The region's fund managers are making more use of independent custodians and administrators, and demanding increasingly sophisticated services, ABF discovers.
The Middle East's mutual fund industry shows some signs of taking off, but investors may still be wary of asset management firms that have not yet implemented international best practices.
Funds that are administered in-house may be handled correctly, but independent administration could give investors, particularly foreign ones, more confidence.
Fund administration is nothing like before.
However, until recently there has been a lack of high quality administration and custody service providers in the region, as well as reluctance by fund managers to outsource these processes.
Outsourcing may not happen until the region's regulators require asset managers to use independent fund administrators and custodians. The Central Bank of Bahrain and Dubai Financial Services Authority both require this for public funds, but in some jurisdictions regulatory requirements can have the effect of limiting choice. For example, funds based in Oman must use a custodian based in the Sultanate, which does not give asset managers many options.
Increased use of fund services providers could, however, be driven by investors' demands for best practices. "Fund administration is nothing like before," says Agnello Fernandes, assistant vice president, fund administration, Gulf Custody Company. The firm, which has offices in Bahrain and Kuwait, has seen funds in the region becoming more sophisticated and increasingly take on an international aspect. In response, Gulf Custody Company has built strategic alliances with international partners like Bank of New York Mellon and Standard Bank, which act as its sub-custodians in overseas jurisdictions like the Cayman Islands.
This has enabled Gulf Custody Company to operate with the best practices used by these firms, something that is often demanded by its clients. "We are currently doing a very complex fund with National Bank of Kuwait (NBK), the NBK Private Equity Fund, in alliance with Standard Bank," says Fernandes. "That fund requires the EVCA (European Venture Capital Association) standard."
Gulf Custody Company does not invest on its own behalf, and Fernandes says it may be difficult for other firms that concurrently carry out proprietary investments to convince their clients that there is no conflict of interest.
As part of this drive towards best practices, asset managers may use a standalone administrator. Apex Fund Services is one of the few firms in the region to specialise purely in independent fund administration. It has an office in Dubai International Financial Centre (DIFC) and will shortly be opening in Bahrain.
"Fund managers are looking to attract a greater level of capital, they are looking to demonstrate that they are observing best practice, and having an independent administrator goes a long way towards doing this," says Craig Roberts, CEO, Apex Fund Services (Dubai).
"The fund managers here are looking to attract assets from outside the region. For that, they have got to step up and have higher levels of transparency, higher levels of corporate governance. There is a misconception that everything is a dodgy deal here.
Roberts says that a specialised fund administrator can also help asset managers to tailor their funds to particular jurisdictions or investor bases.
"We understand what makes a fund more attractive or less attractive to a particular kind of investor," he says.
"There's no point doing a daily fund for a private equity client, for example. Those things are obvious, but we still get asked the question.
He says that one of the firm's clients in Dubai has been able to increase its asset base by more than 50% during 2007 as a result of working with Apex to develop a more attractive fund structure.
As well as new structures, increasingly speed is of the essence when it comes to transaction processing and reporting. Hashem Montasser, regional head of asset management, EFG-Hermes, says that the increased trading volumes on Middle East equity markets poses a challenge for fund custodians and administrators. "Custodians are required to facilitate faster transaction processing and increase capacity of credit lines with local exchanges so as not to limit trading to investors due to the maximum daily settlement cap/limit being exceeded," he says.
Montasser emphasises the need for efficient trade settlement and timely reporting, which increasingly is being driven through electronic channels.
They have to provide global standard services at reasonable prices.
He adds: "With the increased volumes of subscriptions and redemptions, it is becoming increasingly important for fund administrators to deliver information to investors and fund managers in a more efficient and timely manner through the use of web-based reporting platforms.
Apex offers an online reporting service, ApexFundsNet, which Roberts says has been well received in the region.
"A fund manager can effectively use this as his operations data: he can drill into his general data, his trading positions, his trading history and he can see what's gone on there, or he can make the tool available to investors and they can look at whatever level of transparency a fund manager wishes to offer - top 10 positions, complete portfolio," he says. "He can tailor it completely to the particular investor.
The service can handle many investor queries about particular funds, allowing staff to focus on other tasks.
Gulf Custody Company has also made a large investment in automating its systems. In the first quarter of 2008, fund managers should be able to access their fund information online, and much of the paperwork involved in subscription and redemption should be eliminated. The company is in the process of developing a software that will enable investors to subscribe, redeem, and pay and receive money electronically.
Increased use of technology could contribute to bringing down fees for administration and custody, both of which have historically been higher in this region than in more mature markets.
"We have found that, by and large, fees being charged by custodians and administrators are definitely on the rich side," says Imran Ahmed, managing director, head of asset management, Mashreq.
"If you compare them to fees that are being charged in other jurisdictions overseas, you'll find that they are charging, at times, double or even more. Of course, their response is that fund sizes here are much smaller.
"I would suggest that if you look at funds overseas, whether they are in the UK, Jersey, Singapore or Hong Kong, you will find that funds that have sizes of US$30-50m are being charged much less than what administrators and custodians are charging here."
Ahmed believes that the situation will improve with increased competition, but at the same time concedes that new fund service providers may not want to enter the region until the asset management market is larger.
"The administrators and custodians have to realise that in order for the industry to develop, they have to provide global standard services at reasonable prices," he says. "We've been in the business for three years dealing with custodians and administrators, probably longer than most, and we have had to work very hard with our service providers to make sure we get the type of service that we expect.
"This has taken time, it has taken resources, and in the process what has happened is that investors should have been getting a certain level of service a year ago but it has taken us longer to get there.
He believes that this may even have slowed down product development.
"Today, we mainly find broad country funds or GCC level funds," says Ahmed. "We don't really find industry funds, we don't find style funds. We do think that the underlying equity markets have developed to the stage where these kinds of funds are possible, but in order for these types of funds to be pursued, there has to be a certain economic viability."
Ahmed says that the different regulatory requirements can increase costs and complicate operations for a multi-country fund, something that Mashreq has experienced with its GCC funds.
"We've got six different markets and at this point in time, from an administrator and custodian's perspective, you have to deal with six different brokers, six different settlement cycles and bank accounts, etc. so this can become operationally intensive," he says. "We need to move towards a system for the industry where the concept of one-stop shops are efficient and reasonable in cost.
"These are issues which we as fund managers look to our custodians and administrators to address.
There is disagreement within the industry on whether or not fund managers should allow a single firm to handle both administration and custody of a fund, but in the Middle East this can sometimes give a more coordinated service.
"Based on the experience we have had, if we were to give the custody business to one player and the administration business to another player, it would be operationally pretty messy," says Ahmed.
"Our experience with players in the region has been that if things are not centralised the process flow will lead to delays and possibly, therefore, issues with brokerage settlements, trade flows, and cash flows, which could impede the ability of the manager to buy and sell as they like. So I would say that in the environment we find ourselves in, only a brave fund manager would give the administration business to one entity and the custody business to another entity because the administrator and the custodian will then need to coordinate all of the process flows. If you're bringing another person into the picture you could find that trade deals and the ability to settle your brokerage relationships could be affected.
From the custodian's point of view, many processes are more straightforward if they are all carried out under one roof.
"One of the major advantages is when there is a subscription or redemption," says Fernandes of Gulf Custody Company. He points out that giving one company the responsibility to act as custodian, administrator, transfer agent and share registrar can streamline the entire process when investors enter or exit the fund.
However, Middle East fund managers may not be able to obtain precisely the service they require, due to the low number of specialist fund services firms in the region. There is a shortage of high quality fund custodians with regional coverage, a situation that some custodians are exploiting by insisting that custody clients also take administration services, according to Apex's Roberts. "Some custodians are acting in a way that is not positive for the region," he says. "They are trying to take choice away from the client.
"It's not working for anyone. For the custodian's business to grow, they've got to be able to ensure that clients have the power to choose an effective solution for their products. If they're going to get a sub-premium level of either administration or custody service they are not going to want to do business.
It seems that both fund managers and service providers see the need for higher standards and greater efficiency in the Middle East market.
If the region's asset management industry, including the smaller players, can make a commitment to best practices and use independent service providers for custody and administration, it could help drive costs down, with the result that more sophisticated funds become viable.
With such a huge capital base in the Middle East, product innovation, supported by more efficient operational processes, could see the regional asset management industry finally get the investor base it deserves.For all the latest banking and finance news from the UAE and Gulf countries, follow us on Twitter and Linkedin, like us on Facebook and subscribe to our YouTube page, which is updated daily.