Ask global network SWIFT which helped create ISO message types for communication information on payments, foreign exchange transactions and finally post-trade instructions for banks and treasuries. Or ask FIX Trading Community, which developed FIX message types for trade execution. Neither of the organizations found acceptance an overnight miracle.
There’s the vision, and then the long slog through definitions and development, winning early participants and supporters, overcoming the inertia of “that’s the way we’ve always done it” tradition, and finally overcoming the competing options from people who see other ways of fixing the same problem.
Now a group within the private equity fund community is following in their footsteps through an initiative called AltExchange Alliance, which aims to standardize — and automate — how private equity fund managers report critical financial information to investors.
Five private equity fund managers are beta testing the first incarnation of the XML-based data formats with a limited group of institutional investors. This first set of traditional fund reporting messages — called Group One– describes underlying financial instruments, related capital calls and distributions to investors. A second more complex standard or group, under development, concerns information on portfolio companies: sector, underlying holdings, revenues; net debt, capital expenditure spending; and cash flows. Yet a third group is envisioned to extend the coverage to fee-related data and other details of benefit to investors.
Such a phased approach gives private equity fund managers plenty of clout over just how much information they wish to release. Within each group of data there will be tiers of information, with tier one being the top-level and tier three being the most detailed. The private equity fund manager can decide which tier it wants to provide its clients.
The AltExchange message types replace a hodgepodge of proprietary data formats and content which private equity fund managers, otherwise called general partners, provide their institutional or limited partners each quarter often through PDFs.
Sending out hundreds of quarterly reports to institutional investors might not sound too difficult for private equity fund managers to accomplish. They should have all the data stored in their internal applications and available at the touch of a button.
But what if a good percentage of those investors — known as limited partners — wanted to receive customized reports with information on underlying portfolio companies and transactions? Private equity fund managers could spend weeks generating several dozen of those reports on a case-by-case basis.
Taken in reverse, how will each of the investors, who might well be allocating a good chunk of their money to multiple private equity funds, compare the performance and risk taken by private equity fund managers if private equity fund managers deliver different data or the same data in different formats?
This is the scary scenario facing private equity fund managers — called general partners — and their limited partner investors at least every quarter when financial reporting typically takes place and a multitude of questions must be addressed. What the private equity fund manager invested in, how much it’s worth, and when the institutional investor’s funding commitment is coming due are just the tip of the iceberg in the hundreds of data points appearing in the limited partner reports.
With the percentage of assets allocated to alternative investment funds on the rise, and private equity fund managers chasing after those dollars, operational issues related to communications between general partners and their limited partner investors have reached the breaking point. And the situation is only likely to become more stressful as this market grows. The average allocation to private equity funds has risen from an estimated three percent to at least ten percent for many public state plans.
The problem is not just a matter of what information institutional investors want, but how they want it. In order to review their exposure and risk across their entire portfolios very quickly so they can allocate and reallocate their investments, they not only need specific details, but they also need it consistently defined and formatted.
The attraction of standards is equivalent for the general partners or private equity fund managers. They can cut down the time they need to generate custom reports for limited partner from a few weeks to a few days.
Officials representing AltExchange in London won’t disclose the names of the private equity fund managers or their institutional investors which are participating in the beta test. Apparently, the private equity fund managers don’t want to get their customers excited about the initiative before they have a chance to test the waters.
However heavy hints of just who is participating do exist. A press release issued by AltExchange in December 2013 includes an endorsement of the testing from Franklin Park, a fund of funds and investment advisory firm. Among the private equity fund managers listed on AltExchange’s website as members are Kohlberg Kravis Roberts, StepStone, and Switzerland’s Capital Dynamics. Institutional investors include the University of Texas Investment Management Company, the Employees Retirement System of Texas, the Teachers Retirement System of Texas, France’s Ofi Asset Management and Switzerland’s Unigestion.
“The private equity fund industry did have high-level guidelines as to what information should be included in reports, but can now count on consistent data formats and data points,” explains Stuart Keeler, chief operating officer of eFront, the private equity fund technology provider behind the AltExchange initiative.
The members of AltExchange Alliance, as the group calls itself, took the guidelines provided by the Institutional Limited Partners Association (ILPA) and the International Private Equity and Venture Capital Valuation (IPEVCA) and translated them into computer writable and readable XML-based language. They also added a message validation engine to the mix.
Here is how AltExchange works: private equity fund managers identify the data they need to populate the AltExchange data file, which is then produced by either a fund manager writing a program in its system or using the Excel plugin produced by AltExchange. The fund manager then uses either an API file to automate connect to the AltExchange Validation Platform or loads a file manually using a web browser. In both cases, if a file passes validation, a certificate is returned. The validation relates only to checking for completeness of the data and the data types, not correct figures as the platform doesn’t store data. The private equity fund manager then sends the AltExchange data file and certificate to participating investors using either email or an existing investor portal.
“By having the exact same information using consistent XML-based formats in electronic form, institutional investors should have far less difficulty in interpreting the data,” says Keeler. “Institutional fund managers wanting to consolidate their capital with fewer, better performing private equity fund managers can understand data at the investor and eventually below the portfolio level.”
What’s more, institutional investors relying on the AltExchange formats will also be able to download the information far more quickly into their internal applications. They will no longer have to normalize and rekey data from PDFs — a time-consuming and error-prone process.
End result: a win-win for private equity fund managers and their institutional investors, says Keeler.
The cost: Each of the private equity fund manager members of AltExchange pays an annual fee of US$1,000 and general partner members pay an additional annual licensing fee of US$10,000 for using the platform regardless of the number of funds they manage. Limited partner members don’t pay the extra licensing fees.
AltExchange has signed a five-year exclusive contract with eFront, which naturally hopes to recoup its investment in the project. The contract, which expires in 2018, includes a cap on the annual profit margin eFront can earn and requires it to return any excess as a rebate to the platform’s general partner users.
Regardless of how much or how little eFront earns from AltExchange it will clearly benefit from the marketing cachet. It will have a natural edge in convincing the institutional investment fund managers already using its private equity systems to join the AltExchange initiative. Likewise, it will also have an easier time convincing institutional investment managers they should use eFront’s technology, if they want to capitalize on the benefits of the AltExchange data formats and, especially, if other vendors fail to adopt the standard.
As general partners typically rely on internal or external reporting tools to populate the investor reports and limited partners typically import data from Excel spreadsheets into their automated systems or even bigger Excel spreadsheets, vendor participation isn’t necessary for AltExchange to succeed. Naturally, it would be ideal if they upgraded their offerings to do so. Nonetheless, the AltExchange standard simply guarantees a consistent reporting format which requires changing of import mapping only once. The process then becomes repeatable.
Although Keeler insists that eFront’s goal in the AltExchange initiative is for the greater good and not to line its own pockets, he does acknowledge that eFront was approached by its institutional fund manager customers to help create the industry-wide reporting standards. General partner members of the AltExchange initiative use SunGard’s portfolio management technology.
Just who will be most important in driving greater adoption of the initiative remains to be seen. Will it be general partners or private equity fund managers wanting to reduce their administrative workload or will it be institutional investors who want greater consistency? So far, it appears that the number of institutional fund managers far outweighs the number of private equity and managers.
Of the 46 firms which are AltExchange members, only ten are private equity fund managers; the remainder are institutional investors, service providers and software vendors.
But where do fund administrators and other technology vendors stand? One of the more surprising shortcomings of the AltExchange initiative is the lack of participation from the large bank-owned private equity fund administrators. Three initially signed up: GenII Fund Services; MB Fund Administration; and Aztec Group. SS&C, a fund management software vendor and private equity fund administrator, is the most recent entrant.
AltExchange, concedes Keeler, has so far not been marketing heavily to fund administrators. Practically, speaking, that means general partners or private equity fund managers who outsource investor reporting process to their fund administrators will have to convince their fund administrators to adopt AltExchange, if they want to benefit from the AltExchange. The same holds true for their institutional investors.
Could fund administrators be thinking of creating a competing data format? Are they too entrenched in the status quo to promote change? Or are they waiting for further acceptance from their own client base?
Waiting for Demand
Keeler thinks that more fund administrators will eventually join once they see demand from their clients. That appears to be the case for at least one private equity fund administrator trying to break into the US market.
“We think that AltExchange is a worthwhile initiative which is why we joined,” says Gus Tambakis, director of business development for MB Fund Administration in New York. “We will be testing the formats after we complete our installation of eFront system and have one private equity fund of funds client who says it is interested.”
For all its fanfare, AltExchange also isn’t the only game in town. Burgiss, another private equity software provider, offers a popular data gathering service for institutional investors with its own formats, while Blackstone Group spin-off iLevel says its software offers help with data collection and customized reporting for private equity fund managers and investors. Neither Burgiss nor iLevel officials were available for comment at press time.
Without an industry consensus incorporating fund administrators as well as other technology providers, AltExchange could face a long haul to win critical mass. As with other attempts to establish new messaging standards, the Catch-22 is that greater benefits emerge from more universal buy-in for both institutional investors and private equity fund managers. Comparatively speaking, early adopters have to rely on faith.
“It’s the first time that general partners and limited partners have sat at the same table and reached a consensus,” says an optimistic Keeler. The ILPA and IPEVA guidelines were driven by institutional investors, leaving private equity fund managers to decide whether or not to play ball after the fact.
Change never comes easy to the financial services industry. The SWIFT-ISO and FIX formats were initially promoted by a handful of the world’s largest financial firms before others jumped to the bandwagon. They have now become household names.
The same could apply to AltExchange.