- Transfer agents are beginning to see the benefits of transparency, six years after AIFMD and UCITS V first challenged their opacity.
- The pace of adoption of innovative technologies has been overplayed – but the next five years might tell a different story.
- Cybersecurity should be a key concern, with an increasingly digitised sector exposing itself and its counterparties to the risk of fraud.
- Transfer agent evaluation, selection and monitoring likely to become the norm, as the depositary banks seek to proactively reduce their exposure to high-risk entities.
- A new area for scrutiny has arisen in recent years with the surge in Fund Platforms, but their place within the industry’s regulatory framework remains unclear.
With the introduction of AIFMD and UCITS V in 2014, transfer agents were dragged out of the shadows. Despite being a key function in the investment process – maintaining official ownership registries of funds and settling cash movements – transfer agency was an activity buried deep in the fund industry’s infrastructure, often poorly understood outside the TA community and rarely monitored adequately. Most transfer agents were uninformed and unprepared, and many were resistant to giving up the privacy that they regarded as fundamental to their business.
When the regulations rendered European depositary banks liable not only to AIFs and UCITS funds – their clients – but also to the underlying investors, the banks were suddenly required to gather vast amounts of information from transfer agents who had no legal or contractual obligation to respond, and where many had no prior contact. The need to monitor every transfer agent servicing all the funds where their underlying investors held positions was an administrative nightmare for the banks, and the transfer agents were not prepared for the volume of requests for information which followed.
Thomas Murray worked with the industry to develop a monitoring programme which would ease the burden on both the banks and the transfer agents. Assessing a set of key risks in transfer agents across 70 markets, our analysts were able to point to areas of high risk within transfer agents’ operations. With the programme now in its seventh year, monitoring over 1,000 transfer agents worldwide, an analysis of the sector has uncovered some surprising trends.
Where are the risks?
Among the most surprising findings is that there is little variation between markets for transfer agency risk. In any given market there is an almost equal likelihood of finding a high-risk transfer agent – although there is inevitably some fluctuation. In particular, markets with looser regulation do tend to demonstrate correspondingly higher risk in certain areas. Data Protection and Conflicts of Interest are often the areas in which transfer agents demonstrate the highest risk.
The number of self-administered funds – where the fund manager also administers the fund – has remained consistent at c.10-15%. This lack of organisational segregation is rarely an indication of operational risk, and many funds justifiably prize the centralisation of these functions. However, in the post-Madoff era, self-administration is a structure that has got to be scrutinised – even though the vast majority of examples will present no additional risk.
Despite opening up to scrutiny, transfer agents’ operations have remained mostly unchanged in the six years since AIFMD and UCITS V were implemented. Notable exceptions include developments in anti-money laundering, know-your-customer and cybersecurity practices – areas of acute regulatory and operational concern which are being proactively addressed.
As a sector made up of many small and mostly unregulated companies, transfer agency is a potentially obvious target for fraud within the investment chain, and an area about which Thomas Murray's clients have expressed growing concern. Cybersecurity remains a hot topic and something the banks, if not the transfer agents themselves, will be looking at increasingly closely.
Image 1: TM's anonymised transfer agency risk index. Each bar represents a single transfer agent and its overall risk score.
More and more of our clients are looking for greater transparency and more transfer agents use openness as a selling point. I always think those being difficult are doing themselves a disservice." (TM Client)
Encouragingly, transfer agents have become gradually less fearful of scrutiny, understanding that enhanced monitoring is a cost of doing business in the post-Madoff era. Transfer agents were initially aggrieved at the lack of consultation before AIFMD and UCITS V were imposed in 2014, seeing the enhanced monitoring requirements as an unnecessary interference, and believing that regulators had no real understanding of the sector.
In spite of this early reluctance, transfer agents are finally beginning to embrace this exposure. In particular, medium-to-small transfer agents are jumping on the opportunity to demonstrate that they are low risk. Eager not to lose business, these groups are discovering that sharing operational data in order to satisfy their clients and counterparties is a competitive advantage. There remains no regulatory or contractual obligation for transfer agents to provide any data to the depositary banks, but those who do so provide greater regulatory comfort to the depositary banks and therefore the underlying investors.
Several of the larger, global transfer agents have been the most resistant to scrutiny. Some are unable to respond adequately, with years of acquisitions and absorptions leading to complex internal structures with no single set of data. However, the global groups who seek to consolidate their services centrally demonstrate greater transparency. Undoubtedly, the larger groups’ patronage of innovative technologies has contributed to eliminating human error, which is still the most common cause of failure at a transfer agent.
Transfer agents’ failure to comply with monitoring requirements remains an area of acute concern for the banks, and the sector’s slower-than-expected consolidation could be explained in part by some larger groups’ reluctance to be scrutinised. Many of Thomas Murray’s clients consider transfer agents to be ‘high risk’ if they refuse to respond to requests for information or routine due diligence and put in place various remedial measures to reduce their risk exposures. Maintaining a blacklist of transfer agents appears to be a solution favoured by depositary banks. Where they are unable to obtain a clear view of the transfer agent, an investor is likely to be advised against investing in any fund serviced by that transfer agent. Transparency is quickly becoming a prerequisite for doing business.
Much has been said about the transformations – current and future – wrought on the sector by innovative technology. There is no doubt that online portals enabling transfer agents to transact and service funds have been on the rise, but reports of these technologies’ wide-spread adoption may have been overplayed to date. Transfer agents utilise a bewildering array of third-party and proprietary software solutions and appear unlikely to invest significant sums in adopting the new technologies. In reality, standardisation of systems and system migration compatibility appear much further off than has been predicted.
FinTech is not changing the sector as quickly as some commentators, and many investors, believed likely. While software companies clamour for recognition and market share, most transfer agents appear unwilling to migrate from their legacy systems. The margins for providing transfer agency services are too small to justify replacing software with costly new alternatives. Many administrators provide TA alongside other, more profitable, services, and most local, medium-to-small TAs are unlikely to invest where they do not have to. No single leading software solution has emerged at the head of the pack – and, until there is a clear industry-leader facilitating easy migration at an accessible price, we are unlikely to see large-scale adoption.
Image 2: The variety of software platforms used in the TA sector. Only c.50% of TAs use a transfer agency platform, and among those who do there is little standardisation.
Adoption of DLT and Blockchain is slower than predicted, and is only really gaining traction with the prominent administrators. Smaller, local TAs – the bulk of the industry – retain their traditional or legacy systems. Despite much noise and speculation from commentators, there appears to be little pressure from clients to depart from existing systems.
Consolidation & Outsourcing
The sector has seen consolidation in recent years – partially as a result of increased regulation – but not nearly as much as predicted before 2014. There are still over 2,000 entities of all sizes in the world providing transfer agency services. Much of the consolidation that has occurred has been strategic, rather than as the result of the increased administrative burden. M&A in this sector is often no more than an exercise in rebranding, where a full merger of records and systems is deemed too onerous to contemplate (partially a result of legacy and proprietary software).
The COVID-19 pandemic may well have an impact on future consolidation and we could see a spike in M&A activity and a refocusing on outsourcing may be the inevitable result of full BCP enactment and the resultant fallout.
When Thomas Murray began looking at transfer agents in 2014 the sector was in uproar, reeling at the prospect of transparency requirements that appeared to cannibalise the confidentiality on which they built their businesses. Many of these were opaque and remote entities, left alone to carry out the core tasks of processing subscriptions and redemptions and maintaining the fundholder register.
Since the launch of our Transfer Agency Monitoring programme, and with the sector growing more familiar with monitoring and risk assessment generally, transfer agents have begun to recognise the benefits of increased transparency. It is likely in the coming years that many more will do so. For one thing, a critical mass of transparent transfer agents would help individual groups identify where they stand against their peer group, and understand how to differentiate themselves. For another, it should bring the whole process of TA selection – an unscrutinised activity – into the open.
The selection of transfer agents is likely to become a standard procedure. The regulatory burden and cost concentrated on the depositary banks is driving them to be more proactive. Rather than continue as the silent partners in a regulatory burden not of their own choosing, the depositary banks will begin influencing the selection of white-listed transfer agents at the outset. The risk of exposure to high-risk transfer agents – chosen on the basis of an existing relationship, or to reduce the fund’s administration costs – is too great for them to ignore. It is likely this pressure may even lead to RFPs aimed at markets, as costs come under scrutiny and depositaries decide to take a more active approach. Benchmarking and selection on the basis of risk as well as cost could become the norm, particularly because it is an area where the cost of monitoring could be recouped. An inevitable result will be the increased competition arising from formal selection and accreditation, and a resulting consolidation of relationships in the sector. The most transparent transfer agents – those who the depositary banks can scrutinise, advise and white-list - will come out on top, and their clients and counterparties, as well as the underlying investor, will be better served.
Afterword – Fund Platforms
With the proliferation of business being placed with fund platforms, these organisations will be playing a critical role in the asset safety chain for fund investors and as such should not be omitted from this conversation. Many believe that the expansion of fund platforms as increasingly prominent intermediaries makes them an area ripe for scrutiny. The demonstrable sophistication, extent and efficiency of their offering has led to a surge of activity in recent years, but fund platforms are also counterparties whose place within the fund industry’s regulatory framework remains ill-defined. Their direct exposure to thousands of transfer agents, on behalf of millions of investors, does not seem to have been adequately addressed, and the quality and scope of their monitoring is largely unknown. At the same time, the fund platforms themselves require monitoring – but it is currently unclear who will undertake to monitor them and to what level. As with transfer agents, it is likely that the regulatory buck will stop with the depositary banks, who will need to develop a common approach or they will risk years of non-cooperation.
Thomas Murray actively monitors over 1,000 transfer agents globally, according to an industry-agreed questionnaire which satisfies our clients’ requirements under AIFMD and UCITS V. To find out more about our services and whether they’re relevant to you, please contact:
Director, Thomas Murray