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"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'
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