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Keeping Your Hedge Fund Organization Lean and Nimble: As the Tide of Regulation Mounts, The Middle Office Takes the Heat

By Ed Gouldstone, Head of Product Management, Linedata


Keeping your hedge fund organization lean and nimble: as the tide of regulation mounts, the middle office takes the heat

Many hedge fund managers today are looking at how to keep their organizations lean and focused on their core business of raising and managing funds, but this is proving a tough feat to achieve, as a tide of global regulation and market changes put extra pressure on the middle office. Enter the outsourcers: can this trend really live up to the promise of taking away the burden of operations? Yet still leave hedge funds with the control required to satisfy their investors and the regulators?

The middle office within the hedge fund market is fast evolving due to two key drivers that are almost diametrically opposed: regulation which is pushing more onto the plates of the middle-office teams, and a change in the hedge fund business model, which requires firms to do more with less and manage their business costs effectively. Much has happened in the last year in the middle-office outsourcing space, and here I suggest some of the key things which I believe make for an effective approach to middle-office outsourcing.

First there is the question of freedom and independence

Many of the middle-office options available to the market today are provided by fund administrators, who often package them with traditional administration services, and sometimes other services such as custody and banking - that may be of particular use to those in the hybrid hedge/traditional fund world. However an important point to consider is whether this is an ‘open’ platform, and if not, is this cause for concern? Should a particularly attractive managed account mandate come along that requires the use of a specific administrator, will it be necessary to split the middle-office function? Or will an outsourcer be able to take this in their stride? If a hedge fund needs to start undertaking aggregation of information across different middle-office solutions to get the level of reporting required, then are they really getting the benefit of outsourcing needed, or is it a question of paying for off-site operational staff?

Next on a checklist for efficient outsourcing - Look at the technology

One of the key functions a middle-office team performs is making sure that the investment team has accurate information on which to base trading decisions. Depending on a hedge fund firms’ style and process, that might be anything from a single reconciled, accurate portfolio holdings report at the start of the day, through to a live real-time feed of positions with analytics and risk information combined.

Making sure that there is an excellent match between what an outsourcer can provide and what a hedge fund firm wants is key to avoid having to bring operational work back in-house. How the outsourcer uses technology will also provide hedge fund decision makers with a view of an outsourcer’s scalability and flexibility, so that they can be aware of where the limits will be - exactly as if a hedge fund firm were undertaking the work in-house.

Now comes the hard part

As the post-crisis wave of regulation starts to break on the shores of the middle-office, as a COO or other hedge fund decision maker - how does this apply to you?

How do you best decide that your firm is well equipped to deal with future challenges?

Much of the new regulation involves reporting, AIFM, Form PF, CPO-PQR, EMIR trade reporting – take your pick. Many of these regulations need to be compiled on a regular basis by taking data from various different areas of the firm including risk, accounting and trading. From the client and industry trends I see today, this task is falling to the middle office, as generally they are the people with the access to and knowledge of how to aggregate this information as required – no easy task. At the same time, those same individuals are being asked to oversee tighter controls on matching, reconciliation, trading of derivatives through central clearing parties, and even management of shorter settlement cycles.

How will the outsourcing of part or all of the middle-office process fit with your firms approach to compliance?

  • If a hedge fund firm outsources the ‘daily’ tasks of reconciliation and matching, will there still be the same access to the level of information required to complete the periodic reporting needed?
  • If a firm was to outsource all middle-office tasks, would they still have enough oversight and control to show investors they are managing their funds effectively?
  • And how would they know that a provider is going to be able to comply with the next wave of regulations that may be brewing?

The answer

Make sure you find a provider for whom you will be a valid customer, and who works closely with their clients to ensure their communication and service level stay responsive. It may sound obvious, but when you are dealing with the outsourcing industry - which at its core is about efficiency through scale - ensuring you have a good relationship is key.

Three key points when considering outsourcing

  • Will you have the right level of independence?
  • Are you happy with the technology and access to data expected?
  • Can you build a relationship that gives you confidence for the future?

As someone who spends a great deal of time working with and advising hedge fund clients on their middle and front-office technology and processes, my world view may be biased towards the areas discussed above, and I have not even highlighted other major concerns like costs, location of staff, service levels and the like - all of which are important – but I certainly believe if you can get these three key outsourcing points right, then you will be able to position your firm well to take advantage of the evolution of middle-office outsourcing in hedge funds.

Outsourcing to Linedata

Linedata provides outstanding managed services. From full hosting to expert hedge fund technology consulting, Linedata’s solutions are driven by innovation and exceptional commitment to client service. Clients have the option to outsource full front-to-back technology and/or their compliance requirements. Whatever the investment style or strategy, clients can improve performance in an increasingly complex trading environment and experience the measurable benefits of a streamlined and efficient trading and operational workflow. Accurate and timely reporting, management of affirmations on derivative trades, corporate actions, tracking of financial transaction taxes, flexible and intuitive access to historical data, Linedata Global Hedge incorporates all of these options and more. Linedata Global Hedge is the award-winning solution created specifically for the needs of hedge funds, supporting trading and order management, portfolio management, compliance, reporting and investor accounting. Over 200 of the world’s largest hedge funds currently work with Linedata.

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