Why has private equity been so slow to embrace third party fund administration?

Posted by Andrew Borowiec on Jan 22, 2019 11:32:52 AM

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It’s a well known fact that the adoption of third party fund administrators has been substantially slower in private equity than elsewhere. Other sectors have made it the norm, whereas it has still been a comparative rarity here until very recent times. So how significant is the difference between categories of financial institution? How are they changing? And what does that mean for due diligence professionals? We take a look at where this trend sits right now.

Where did the difference originate?

Private equity has long been seen as a more transparent form of investing compared with its brethren in hedge funds for example. Investors know that their fund managers are investing in privately held companies. It is perhaps this straightforward nature of the investment space that led to private equity firms not feeling the need to outsource their fund administration in the same way as happens elsewhere.

How big is the difference?

To give this claim some context, various surveys have listed private equity adoption of 3rd party fund administration from 20-30% (BNY Mellon, Preqin) when comparatively hedge funds have a massive 90% adoption. This has been observed to be on the move in an upward trajectory, with Preqin citing a 15% increase to 45% adoption last year. This leaves the sector far short of the majority adoption found elsewhere but still represents a massive shift.

What’s prompted this change?

Traditionally, private equity firms have self administered. This means no third party books or records are kept outside an annual audit. This presents a big challenge for these firms when they are investigated, which used to be a rarity but has increased significantly in the last few years.

To provide an indicator, the 28% of firms who reported being audited by regulators in 2013 became a far more widespread 47% in 2015. This increased scrutiny is one driver behind private equity firms finally moving towards third party fund administration.

Another key driver has been the preferences of the investors themselves. As more and more investors look favourably on third party fund administration as providing a greater degree of independence and objectivity, there emerges a commercial imperative for adoption as well as a regulatory burden.

Will adoption ever equal the almost total coverage seen in other sectors? Only time will tell. But this is definitely a trend worth watching and a due diligence question worth asking if your institution is looking to invest in the private equity space. The IMDDA is working on this subject, so be on the lookout for it. 

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Tags: Fund Administration, Private Equity

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