This article is Part 3 of a series of articles relating to the mutual fund industry in Bermuda. These articles are sponsored by The Bank of N.T. Butterfield & Son Ltd., Bermuda's first bank, and will include contributions by various legal, audit, investment and banking professionals in Bermuda. The articles are written to inform the reader of Bermuda's mutual fund industry.
Bank of Butterfield provided administration to one of the first mutual funds in Bermuda in 1969. Since this time, mutual fund administration has become one of Bank of Butterfield's core services. Bank of Butterfield, whose roots can be traced to 1785, has formally operated as a bank since 1858. As a full service commercial bank, headquartered in Bermuda, the Bank has expanded into Hong Kong, London, Guernsey, and Cayman Islands, to strategically position itself to enhance client services. Through its subsidiaries in each of these jurisdictions, the Bank provides administration to mutual funds, unit trusts and limited partnerships. These services include corporate administration, registration and transfer agency, accounting, valuation, and custody.
Choosing an Offshore Service Provider
When considering the establishment of an offshore fund, other than the jurisdiction, one of the key criteria should be the selection of an administration service provider. The fund administrator is often under-estimated in its importance. Evaluation of the key decisions affecting the administration of an offshore fund is necessary in order to manage a fund sponsor's risk.
There are two key administration functions that are required to be provided to an offshore fund:
Fund Administration (Back Office)
A global custodian should provide:
- placement and settlement of investment transactions
- income collection and the monitoring and reporting of corporate actions
- cash management and reporting of uninvested cash on a current and projected basis
- ability to provide banking services including money market, foreign exchange and credit facilities
- tax reclamation.
I've only touched on the global custodian requirements as this paper will focus on fund administration.
It is becoming increasingly common for sponsors of funds to identify the situs for the fund but seek administration in a difference jurisdiction. The reasoning behind this is threefold:
The jurisdiction may have been chosen solely on its merits as a flexible jurisdiction that provides a less regulated environment for funds being created solely for investors who have little need for formal investor protection.
There may be a perceived shortage of certain administrative skills in the jurisdiction chosen and the sponsor may wish to have the administration delegated to a jurisdiction where there are a number of funds of a particular type and hence a perceived level of expertise to service them.
The sponsor may prefer to have the day to day administration carried out in a time-zone more suitable to them. This is particularly the case to ease communications difficulties between the administrator and the investment manager.
Care has to be taken over the delegation of fund administration functions both when wishing to delegate out of a jurisdiction and when wishing to delegate functions into a jurisdiction.
Jurisdictional Issues - The Environment
In most sponsorships, the sponsor and/or their professional advisors decide on the jurisdiction before considering a service provider. As the previous panel discussed the selection of a jurisdiction, the following jurisdictional considerations assist in the determination of the service provider:
- time zone
- political risk
- regulations and confidentiality
- proximity (shareholders vs manager)
- infrastructure (air accessibility, state of telecommunications, etc.
- service providers
- business climate.
It is important to understand the environment the service provider operates in, this is particularly relevant in certain offshore jurisdictions. The following warrants consideration:
- does the jurisdiction have full employment?
- what is the service provider's attitude for expansion?
- what is the attitude of the local government and regulatory authority towards the finance industry, is support being given?
Communication issues which may be taken for granted can sometimes be a source of problems. As mentioned above, differences also in time zone, language and technology can impair critical communications between the sponsor and the administrator. An offshore administrator with inadequate experience or capacity could result in operational mistakes which could eventually affect the reputation of the investment adviser. Insufficient monitoring procedures and compliance may not detect problems effectively. This may pose potentially serious operational and client service risks.
The choice of jurisdiction is often left to a fund sponsor's legal, audit and tax advisers. I recommend the senior management of sponsors be involved in this process and, in particular, the choice of the administrator.
Duties and Services of an Administrator
Aside from possible custody, an administrator should provide such fund services as:
Fund accounting and net asset valuation calculations
Act as the registrar and transfer agent to handle all aspects of shareholder subscriptions, redemptions, transfer agency, and facilitate corporate actions of a fund (i.e. dividend payouts, etc.)
Corporate secretarial services for maintaining the corporate minutes and records, calling of the annual general meeting, directors meetings, and provision of the fund's registered office
In proceeding with the establishment of an offshore fund, the sponsor needs to know the who, what, when, where, why and hows of choosing an administration service provider.
To assist in this determination, consider my simple approach of the ABC's in selecting an administrator.
The ABC's In Selecting a Service Provider
An offshore administrator will be normally required to carry out accounting and net asset valuation calculations for a fund. A fund sponsor should carefully assess the administrator's depth and capability for accounting. Consider the following:
- Can the administrator perform daily valuations?
- How are the entries carried out, are they manually inputted or do they have an on line feed capability?
- Is their system an off the shelf product that is actively upgraded or is it in-house designed and supported?
- Can the administrator track sales commissions or loads charges if charged at discretion by the manager or its sales force?
- Can the system support multi-currency accounting, limited partnership accounting, or multi class and multi-feeder structures?
- Can they calculate performance fees of the managers and account properly for complex fee structures?
It is important that the administrator have pricing sources to confirm prices and have a review function of the NAV prior to its publishing. Their valuation must also be completed in a timely manner following the dealing day of the preceeding period dealings.
Is the service provider part of a banking group or does the service provider have good banking relationships? This can be important in assisting the fund sponsor obtain offshore credit facilities which may enhance the fund's liquidity. Also, if the bank has an asset management department, perhaps they can assist in the fund's marketing or allocate private client investment to the fund.
Is the service provider able to perform custody or have good relationships with custodians. If the service provider is also a custodian, there is often efficiency in performing fund valuations, audit trails and detecting failed trades. It is important for the administrator/custodian to have good relationships with sub-custodians in global markets for equity and fixed income funds, and co-custodial relationships for futures and options. How active is their custody network in emerging markets, and how quickly can they set up accounts in these markets? Will they be able to reclaim any withholding tax?
Can the service provider carry out distribution of the funds? To what extent is the distribution? Do they provide distribution of a fund's prospectus to prospective investors, and to this extent, is this distribution also a marketing effort? Additionally, can the administrator provide distribution of dividends or income through the fund's corporate actions?
Experience is an important consideration the fund sponsor should assess of the administrator. Ideally, we would like the administrator to have a well educated, knowledgeable, experienced and motivated work force. However, this cannot always be guaranteed. Consider asking the following questions:
- How well educated is the staff?
- What kind of experience do they have?
- Do they have experience in multi-jurisdictions and in different markets?
- Are the employees recruited locally or are they predominantly comprised of expatriate staff?
These factors can make a difference in the quality of service you get.
Fees can be charged in a variety of ways. It is important to understand all the fees and how they are charged:
- Can the administration service charges be based as a percentage of the fund's assets, or are fees charged per service on a time spent basis subject to annual minimums?
- Is the fund administrator capable of lowering their annual minimums for a smaller asset based fund with a stepped up scale to increase fees as the fund grows? In other words, are they willing to take a risk in the early stages of a fund to be later well compensated proportional to the fund's growth?
- Aside from the fees related to the normal administrative services, what other costs are charged by the administrator if out of pocket expenses, such as telephone, fax and couriers, are charged back to the client, are they charged at cost or at a multiple thereof?
- Will the administrator also charge for mailings to shareholders and other setup fees?
Government (+ Local Regulation)
In choosing the jurisdiction for a fund, the sponsor should consider the regulatory environment and over sight in that domicile. In these jurisdictions, do the administrators belong to an administrators association and are the administrators regulated and bound to a minimum standard? If not, to what extent does the administrator have a relationship and a solid rapport with Government. It is important for the local government to take a sincere interest in the fund industry and how it impacts the local economy and that jurisdiction's global reputation. Is the government in a partnership with the local fund industry? The existence of local regulation may also indirectly contribute to increasing the administrator's costs of doing business.
Although not a normal consideration or priority of a fund sponsor in setting up a fund, are statutory and non-statutory holidays in the offshore jurisdiction. It is important to understand what holidays are declared in the offshore domicile and if they coincide with the fund sponsor's statutory holidays. This can be an important consideration for a daily valued fund whereby a local holiday for the administrator may cause delays or problems in the fund's daily valuation. Will they work on their holidays if it doesn't coincide with a fund manager's holiday?
Integrity and Responsibility
Integrity is paramount and is often maintained by ensuring good compliance.
There are a number of issues a good administrator may consider and undertake. Do they produce a procedural document which cites their responsibilities to the fund and the reciprocal responsibilities they require from the fund manager to ensure quality control? Do they also undertake compliance reviews to the fund bye laws and investment objectives to ensure the fund is within their disclosures restrictions and conforming to their investment policy.
There may be benefits to dealing with the service provider that has offices in different jurisdictions. In some circumstances, where a sponsor may be marketing to several countries through a number of service providers, it may be more prudent to first look for a reliable administrative partner that can service your needs from a number of jurisdictions. This approach may allow for consistent administrative standards and efficiencies, a standard review and compliance procedures, standardized shareholder communications and a lower overall fee with greater control from the fund's sponsor's prospective.
The administrator should be knowledgeable of the various markets in which the fund's sponsor may invest. Ask the question, do they have an independent or in-house source for providing research on the markets invested? Such considerations include currency or market restrictions (for example, foreign ownership restrictions in the Korean market place, etc.). To what extent is their knowledge based on? Does the administrator have an in-house training program or any training program for the administrators to increase knowledge and to be kept abreast of changes in developments within the industry and the market place? Does the knowledge base include important and hot issues for fund sponsors, such as requirements to be listed on various exchanges, or master-feeder type fund structures and changes in laws that may impact their responsibility and quality of service.
A multi-linguistic administrator can be an asset to fund sponsors. This can be valuable in dealing with multi-national investors and shareholder communications. How important is it for the manager with multi-national investors to make inquiries to have the telephone answered in other languages or will they need to have correspondence and shareholder communications in those other languages.
A good administrator should have experienced management. How is the management structured, do they have a manager for each administrative service area, for supervision of work performed by the administrators? Just as the service requirements of funds vary widely, the organization of the service provider should be sufficiently flexible to adapt to client needs.
Network of Custody/Sub-Custody
What network of sub-custodians does the administrator have in place across the market? How do they monitor this network and do they have a compliance function for conducting frequent reviews? Will the custodian or the administrator, through appointment of a custodian, have a network extensive to carry out the needs of the funds or will the appointment of a custodian in emerging markets cause costly delays for the fund's launch? Further consideration should be given so the custodian can provide, through its network, other value added services such as security lending and margin capability and tax reclamation.
In a growth environment, is the service provider organized to ensure ongoing quality service to existing clients without disruption caused by the new business assimilation process? It is most important that a team of professionals dedicated to new business integration is identified by the service provider to stabilize long term delivery of service commitments to all clients.
Professionalism is expected by the fund sponsor, but consider what professional designations are held by the administrator's staff. In particular, do the administrator's accountants hold a designation, and what higher degrees are held by the other staff?
Quality and reliability of service is key. Administrators need to focus first on the client to satisfy their needs and meet the responsibilities with precision, accuracy and quality.
This is perhaps one of the most important "all encompassing" factors. Try to make sure that you have the answers to the following:
- Is the organization well known and well respected?
- Who are their clients?
- Who are the top management and how is the management structured?
- Does the administrator have a quality control and compliance review function to ensure high standards?
In many cases, the service provider's reputation may be well known in the industry. Talking to people in advance may save you a lot of embarrassment and risk to your reputation.
This is a very important issue for a fund sponsor to consider when assessing an administrator especially in today's global market.
Consider asking the following questions:
- What systems is the service provider using?
- Are the systems off the shelf products from different vendors or were they designed internally?
- Are the systems compatible to your system? and
- Are the systems compatible with their other offices?
- What type of support does the system have? Do they have in-house technical support group or do they rely on outside third party?
- What, if any, developments or enhancements are they planning?
- What interface links do they have for third parties, prime brokers, and sub-custodians, etc.?
- Can their system be networked with yours?
In today's changing business environment, it is critical that you work with somebody who is technologically up to date and has the ability to adapt to this changing environment. The electronic interface is, in particular, very important for daily or weekly valued funds which will require downloading of brokerage statements and confirmations of trades coming from the administrator to provide a timely NAV calculation.
Section 864 of the US Internal Revenue Code, more commonly known as the Ten Commandments, is an important issue for US fund sponsors. The Ten Commandments should also be understood and of common practice by the offshore service provider. This is very important in that a good administrator will encourage the fund's sponsor to adhere to such policies. Additionally, the offshore service provider should not be relying on an onshore backup service provider to provide any one of the Ten Commandments issues under sub-contract which could put that fund at risk.
Most, if not all, of offshore funds have prohibitions to US investors unless otherwise duly registered in the US for distribution or exemption from registration and maintains this compliance.
Not only should the fund sponsor factor this into its consideration of launching a fund, but also should consider what effort and reporting an offshore administrator will provide about precluding US investors. Will they be proactive in advising if a US investor has subscribed and leave the subscription's discretion to the fund manager?
Variety (- Fund Structures)
The administrator should have experience in setup, knowledge and responsibility to act for a variety of collective investment scheme structures. Namely, the limited liability company as either are open ended or closed ended mutual fund, a unit trust, limited partnerships, and limited duration companies. Further, it may be important to the fund sponsor to structure and market the fund in the UK or Europe, thus experience in administering a UK class scheme or a UCITS will be an asset.
Work ethic is preeminent to ensure a quality of service. This entitles accountability and a discipline to meet the fund client's needs.
Since most successful relationships come down to people, it is worth establishing a rapport with the key personnel of your administrator. A relationship manager is also a good way to service the client where they own the relationship and can remit to each of your inquiries in an expeditious manner. A service provider that takes the time to get to know your business and your operation will help you to get a better level of confidence in their commitment to the business and to you as a valued client.
Zones (Time and Multi-Jurisdictions)
Portfolio management in multiple time zones has increased the importance of timely and accurate reporting. When a problem occurs, a timely remedy is possible, only if there is early recognition.
Most larger administrators offer services in multiple jurisdictions. This can be important, specifically in the case where multiple time zones in the markets traded differ significantly from the domicile of the fund and where the net asset valuation is calculated daily.
Other Issues to Consider
Other issues that fund sponsors may wish to explore are the administrator's agreements and to assess their idemnification, liability and exculpation clauses. Do they employ language of restitution for negligence or gross negligence in performing their duties? What is this policy and ability to correct a mistake made by the administrator that may have a material or negative financial impact to the fund?
Finally, can the administrator carry out duties to comply with strict anti-money laundering legislation(s)?
How Practical is Changing Administrators?
Changing administrators can be an expensive and time-consuming process for a fund or its sponsor. Costs can include reconciling positions between the new and previous service provider, one-time startup costs such as programming, legal fees, and shareholder notification. For many reasons, offshore funds rarely change service providers. However, sponsors should be aware that competition has developed in many jurisdictions.
Error free performance is probably not a realistic expectation. Nevertheless, operating and accounting standards must be established and communicated. If a service provider does not meet those standards or other expectations, the sponsor must compare the long term costs of lower service levels against the short term costs of changing a service provider. Although the process is onerous, successful conversions can be accomplished.
Bermuda Monetary Authority Statistics
Collective Investment Schemes in Bermuda
Bermuda Monetary Authority Statistics Collective Investment Schemes in Bermuda Dec '93 Jun '94 Dec '94 Jun '95 Mutual Funds 248 261 318 341 Umbrella Funds 29 42 35 53 Sub-Funds operating under Umbrellas 127 149 183 181 Total Mutual Funds 375 410 501 522 Unit Trusts 60 53 64 67 Umbrella Trusts 3 3 4 4 Sub-Trusts operating under Umbrellas 7 7 9 9 Total Unit Trusts 67 60 73 76 Partnerships 16 16 16 16 Feeder Trusts 1 1 1 1 Grand Total Collective Investment Schemes 459* 487 591 615 Total Net Asset Value (N.A.V.)in Billion $11.2* $11.6 $13.7 $13.68
*Certain of the 1993 figures have been restated due to subsequent amendments by reporting institutions.
Source: Bermuda Monetary Authority
Bank of Butterfield will continue to publish articles relevant to the current mutual fund industry in Bermuda. An example of future contributions will include:
Companies Act 1981
Regulations and the Code of Conduct
Mutual Fund Administration - keys to selecting an administrator
Bermuda Stock Market - Listing for Funds.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.