I already know of some companies who have reprogrammed their ERP systems not to pay invoices over £10,000 or under £5,000, but it’s the wrong way as it creates uncertainty. It’s important to know when payments are going to be there,” he adds.

The second area he sees as important is examining your own customer base. “A lot of firms are dealing with non-profitable customers, they’re just looking at revenues, when in fact delays in payment and profit margins might be low. It might be better to lose them and concentrate resources on the profitable customers,” explains Mardle.

John Mardle’s next CIMA Mastercourse on ‘Managing Work Capital’ is on 7 May 2009 in London. Go here for details of this and other CIMA Mastercourses.

working capital

October 2008 FT Mandate

The one consistency the markets have been showing in recent months is volatility. Where there is movement, the investment sector finds opportunity and in recent years volatility trading has found a ready market amongst the top-feeders, hedge funds. But there are indications that more traditional investors, pension funds and insurance companies, have embraced forms of volatility trading too.

Backed by options, OTC products or the limited number of volatility indices, it allows traders and institutions to invest in the volatility of the trading markets, volatility being defined as the standard deviation of shares or indices and in falling markets there are elevated levels of volatility compared with climbing markets.

“In terms of trading in the current world, we’re seeing strategies evolving by minutes,” says Adrian Valenzuela, head of equity derivatives investor sales at JPMorgan. “Volatility trading was traditionally the domain of hedge funds, even until three years ago in its purest form it was almost exclusively their territory.”

Even then, however, those hedge funds were not as much in demand as they are now. “At least until two years ago volatility was operating in a tight band – about 15 per cent. There was a lot of convergence, companies had low debt levels and then the banks had solid asset asset to equity ratios,” explains Gerry Fowler, head of European multi-strategy trading at Citi.

As the markets have changed, especially at the start of 2007 as US real estate problems started to become noticed, volatility began to increase. The fairly neutral market of the previous five years began offering volatility players opportunities with spikes hitting up to 25 per cent and higher. RBS has gone from 2 per cent volatility to 105.

“In general this was good for volatility trading positioning long and there was a scramble for put options,” explains Mr Fowler. The use of put options has found favour among traditional long-only asset managers. These options give the holder the right to sell a security for a fixed price at or before a given date. Investors use options to guard against fluctuations in the price of securities they own, speculating on volatility.

While getting reliable figures for the volume of trades relating to volatility strategies are difficult, the huge leap in equity derivative contracts (up 75 per cent year-on-year for Eurex) indicate its growing acceptance. As counterparty worries have continued, the OTC volatility products, most commonly variance swaps, have taken a back-seat to exchange-traded derivatives.

Currently the first index (1990), the Chicago Board Options Exchange Volatility Index (VIX) measuring volatility based on the price of options, hit a record high at the beginning of October, moving to 56.32. To put this in perspective its previous high was 49.53 set in October 1998, when Long-Term Capital Management collapsed.

“There are two basic ways to trade volatility: to diversify portfolio or smooth out the risk profile by exposure to returns,” explains Nick Tranter, head of European equity derivative flow sales at BNP Paribas.

“The most significant area of change in the past two years are institutional clients looking at hedge fund volatility players, not so much for profit but for risk,” explains Mr Tranter. He points to insurance companies as moving to exploiting these strategies for risk purposes, “With CP195 rules to realistically mark to market of liabilities of insurance companies, they have used hedge funds, but also options effectively taking a notional benchmark such as the FTSE 100 and play an option with a 25 year maturity.”

JP Morgan’s Mr Valenzuela also points to more complex strategies including expressing views on skew as correlation and broadly arbitraging option prices as ways of building positions on de-corollated assets, but warns these deals require well-groomed pricing, structuring and trading skills.

Market+Volatility+investment