With increasing regulatory scrutiny in private markets leading to a greater focus on operational challenges, what measures should CFOs and COOs be taking to address investors’ concerns?
Historically, the low volume, illiquid, and long-term nature of private fund investments has meant that private markets have been relatively less exposed to operational risk when compared to hedge funds. Hedge funds, by contrast and by their very nature, have tended to carry more operational risk due to factors such as trade settlement, collateral management, liquidity management, and counterparty risk.
However, in recent years, an increase in regulatory scrutiny in many jurisdictions across both private and hedge fund markets has led to a greater focus on operational challenges, risk mitigation, and best practice. Moreover, this level of scrutiny—and the consequent need for robust operational controls—is only set to increase further with the democratization of private funds. Additional factor has been the greater emphasis potential investors have placed on due diligence, and on potential investments and allocations into funds.
AIFMD 2.0, and even the now vacated SEC Private Fund Advisors Rules (PFAR), are evidence of this changing environment. As regulations continue to evolve, fund managers should expect greater focus on transparency around performance reporting and expense allocations.
At the same time, the growth in private funds using leverage through subscription lines, GP lines, or NAV lines, also needs to be managed, again increasing the operational burden. And the move by larger GPs into new markets and new asset classes—for example, real estate managers expanding into the debt markets—requires the development of new skills, once again increasing operational risk levels.
In this new environment for private markets, CFOs and COOs are firmly in the spotlight
As well as the investment side of any business, investors are now increasingly looking at operational risk levels and how firms are managing them.
Much of this operational responsibility sits at the CFO and COO level, making it crucial that these individuals have a very strong appreciation and understanding of the regulatory environment in which they’re operating. Whereas previously the private markets CFO was more likely to operate behind the scenes, he or she now has a clear responsibility to ensure that regulatory matters are being addressed and that the optimal operational and control frameworks are in place.
From a technology perspective, the increases in data privacy, social engineering, and cybersecurity issues are also placing a greater focus on management to mitigate potential risk by ensuring the most robust technology systems are in place. For example, we expect to see widespread use of two-factor authentication, domain security, and data warehousing.
Additionally, there are cost implications for CFOs of having the right controls, skillsets, and people in place to address this increased scrutiny and mitigate operational risks.
What steps should firms take to address operational risk?
All the above points to the need for firms to demonstrably have the right control environment in place, potentially outsourcing responsibility for this to their fund administrator or service provider.
At CSC, for example, we can provide businesses with a best-in-class control environment, with our SOC1 Type2 reporting able to provide a verified measure of a firm’s control reporting. Importantly, this gives comfort to both the GPs and their LPs as to the quality and standard of our work.
And if CFOs and COOs can take good comfort that their service provider is providing work of the highest standard, they potentially don’t need to expand their internal operational team or employ additional internal resources to support them. From a CSC perspective, we have found that the amount of engagement around fund administration we’re having with CFOs and COOs has significantly increased in recent years.
How can CSC help?
CSC’s experienced team, culture of compliance, and tech offering help reduce our clients’ operational and compliance concerns so they can focus on what they should be doing—raising assets from investors and deploying those assets. Ultimately, CSC can provide the resources to enable CFOs and COOs to focus on running and building their business.
Fund administration has evolved from a simple task to a complex, intensive activity. CSC has worked with private equity funds of all sizes, structures, and investment strategies, ranging from emerging managers and first-time funds to those with multi-billion-dollar commitments. As a single-source provider for operational and compliance services across the fund life cycle, we go far beyond traditional fund administrators to enhance back-and middle-office operational efficiencies. Learn more about our fund administration services and to access our range of resources here.
