PROFILE

INDOS Financial: Gathering Momentum Why AIFs choose an independent depositary

HAMLIN LOVELL

ill Prew, INDOS Financial Limited founder and many issues through their fund oversight. Some have led to NAV CEO, believes that the AIFMD depositary fulfils a restatements, and to administrators compensating funds for utility function of benefit to the whole financial processing errors. community, policing funds from many angles on a daily basis, and alerting administrators, Depositary services are nearly always bundled with managers, fund boards and where appropriate administration or custody (or both) as current market practice regulators to concerns. Prew argues that a encourages this. Some asset managers want a “one-stop shop” Bproperly assiduous AIFMD depositary would have blown the including all three services, and the “inertia factor” meant that whistle on the Weavering fraud. Of course, the whole industry using the incumbent provider was the line of least resistance has raised its game since the credit crisis, but INDOS identify when AIFMD required some AIFs to have a depositary.

(L-R): Bill Prew, CEO, Andrew Watson, Nicola Harte (both Depositary Managers), Jon Masters (Head of Client and Business Development).

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Very few independent depositaries exist, and some and Business Development, Jon Masters. INDOS has do not want to risk jeopardising the more lucrative Start-ups and small funds providers may be reluctant to offer depositary on a connectivity with 16 administrators, and 17 prime administration business. The lack of issues being Testimonials standalone basis. As part of a depositary mandate, brokers and custodians. “File Transfer Protocol reported by affiliated depositaries, suggests some one global custodian demanded custody of assets, (FTP) files enable a smooth transfer, so that we hit are doing little more than rubber stamping the “As banks can Prew said. This was not a viable option as taking the ground running on day one with cash-flow and work of their administrator “siblings”, and are NDOS has some appetite for start-up assets away from prime brokers could have severed NAV information. We do all of the heavy lifting,” failing to pick up and report errors, according to ays Khan “When I was working for and smaller managers and has recently have rigid pricing the fund’s prime broking relationships. says Masters. “It was very easy to switch. INDOS Prew and some INDOS clients. the Canosa macro fund, partnered secured the mandate for Indar Capital, did everything, it was seamless,” says Indar Capital with Brummer and Partners, we structures, INDOS I which has an anchor seed investment INDOS claims to be the UK’s only independent COO, Raza Khan, who switched a previous fund from What are depositary duties? met INDOS from the start, liked the from Tages Capital. INDOS works for some S depositary for alternative investment funds, defined an administrator-affiliated depositary, to INDOS. “What distinguishes us is the thorough pitch, and asked Bill Prew to present to the may be able to offer sub-AIFMD threshold managers (open ended as depositary being its sole function. The same approach we take to our duties covering cash- board of the Fund to get them comfortable funds with gross assets under EUR 100 is true in Ireland, judging by a list of seventeen Onboarding and offboarding flow monitoring, oversight, recordkeeping and with the idea before we decided to switch”. million, or closed end funds with lock ups depositaries from the Monterey Research Ireland INDOS’ due diligence process occasionally results verification, and custody of assets. We understand better value. A $1 of at least five years running below EUR 2017 report: all are affiliated with either banks or in it declining to act for a potential client. One what funds do, perform daily reconciliations, Says fund director Gaze, of Danesmead: billion fund is not 500 million) that are not required to have administrators or both. UCITS funds are required to instance was a fund with unusual related party meeting managers and administrators, and flush “We don’t insist on managers appointing a depositary. “Smaller managers really use a credit institution as depositary, but AIFs have transactions and borrowings, which was later out anything that does not fit. We are carrying out an independent depositary, though we do more choice. sanctioned by the FCA. Another mandate turned a real-time audit function, touching a fund 220 10 times the work appreciate the added value provided by encourage managers to talk to INDOS in down was a Singapore-based manager, which had times a year,” says Masters. Both Prew and Masters INDOS, such as a NAV restatement that a their depositary RFP process, rather than just INDOS was the first non-bank entity to be no independent fund directors at the time (but have been COOs of hedge funds before – and so are or risk of a $100 third party AIFMD platform did not spot,” opting automatically for the administrator- authorised as a full UK AIFMD depositary in has subsequently taken steps to add independent on the same wavelength as other COOs. INDOS has says Prew. However, he realises that INDOS’ affiliated depositary. In our opinion and 2017, having been the first FCA regulated AIFMD directors). In a third case, the prospective client also obtained some quality assurance certifications: million fund.” minimum annual fee (of USD 30,000) may experience, there is less added value from be too high for some small funds, which depositary in January 2014. was deemed to be unreasonably inquisitive about Type II SOC1/ISAE3402, and Cyber Essentials Plus. competitors that are clients of INDOS. In a fourth, “We have invested in systems and process to carry having an administrator-affiliated depositary, — BILL PREW might be paying as little as USD 50,000 a INDOS is gathering momentum, with $26.2 billion there were no issues with the manager – but INDOS out depositary duties in an efficient and cyber- than there is from having an independent year for administration. INDOS is paid by of client assets under oversight as of July 2018. was not confident that a fund administrator had a secure way,” says Prew. depositary”. He adds “There is a definite funds, but an expense cap can in effect mean $22.6 billion relates to 79 hedge funds from 57 sufficient critical mass of relevant clients to warrant value add to investors from having additional that a small manager would have to forego hedge fund clients; and $3.6 billion relates to 36 the costs of forging a relationship, which would Valuation of level 2 and 3 assets can be contentious independent oversight. I have had three some management fees to accommodate private equity or real estate funds from 20 clients, have included overseas site visits; the model is not and has attracted the attention and ire of occasions as a fund director where an issue the depositary cost within the expense ratio of which $1.9 billion is represented by eight listed 100% open architecture. regulators. It is one of multiple areas under the has been picked up by the depositary, all ceiling. UK investment trusts. The growth has been all depositary’s oversight umbrella, which can have been by INDOS, where none to date organic. When one administrator ceased offering INDOS has never lost a client due to its be used to illustrate INDOS’ approach. INDOS have been raised by an administrator- INDOS’ growth is increasingly coming from depositary services in 2016, nine of its ten clients performance. There is some natural turnover of the is not an arbiter of level 3 valuations per se, affiliated depositary”. seasoned funds with track records beyond selected INDOS, in what was an entirely arms- client base as funds or managers close down or lose but rather monitors the quality of the process. five years, and ten figure assets: seven length transaction. seed investors. On one occasion, INDOS exited a INDOS ascertains “that processes are being Says Cantab Capital COO, Fraser McIntyre: manager clients have an underlying NAV client that provided insufficient information. consistently applied in terms of governance, pricing “I was uncomfortable about having the overseen by INDOS over $1 billion. They are INDOS carries out depositary lite (depo-lite) – cash committees, documentation, and in some cases administrator as admin and depo-lite flow monitoring, asset verification and oversight The modus operandi for declining to act is to back-testing marks versus exit prices. For level 2 switching from bundled providers to INDOS’ provider. It felt like they were “marking their but not safekeeping – for EU and non-EU AIFMs recommend that a client or potential client engages assets, we will obtain copies of broker quotes to standalone offering. own homework.” By that I mean they rarely managing non-EU domiciled funds, including another depositary and make introductions where check that administrators are consistently applying queried the manager and any probing felt Cayman, Bermuda, and Channel Islands funds. possible. processes,” says Prew. INDOS has picked up stale light. They would source answers internally”. INDOS also acts for some non-EU managers of non- pricing of level 3 assets. Cantab directors also helped to make the EU real estate and private equity funds, who need Independent oversight a depo-lite to market in Germany and Denmark, One motivation for moving to an independent The three INDOS clients we interviewed highlight decision: “a couple of the Cantab fund Pierre Lagrange, which “gold-plated” article 42 of AIFMD. INDOS depositary is the perception that some affiliated various facets of the INDOS service. directors have other clients who use INDOS Man GLG has a growing list of full depositary mandates, offerings can entail potential conflicts of interest. and they said that they had been impressed including custody, for UK AIFMs investing in Granted, AIFMD contains some provisions around Says Fraser McIntyre: “They are very detailed, with them too,” adds McIntyre. “So we feel the core CSD (Centralised Securities Depositary) “functional and hierarchical separation” of the and we have proper questioning and analysis of we get a more thorough service and for a markets including US, Canada and Europe, and also depositary but these are not focused on separation our processes. Coverage is thorough and well lower fee. This is a win-win for our investors, for UK private equity and real estate AIFs. INDOS from fund administration which forms a large presented. We meet twice a year to assess how the says McIntyre”. plans to obtain a regulatory authorisation for its part of the depositary oversight function. Instead relationship is going. They are very professional in well established Irish office to act for certain Irish EU regulators have adopted different approaches all of our undertakings”. domiciled funds. to regulation of depositaries, which generally have separate management, governance, and Says Raza Khan “The quality of reporting and work Says Nick Gaze: “They totally understand all AIFMD Seamless switching other policies to mitigate potential conflicts. was a huge improvement. They look at things in requirements, have put in place the infrastructure “Such switches can be effected within a month Notwithstanding this, Prew believes that the a more comprehensive, detailed manner, using to deal with all the main administrators and or two and are much more seamless than those revenue disparity between administration and technology effectively. Whereas some other prime brokers and have continued to bring on involving some other service providers, such as depositary is an overriding and inherent source depositaries only carry out reviews for quarterly knowledgeable staff as the business has expanded. Left: Xavier Witkowski, Societe Generale administrators. The FCA requires only a month of of conflicts. Administration pays 8-12 basis points board meetings, INDOS provides more frequent They have a good working relationship with the Project Manager on the Imagine work notification, and our due diligence on-boarding versus 2 or 3 for depositary, so his concern is that reviews. The work is performed to a really high administrators and prime brokers whilst also process takes another month,” says Head of Client depositaries are “pulling punches” because they standard with a more hands on service”. maintaining good independent oversight”.

3 4 (L-R): Áine Courtney, Mark Drennan, Micheal Reddy, Jennifer Rothwell, Bill Prew, Conor Cowman, Sarah Doyle, Helen Gregg, Michael D’Arcy TD, Ireland Minister of State, Sven Salm, Padhraic McLaughlin, Michael Lowney, Eamon Martin, Andrew Turner, Charlotte Ryan. PROFILE July | August 2018

“There is a definite value add to investors from having additional independent oversight. I have had three occasions as a fund director where an issue has been picked up by the depositary, all have been by INDOS, where none to date have been raised by an administrator-affiliated depositary.” — NICK GAZE

Issues identified These errors and omissions have been shared with INDOS has a quantum of professional indemnity (PI) Brexit Unlike UCITS, AIFMD does not require the striking of one or more of administrators, boards and in one insurance (GBP 20 million, which it regularly reviews In July 2016, a few weeks after the Brexit referendum daily NAVs, but does require monitoring of cash- case the regulator, but sometimes not appeared in and increases in line with underlying growth of assets vote, Prew was quick off the mark in contributing New service lines: flows on a daily basis, to identify “significant or administrators’ reports. Some of these errors have under depositary) that is larger than that held by an article to The Hedge Fund Journal on Brexit and MLRO, digital, ESG unusual transactions” which can take many forms. required multiple NAV restatements, and sometimes some administrators, according to Prew. depositaries (The Implications of Brexit on Depositaries, Reviewing the issues identified by INDOS reveals administrators have made a fund whole for processing in Issue 115), mapping out potential impacts on how much detail is involved in their duties. errors. INDOS is not acting as depositary for assets in certain different combinations of EU and non-EU managers; EU INDOS became profitable in 2016 and is exploring emerging and frontier markets, such as Russia, that and non-EU funds; being marketed inside and outside the potential for offering complementary services. INDOS’ monitoring has identified dozens of issues of Proprietary technology have historically been flagged up as posing higher the EU. varying degrees of gravity – in both full depositary Some of the issues have been flagged up by INDOS’ in custody risks. and depo lite mandates. The errors found by INDOS house technology. “We felt that third party software INDOS’ base case is that post-Brexit, the UK will illustrate the complexity of fund accounting, which had room for improvement and so we have spent over Informal consulting and regulatory change continue to access EU markets through equivalence, involves coordinating many moving parts that run two years developing DEPOcheck, in conjunction with On top of its hard core operational drills, INDOS can which will require an AIFMD regime including at different periodicities and subject to their own Centigen, as an integrated workflow management share some market intelligence. “At a time when depositaries. The FCA is clearly committed to the rules. One cog askew can throw the whole NAV out and depositary oversight tool that carries out some prime brokers have cut back on PB consulting, depositary concept and Prew believes regards the MLRO and administrators, but has not accepted of kilter - and apparently does from time to time. automated, daily cash flow monitoring and position we also like to offer some informal consulting and depositary as a cornerstone of good fund governance: In response to new Cayman Islands AML any such mandates, and is not aware of any record keeping, as well as position reconciliation, market colour when meeting clients. We have a good the regulator chose to gold-plate AIFMD by regulating requirements, INDOS is planning to offer cryptocurrency funds that have been structured INDOS has enumerated issues identified, under pricing and investment restriction checks at each NAV view of market practice and can act as a sounding the depo-lite function that is not for example regulated Money Laundering Reporting Officer (MLRO) under the scope of AIFMD and therefore three categories from the articles of AIFMD as date using data from prime brokers, administrators board for benchmarking different administrators and in Ireland. Prew thinks that the FCA was wise to services to certain depositary clients. INDOS required a depositary. This is early stage: Prew follows: and market data sources,” says Prew. prime brokers on metrics such as their reporting and regulate depo-lite and has found clients like the fact has on one occasion alerted a manager to a explains that it is not clear if crypto assets operational processes,” says Prew. that INDOS is regulated. Politically Exposed Person (PEP) not identified would be classified as “financial instruments” • Article 21(7) cash flow monitoring issues included: INDOS has been investing in technology to scale expenses paid from a wrong fund bank account, and build efficiency into its process but will always INDOS also has a long history of paying close Growing Irish office by an administrator, as well as AML screening and therefore be subject to depositary liability duplicate payments, and dormant bank accounts retain a high human touch and understanding of the attention to regulation. During AIFMD’s long and Still, Prew acknowledges that uncertainties remain processes at another administrator which in an EU legal context (some US regulators with residual balances not being closed. funds its services. Homing in on the reviews, “cash delayed gestation, Prew got up to speed on the over Brexit, and is anyway now seeking authorisation were off-market compared to industry best have said they are securities). However, “with • Article 21(8) verification of non-custody assets wires are prioritised as they carry a higher risk of directive and garnered some goodwill by briefing over for depositary functions that are regulated in Ireland. practice. Prew believes that depositaries, who the right firms, network, infrastructure and issues included: unclear naming conventions, misappropriation whereas delivery versus payment 100 COO’s from the London hedge fund community Having hitherto supported INDOS’ depo lite services already have oversight of a fund’s activities and operational models involving tier one providers, duplicate trades causing pricing errors, and does not,” says Prew. Over time, artificial intelligence on it. INDOS are members of AIMA and try to stay from the Ireland office, in Enniscorthy, County Wexford, good knowledge of the manager’s operations we would look at digital asset custody and omitted trades and expired options not picked up enhancements to DEPOcheck will help identify ahead of the curve by keeping abreast of new INDOS believes there is a gap in the Irish market for are in the best position to carry out the oversight and we continue to explore,” he says. by administrator reconciliations. unusual transactions and reduce the need for human regulation. a specialist, independent depositary particularly for MLRO function and is keen to persuade other • Article 21(9) oversight is a broad remit where inputs. private equity and real estate funds. Irrespective of depositaries to offer MLRO services. INDOS is ESG INDOS has found the largest number of issues. Via its affiliate membership of the Depositary Brexit, it makes sense for INDOS to expand the Irish using an independent screening system called Environmental, social and governance Accounting matters have included incorrect fee Pricing edge and Trustee Association (DATA) trade body for UK office in order to provide full depositary services Spear Watch, which Prew believes gives the (ESG) investing is rapidly growing amongst calculations; mispriced securities; incorrectly Prew believes that INDOS should command premium depositaries, INDOS has contributed to ESMA’s for Irish domiciled funds and it plans to apply for a firm an advantage, because it is different to the alternative asset managers, and Prew sees calculated expense caps; omitted or incorrect pricing but the reality is that INDOS may in some consultation on asset segregation, which is specialised depositary license from the Central Bank of systems most commonly used by administrators potential for depositaries to monitor ESG accruals; incorrect processing of corporate actions situations be able to save funds money. “As banks potentially germane to some of INDOS’ full AIFMD Ireland. and includes alias identity checks and screens compliance. He distinguishes between the and dividends; withholding tax issues; erroneous can have rigid pricing structures, INDOS may be able depositary instructions. In fact, it is not relevant to against multiple data sources. Masters argues quantitative and qualitative elements of ESG: balances; wrong allocation of master fund P&L to offer better value. A $1 billion fund is not 10 times most impacted INDOS clients as they have segregated INDOS Irish office co-heads, Micheal Reddy and that typical market pricing of $5,000 to $10,000 “Clearly the quantitative aspects are easier to between share classes; and wrong exchange rates the work or risk of a $100 million fund,” says Prew. accounts, rather than omnibus accounts. Still, INDOS Padhraic McLaughlin, had each spent more than a for an MLRO service is not sufficient to cover implement – for example a fund could have an used for currency share classes. INDOS can offer a lower percentage charge for larger has ascertained that one probably impacted client decade working at big administrators in Dublin, before the work involved in doing thorough MLRO investment restriction to not invest in certain assets whereas some others may charge fixed rates. should be compliant with the rules that should be deciding to seek a new challenge with a smaller Pierre Lagrange, Subscription and redemption related errors have A typical headline pricing figure is two basis points, finalised in 2019. firm. Eight of the sixteen staff in the Irish office are checks, which should in his opinion involve sectors or to ensure it has minimum x % of Man GLG included: share class registers being misaligned though it can be lower for depo lite and higher for full former colleagues of Reddy and McLaughlin, who say minimum six-monthly site visits to fund a portfolio in an MSCI ESG index. This could through time and space; delayed processing of depositary. Other factors that can influence pricing “We were early to issue our GDPR addendum in “knowing them from a previous job is a huge bonus”. administrators. One manager told us they were just be built into our DEPOcheck system like share class transfer requests; and incorrectly applied include complexity, such as the number of prime March 2018, highlighting the approach taken with Fourteen of the sixteen staff live locally, so save time not comfortable with an administrator’s MLRO any other restriction. The qualitative aspects redemption holdbacks. brokers and ISDAs. full data mapping, identifying key service providers, on commuting into Dublin and also avoid high capital officers double-checking its own AML processes, would be based on an on-going review of an providing clients transparency and enhanced contract city housing costs. Over half are women and some of because they would look at it in the same way investment manager’s investment processes INDOS has also spotted breaches of investment Custody risk per se is not in practice that relevant wording. There was no commercial benefit to INDOS whom have returned to work after multi-year spells out philosophically and culturally. Prew also points which implement their ESG policies. We restrictions, re-hypothecation indebtedness for the pricing of INDOS’ full depositary mandates. in taking on these extra contractual obligations,” says of the workplace. There has been no specific drive to out that many banks have faced AML sanctions, would visit managers and review their policies and AIFMD and other leverage restrictions, and Though a UCITS depositary cannot discharge liability Masters, but INDOS was keen to be proactive and pre- hire women, but INDOS has attracted applications from and several bank owned administrators will not and processes to form a view in order to consequently breaches of stock exchange listing to sub-custodians, “for AIFs in the hedge fund emptive in creating an audit trail for data and helping well qualified women. As a firm, INDOS offers flexibility be offering the MLRO services. independently report to the fund board etc. We rules. market, it is customary for a full depositary of an EU its clients comply with the new requirements. to employees where possible. Most of the staff hold the are working with a firm called Prime Advocates fund to discharge liability to sub-custodians (often title of analyst or senior analyst, and some more junior Digital custody who have a lot of experience advising INDOS has, as well, found managers not doing prime brokers) and have a contractual indemnity, Another new 2018 regulation, MiFID II, has no direct ones have been hired fresh from a local university. INDOS has for 18 months or so been considering managers on ESG strategy implementation and Annex IV regulatory reporting as often as required; disclosed to investors. We are also acting for funds impact on INDOS but is tangentially relevant in Turnover has been low; only two staff have left in three Left: Xavier Witkowski, Societe Generale potential depositary and custody models for will leverage this knowledge and experience lacking adequately documented and controlled risk with straightforward assets and requirements, but creating extra cash wires, payments and budgets for years. INDOS plans to expand the Irish office headcount Project Manager on the Imagine work digital assets, in discussions with law firms where appropriate”. management, and inadequately documenting side in some cases lack the scale to be attractive clients INDOS to monitor, where research is being charged to to 30 to fill the new office over the next few years, to letter fee arrangements. to the bank owned depositaries,” says Prew. Still, the fund. handle the ramp-up of new clients. THFJ

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