Compliance and operations managers at fund administration shops in Ireland will need to keep closer tabs on middle and back-office activities outsourced to third-party firms or even offshore affiliates.
In March, the Central Bank of Ireland sent chief executives of fund administrators in Ireland a stern letter about shortcomings in monitoring of offshore operational work with detailed guidance on how it should be done. The Irish central bank’s model of best practice, which includes outsourcing and compliance managers implementing specific oversight programs, could even serve as a word to the wise for non-Irish fund administrators. Out of sight shouldn’t mean out of mind.
Ireland requires fund administrators located within its borders to be authorized by the central bank and to follow specific operating rules. As the second largest funds hub in Europe following Luxembourg, Ireland has about 45 administrators servicing close to €4.1 trillion in assets as of January 2017. The country is home to some of the world’s largest custodians such as JP Morgan, State Street, BNY Mellon, Northern Trust, Citi and Brown Brothers Harriman, which also have Irish fund administration subsidiaries. “We are working closely with the regulator to ensure we satisfy its recommendations and requirements,” says Rachel Turner, head of offshore asset servicing for BNY Mellon’s EMEA operations in a statement issued to FinOpsReport. She would not elaborate on any possible changes, if any, to current practice.
In his letter to Irish-domiciled fund administrators, Michael Hodson, the Irish central bank’s director of asset management supervision, says that Ireland’s central bank is worried about just how much supervised activity is taking place through third-parties or offshore affiliates of the fund administrator. Those concerns rose from a 2016 review of fund administrators, many of which rely on offshore affiliates. The background issue: facing a squeeze on profit margins, fund administrators are trying to use cheaper labor to reduce overhead costs.
“The majority of firms reviewed were found to have no tolerance level in place with regards to how much outsourcing is permitted and many of the other parties were found to be either not regulated at all or not in the same way as Irish fund administrators,” wrote Hodson. In its review of local fund administrators, the Irish central bank found that up to 61 percent of their activities were conducted outside of Ireland by either affiliates of Irish-domiciled administrators or third-parties. Those affiliates or third-parties could be scattered in as many as ten foreign locations. The central bank didn’t say where, but Poland and India are considered popular locations.
The Irish Central Bank is steadfast that any fund administration activities conducted outside of Ireland be held to the same standard as it would if it were conducted within Irish borders. The bank doesn’t care whether the fund itself is based in Ireland.
“None of the provisions should be of any surprise to fund administrators given that these requirements are taken from the Central Bank’s existing rulebook,” acknowledges Andrew Bates, a partner with the law firm of Dillon Eustace in Dublin. “The main difference is that the previous rules have been set down as legislation and will be enforced more rigorously.”
What does that mean? In his letter to fund administrators, Hodson never specified what penalties are in store for not complying with the Irish central bank’s rules. It stands to reason that fund administrators could face higher fines or even be subject to a cap on outsourcing of any activities. “The letter issued by the Central Bank also casts doubt over whether the regulator will continue to approve the outsourcing of these activities to the level they have so far,” says Alan Meaney, director of Fund Recs, a Dublin-based reconciliation software provider. “The Central Bank may decide to look at the overall level of outsourcing by all fund administrators, when approving an outsourcing activity by a fund administrator.”
As a rule of thumb, Irish-domiciled fund administrators are not allowed to outsource their share registry services nor outsource the final net asset valuation calculation to any unit located outside of Ireland. However, they can outsource many of their fund accounting activities leading up to the final calculation of the fund’s net asset value. Although Dodson’s letter never cited any specific mistakes made by offshore offices overseen by Irish fund administrators, fund operations managers tell FinOps that the most costly faux paus is the miscalculation of an NAV. Depending on the size of the miscalculation, the NAV might have to be reset and fund investors compensated.
What does the Irish central bank think is best practice? For starters, it wants every fund administrator in its country to appoint a dedicated outsourcing officer responsible for monitoring any operations activities outside its home market. That outsourcing officer will report to an outsourcing committee comprised of representatives from the risk, compliance and board of directors.
While fund administrators in Ireland appear to be doing that, some may not be keeping detailed records of the activity which is being outsourced. “The firm should maintain a comprehensive centralized log of all outsourcing arrangements which should be updated on an ongoing basis,” wrote Hodson. “The Central Bank should have acess to the log upon request.”
When it comes to the amount of operations activities outsourced, fund administrators need to determine just how much should be acceptable in relation to the risk involved. “For certain firms no tolerance levels were set with respect to the amount of outsourcing permitted for a specific activity. Under the outsourcing requirements, firms are required to carry out regular assessments of the concentration risk associated with their outsourcing arrangements,” wrote Hodson. He cautioned that firms should pay close attention to concentration risk or the potential that too much activity is being outsourced to too few third-party providers or too few geographic locations.
Compliance managers at Irish-domiclled fund administrators also need to be more involved in any outsourced fund administration activities. Too often, warned Hodson, compliance officers of fund administrators reviewed by the central bank did not visit the offshore sites or contribute to the questionnaires for due diligence checks. He urged compliance officers of fund administrators to visit any offshore locations, conduct remote reviews of processes and controls, monitor training programs of offshore providers and hold monthly meetings with the compliance officer at the external provider. Any annual reports written by compliance managers need to be far more thorough. “In some firms, the reports were lacking in detail and not always clear in terms of which outsourcing arrangements the reviews covered,” said Hodson.
He recommended that all staff working for the Irish fund administrator at the offshore location should also undergo annual training in Irish regulatory requirements and correct procedures at that location from the fund administrator’s dedicated ousourcing and compliance managers. Documents should be maintained demonstrating that the training took place and who participated in the training.
Last but not least, Irish-domiciled fund administrators need to conduct an internal audit to review just how well their shops are doing when it comes to monitoring outsourcing agreements. The goal: to assess the adequacy of the firm’s process for ensuring the relationships align with its business strategy, identify, report and manage all risks, and ensure appropriate staffing and expertise is in place to perform due diligence.
Surprisingly, one of the most difficult challenges the Irish-domiciled fund managers might have in meeting the central bank’s requirements may have nothing to do with operational work. The Central Bank requires that any administrators providing services to an investment fund that is not authorized by the central bank must make certain that the prospectus issued by the fund doesn’t state of suggest that the fund is authorized by the central bank.
“Although this too previously appeared in the central bank’s rulebook, it is a matter which is ultimately outside of the control of the fund administrator,” cautions Bates. “The administrator is not the entity which issues the prospectus, so it seems a bit unfair to have such an obligation imposed in circumstances where sanctions for non-compliance can be imposed.”
Meaney recommends that besides following the Irish central bank’s recommendations for better oversight of offshore locations, Irish fund administrators consider keeping more fund activities in their home market. Spending more on technology to integrate data from front to back office systems could be more cost effective than using cheaper labor offshore to do manual work. Fund administrators risk striking the wrong NAV when they manually input data from pricing vendors, a transfer agency system or trade execution platform into fund accounting systems.
Although the Central Bank of Ireland’s regulatory standards for Irish fund administrators are considered rigorous compared to other jurisdictions, it doesn’t mean fund administrators in other countries can afford to be lax in overseeing offshore operations. The US Securities and Exchange Commission holds US fund managers legally liable for any operational glitches, so fund managers won’t hesitate to ask their fund administrators to make them whole in case of any errors.
The Central Bank of Ireland’s strict guidance to Irish fund administrators appears to be in sync with US best practice, US fund administrators tell FinOps Report. In fact, they go the extra mile when it comes to tracking any operational work done offshore. In the case of Piedmont Fund Services, a fund administrator based in Metro Washington DC, work done in Kuala Lumpur involves handling daily trade reconciliations for some US clients. “We assign a manager at headquarters to each engagement and that manager will be responsible on a daily basis for keeping track of the activities in our Kuala Lumpur office,” says Ian Asvakovith, president of Piedmont Fund Services. “The engagement manager will verify the status of the activity, that it has been completed correctly and sign off on the review. An independent second level reviewer will also sign off.”
All of the work done in the US and Kuala Lumpur is tracked using Piedmont Fund Services’ proprietary workflow and dashboard system.”The key benefit for having another team in a different time zone is that we have the ability to provide 24-hour service coverage and turn ardound the daily trade reconciliation process more efficiently,” says Asvakovith. “Nonetheless having the right training and oversight program is critical to achieving this goal.” Piedmont Fund Services will send out senior executives from headquarters to train key personnel at the Kuala Lumpur office. Both the US and Kuala Lumpur offices also undergo an annual external audit known as an SSAE 16 review.
Frank Caccio, managing partner of OpsCheck, a New York-based provider of workflow, oversight and compliance management tools, recommends that fund administrators who outsource any of their activities offshore or even outside their home office, prove to their fund manager clients that they are holding all of their operations staff accountable to the same standards. Institutional investors are also taking the strength of the operational procedures and oversights performed by service providers into consideration when picking fund managers for asset allocation. Therefore, as service providers outsource more of their activities, investor scrutiny will only increase, predicts Caccio.
What does that mean to fund administrators? They will need to implement workflow/oversight management tools, sign-offs and proof of work completed, and records showing that any operational shortcomings have been corrected, says Caccio. Allowing fund managers to have the same transparency as their administrators into the operations of offshore providers can also go a long way to ease any concerns of managers on how well the functions are being handled. Objections can be quickly voiced and addressed. Caccio says that a large US fund administrator using OpsCheck’s platform is providing one of its manager clients look-through access to the activities of employees at offshore locations.