Pricing is not simply a game of winners and losers in the financial services sector and regulators are increasingly calling for a more responsible, long-term approach. Pricing should be based on real costs and no longer be supplemented by hidden profits. Those that fail to appreciate this, should expect a tough time from both regulators and those that have lost out.
As the name suggests, the fiduciary business is built on trust and nowhere does trust matter more than in the management of money. All money belongs to someone, somewhere, and therefore each person that handles money in a fiduciary context must charge no more and no less than is required to supply the services required together with whatever margin a particular market supports.
Fund administration is a fiduciary business like any other. Just as investors rely on an investment manager to act in their best interests, so a manager relies on a fund administrator. Fund administration has evolved because managers can realise significant savings by outsourcing non-core activities to a specialist that can achieve economies of scale and deploy greater expertise.
Pricing is driven by two main factors: (i) the cost of supply, and (ii) the margin supported by a particular market.
The cost of supply will depend on granular matters such as the cost of labour, overheads, service requirements and scaleability, and management will be involved in a constant struggle to maintain the right balance. A well managed business will be structured properly, have a light footprint, control overheads, have low staff turnover, retain expertise and maintain an excellent track record for service delivery.
Margin is a function of supply and demand and is greater where demand is strong and supply is limited. Supply can be limited by the existence of market barriers such as licensing requirements, regulation and increasing product and operational complexity. Applicable margin for the same services varies across jurisdictions and is constantly fluctuating.
Clients need to keep these basic factors in mind whenever selecting an administrator to partner with. This is because pricing the supply of open-ended service provision is notoriously inaccurate and it will ultimately cost what it costs. This is actually critical if there is to be a good, sustainable working relationship. If costs are too low, then the administrator will struggle to deliver quality service support. If the costs are too high, then the manager's business will be prejudiced.
What often matters, therefore, is less a particular proposal itself and more the ability of an administrator to maintain the supply of services on an efficient basis. A proposal that is obviously inconsistent with market norms or an efficient business model, is likely to mean that the mandate (i) has been mispriced and will be subject to correction, (ii) represents a strategic decision by the supplier (and the loss of margin will have been costed), (iii) will be re-outsourced elsewhere and/or (iv) hidden profits are anticipated (such as retrocessions or the tied supply of other ‘premium services’). While none of these reasons may be a show stopper in any given situation, they are worthy of investigation and any downsides flowing from them should be assessed.
Managers should be particularly concerned by hidden profits in the current environment. They too are in a fiduciary position and should be aware of all costs borne by investors who, in turn, should be made aware of them. The FCA and other regulators are taking an increasingly unforgiving attitude to managers, administrators and/or other service providers in the funds’ sector that are not seen to act in the best interests of investors and hidden profits are an obvious sign of this. Moreover, in addition to regulatory sanction, investors may have direct redress under established rules.
In the future, it will pay in every sense for managers to take a critical and industry-wise approach to the pricing of fund administration services. If something is too good to be true, managers should be wary.
previous comment / Edward Moore
If you would like to discuss outsourcing to the Aztec Group or are considering migrating a fund or SPV, please contact James Duffield, our Head of Business Development on +44 20 3818 0250.
Aztec Group Guernsey
Aztec Financial Services (Guernsey) Limited
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Aztec Group UK - London
Aztec Financial Services (UK) Limited
2 Throgmorton Avenue
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Aztec Group Luxembourg
Aztec Financial Services (Luxembourg) S.A.
7, Rue Lou Hemmer, L-1748, Luxembourg – Findel
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Aztec Financial Services (Netherlands) BV
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Aztec Financial Services (UK) Limited
Forum 3, Solent Business Park
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