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Administration of Funds Established for Japanese Institutional Investment
Robert Macpherson, Fortis Fund Services (Asia) Limited

June 2003

"You can have any colour you like, so long as it's black!" Those famous words, imparted by Henry Ford almost a century ago, defined a time when products were being mass-produced with little regard to differences in the needs and expectations of individual consumer groups. The world at large was viewed as a much more homogeneous place than it is today.

Just as automobiles are now offered in a myriad of colours, shapes and sizes to meet virtually every taste, so are services increasingly being customised to meet the specific needs of individual users and groups of users. This is as true for fund administration as it is for automobiles. The "landscape" for delivery of fund administration services in Japan is materially different in many respects from that which is demanded elsewhere. Consequently, service providers which are not conversant with these differences are unlikely to meet the expectations of Japanese investors and will be overlooked by fund sponsors targeting the Japanese institutional market.

Japanese expectations

The Japanese demand for quality is self-evident. Translated into the provision of administration services this means accuracy, attention to detail, responsiveness, accessibility and added value. Understanding how many Japanese institutions operate, from hierarchical decision making processes to generally rigid internal reporting mechanisms, makes these attributes all the more important. The key for the administrator is to ensure all information reported is as relevant and detailed as possible so it may be customised to the recipient's own systems and further communicated up the reporting chain according to specific client requirements. In practice, only a handful of administrators have the capability to deliver such tailored reporting and comprehensive value-added servicing.

How does an administrator deliver to such a high standard? Certainly technology plays a role in the process. But it is much more than that. It requires that the administrator has an institutional focus, an infrastructure which supports adherence to strict operational and procedural disciplines and, perhaps most importantly, quality talent. Quality talent means professionally qualified and experienced staff who are proactive, are accessible to the client and can act as a "knowledge resource centre". The administrator must have developed a corporate culture of professional excellence supplemented by ongoing training to ensure its staff are up-to-date with current industry and regulatory developments and are committed to delivering to an uncompromising standard.

Domiciliary considerations

As recently as a few years ago, offshore funds established for public distribution in Japan were required to be domiciled in an OECD country in order to receive the blessing of the Japanese regulators. With enhancements in regulatory oversight having been implemented to address recommendations made by the Financial Action Task Force ("FATF"), several additional jurisdictions are now considered to be acceptable. Most notable of these is the Cayman Islands. In contrast to a number of OECD countries, the Cayman Islands is widely regarded as being a more expedient and less expensive place in which to establish and maintain a fund and also provides sponsors with greater flexibility in their selection of service providers. For instance, the Cayman Islands permit delegation of administrative and custodial functions to other locations. For investment managers and investors based in the Asian time-zone, the benefits of having services conducted during their own business hours means real-time access to administrative resources.

Fund structures

A Japanese institution with significant investible capital may often establish a proprietary investment program tailored to its specific investment requirements. The services of an external investment manager may be engaged to operate the program and, in such cases, a corporate structure may be suitable for its purposes. Where an institution offers its fund to third-party investors, the fund structure will often assume greater complexity. The structure will generally be designed to reflect the specific requirements of the prospective investors to which it is targeted. For instance, it may address different risk appetites by offering share classes denominated in different currencies, with different distribution entitlements or with different principal protection features. The fund may also take the form of a trust rather than a corporation given the different Japanese tax and accounting treatments that each vehicle may accord the investor.

The most suitable fund structure will be determined in consultation with legal counsel, after careful consideration of all relevant legal, tax and regulatory considerations. It is essential that the administrator has the requisite knowledge, systems and infrastructure to support all fund types and structures designed for Japanese institutional investment.

Fund establishment

An experienced administrator can offer a sponsor considerable practical and technical knowledge during a fund's establishment. The administrator should have a thorough understanding of various fund types (such as hedge funds, funds-of-funds and funds which incorporate capital guarantee features) and fund structures (such as corporations, trusts, partnerships, master/feeders, multi-series and multi-class funds) and also why such structures are used.

The administrator should be actively involved as a key member of the working group and assist with putting the fund and its constituent documents together. In addition to the sponsor, the working group will include lead and jurisdictional counsel as well as Japanese counsel. The administrator's role in the establishment phase is critical for ensuring that all administrative and operational considerations have been fully reflected in the documentation and that everything will work as documented in practice.

Recurrent services

Once a fund has been established, the administrator will be involved in every area of its operation apart from making investment decisions or any decisions relating to the investment function. To put the servicing needs of Japanese institutions into context, it is necessary to look at the main ongoing functions which are typically performed by an administrator and its affiliated companies.

  • Investor communications

    The administrator, wearing its registrar's hat, can be viewed as the "face" of the fund to its investors. In addition to processing all subscriptions, redemptions and transfers to the fund, it is responsible for ongoing communications with the fund's investors and delivering information relating to their holdings in a timely and efficient manner. The administrator is also required to deal with complex issues such as performance fee equalisation and answering queries from investors in relation to such matters.

    Upon application to subscribe for investment into a fund, each prospective investor will be required to complete documentation verifying its identity and the source of funds. It will also have to make various representations regarding its status and eligibility to invest in the fund. The administrator will need to have appropriate systems in place to record information on anti-money laundering/know your customer documentation as well as the various investor eligibility criteria. It will also need appropriate systems and investor servicing infrastructure to calculate and report equalisation.

    It is worth noting that no matter how satisfactory a fund's performance, should the interface between the fund and its investors be inadequate, it may be difficult for the sponsor to retain investor participation in its fund. This will be all the more pronounced in the case of Japanese institutions which frequently require greater information regarding their investment as well as access to a fund representative who understands their requirements, can deliver ad-hoc specialised reporting and provide detailed and timely answers to their queries.

  • Net Asset Value calculation and reporting

    The administrator is responsible for maintaining the official books and records and calculating the net assets of the fund and Net Asset Value ("NAV") per share or other entitlement. As part of this process, the administrator reconciles all of the investment positions and cash to the custodian or prime broker statements and prepares portfolio listings and other reporting. It also calculates and disburses payments of fees on behalf of the fund, distributes the NAV per share to relevant interested parties, and arranges payment of periodic distribution entitlements to investors.

    The pricing of the underlying portfolio is an essential part of the valuation process and entails receiving prices from third-party sources which should, wherever possible, be independent of the investment manager. The fund's placing memorandum should clearly outline the pricing policy and specify what steps are to be taken in the event that independent pricing is not available.

    Sophisticated systems should be employed to ensure that client information is processed and reported in the most efficient and reliable manner. The administrator should be able to receive client data and information through a variety of electronic medium including direct interfaces. Similarly, the administrator should be able to deliver reports by various electronic means, including secure web-enabled technology, according to individual client preferences.

  • Risk control

    Recent financial scandals relating to funds have heightened the need for more independent controls. It is essential that an administrator at all times maintain independence in the operation of a fund in relation to the reconciling and recording of securities. The administrator may also monitor the continued consistency of the pricing policy to ensure that all investors are treated equitably in accordance with the offering documents. Further, proper internal control functions will allow the administrator to monitor different functional areas to ensure that procedures are being followed in accordance with the stated policies of the fund.

  • Financial statement preparation

    The administrator oversees preparation of the fund's financial statements in accordance with current accounting and regulatory requirements. Close liaison with the fund's auditors is essential to ensure timely completion and issuance of financial statements to investors. Japanese institutions will generally require the audited figures for inclusion in their own fiscal year-end results.

  • Domiciliary requirements

    The administrator ensures that the fund is in compliance with the requirements of the fund's local regulator. It reviews the fund's regulatory and statutory compliance on a recurring basis to see that all domiciliary requirements are met. In addition, the administrator ensures that meetings of investors and fiduciaries, where applicable, are convened and held as required by local law and maintains the fund's constituent and core contractual documentation, statutory registers and minute books. It may also take minutes at meetings and provide the registered office address if required. Japanese counsel will advise as regards the fund's compliance with any Japanese regulatory requirements.

  • Custody and financing

    The fund will need to appoint a custodian. Where the administrator is part of a bank, the custodial role may be provided by an affiliate of the administrator. The custodian acting on appropriate instructions settles the fund's trades. It also keeps the assets of the fund in its safekeeping, independent of the investment manager, thus providing additional investor protection and comfort. This can be viewed as both a risk management feature as well as an important consideration for prospective investors. In certain circumstances, the custodian may be able to arrange short-term bridge financing for the fund as well as credit facilities to support currency overlay programs where foreign currency hedging is required. The latter feature may be a particularly important consideration for a fund investing in non-Yen denominated assets, which is distributed to Japanese investors.

    Due Diligence

    Whereas attention previously centred almost solely on the investment manager, recent trends have shown that investors are now increasingly focused on all key service providers in completing their due diligence. Prospective investors are very concerned about how the funds in which they may invest are administered. It is therefore worth emphasising again the need for the administrator to carry out its duties objectively and independent of the investment manager. Investors also require increasing levels of transparency. As a result, administrators need to fulfill increasingly extensive reporting and accessibility requirements. It is essential that an administrator can demonstrate that all administrative duties are discharged in a professional and efficient manner and that it employs industry best practices in doing so.

    Enhanced accountability by sponsors has resulted in many institutions opting for a "flight to quality". Consequently, many users of administrative services now demand an experienced administrator with a recognised name and a global presence.

    How does a sponsor compare administrators and ultimately justify its selection? It can obtain feedback from other sponsors about experiences with their own administrators and check third-party credit ratings. It may consider the due diligence checklist released by the Alternative Investment Management Association ("AIMA") on selection of an administrator. It may also refer to third-party surveys for comments and ratings on administrators, paying particular attention to those surveys which are conducted independently and cover administrators physically located in their own time-zone. The Offshore Fund Administration Survey conducted annually by Global Custodian magazine evaluates the quality of services available to users of offshore administrators. GSCS Benchmarks presents an annual award to the best offshore funds service provider.

    Fees

    Japanese institutions generally accept that premium servicing does come at a price and are more inclined to pay for quality than many of their Western counterparts. As with most things, it is recognised that "you get what you pay for". Administration is no different. An administrator which employs high calibre staff, delivers to a consistent and uncompromising standard and makes itself available to resolve the day-to-day issues which inevitably arise with any fund will cost more than one which is selected solely on the basis of the cheapest fees. Incremental differences in cost are generally more than compensated for by permitting the investment manager to remain focused on investing the fund's assets rather than dealing with daily administrative and operational matters. Investors will also be spared the time and frustration of trying to extract reports and information from an administrator unwilling or unable to deliver. Finally, fees incurred by funds established for institutional investment should be simple and transparent. All charges should be clearly disclosed and understood.

    Other factors

    Japanese institutions have shown themselves to be sophisticated industry participants which demand the utmost integrity, ethics and professionalism from all counterparties with whom they conduct business. A quality administrator can deliver peace of mind through its sound hiring practices, depth of professional talent, commitment to training and adherence to industry best practices. Such attributes are likely to be found amongst only the larger providers. It is also important that an administrator have sufficient financial and human resources to cover the substantial investments which are necessary to implement and maintain the latest technology.

    Where an administrator is part of a global banking organisation, it may offer the added advantages of a more diverse service offering (such as custody, banking and credit facilities) which many funds established for Japanese institutional investment require. The "one-stop-shop" concept offered by a reputable organisation, with a sound balance sheet, solid credit ratings and working in close partnership with a fund sponsor may be seen as an attractive proposition.

    It should be appreciated that administration is a time-zone critical service. As such, Japanese institutions will want an administrator which can communicate effectively, is accessable to them during their working day and is fully conversant with their specific servicing requirements, local regulations and business protocol. An administrator based in the European or American time-zone may not understand local cultural sensitivities. For example, even a single Yen may be considered significant to a Japanese investor when reporting an NAV figure or making a redemption payment.

    Japanese institutions and the people who work for them are committed to learning and avoiding the pitfalls experienced by other sponsors and investors alike. Information sharing and educational contributions made available to them by their administrator will be viewed favourably.

    Finally, Japanese institutions are very sensitive about maintaining the utmost confidentiality surrounding their affairs. An administrator is in a privileged position regarding access to confidential information. Accordingly, it should have internal guidelines which demonstrate its commitment to preserving client confidentiality as one of the hallmarks of its business.

    The final word

    Recognising the specific requirements of Japanese institutions and incorporating these into an administrative servicing platform designed to satisfy their expectations is essential to success in this unique marketplace. Now, more than ever before, the client is king.

    Robert Macpherson, Director
    Fortis Fund Services (Asia) Limited

    (April 2003)


    Please note that this article is the property of Fortis Prime Fund Solutions and is an extract from the upcoming 'Eurekahedge Japan Compendium' due for release at the end of June 2003'

  • If you have any comments about or contributions to make to this newsletter, please email advisor@eurekahedge.com

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