This article was sponsored by RBC Investor & Treasury Services and appeared in the May 2019 issue of Private Debt Investor magazine.
Once a small corner of the fund administration space, depositary services have grown substantially over recent years as they became essential to any alternative asset manager seeking capital from European investors under AIFMD rules. And, as private debt firms have grown significantly to become increasingly complex organisations, with more diverse investment strategies and larger pools of different types of LP, depositary services have had to keep up with and, in many instances, stay ahead of the pace of change.
We spoke to Priya Nair, managing director and global head of product management for private capital services at RBC Investor & Treasury Services, to find out how the depositary role is changing and how providers can help transform the way private debt firms operate.nce a small corner of the fund administration space, depositary services have grown substantially over recent years as they became essential to any alternative asset manager seeking capital from European investors under AIFMD rules. And, as private debt firms have grown significantly to become increasingly complex organisations, with more diverse investment strategies and larger pools of different types of LP, depositary services have had to keep up with and, in many instances, stay ahead of the pace of change.
How has the depositary’s role evolved over the past few years?
One of the biggest changes we’ve seen was clearly the implementation of AIFMD, which required managers regulated under the directive to appoint a depositary to provide an oversight and safekeeping function. Yet this hasn’t just driven business towards depositary service providers; it has prompted much more thought and consideration among fund managers and third-party service providers around the extent and type of outsourcing that can be achieved. For example, US managers that have traditionally leveraged Cayman and/or Delaware may not have outsourced much, if any, but may have had to review this operating model given the need for a depositary if they are seeking European capital. That leads on to discussions around what services beyond those related to depositary functions might make sense, particularly given the greater need for more sophisticated technologies for reporting and the overall running of an efficient firm.
How are depositaries responding to this shift?
Private markets have really come of age in the past few years. Fund managers now have scale, increasingly broad investment mandates, wider pools of investors, more structures and, overall, far greater complexity in their businesses than before.
For depositaries, that means we need to have a broader understanding of areas such as ownership structures, LP expectations, how structures interact with each other and appropriate reporting needs. We really have to understand individual client strategies. This is not just about looking to deliver the right products and services to them but, as a depositary, taking on the liabilities – we have to develop appropriate risk-adjusted frameworks to serve our clients and, of course, to understand what we as a business are taking on.
What are you seeing in private debt in particular?
In private debt, a lot of the complexity in our work comes from the fact that funds’ investment mandates can vary significantly. There’s clearly a lot more activity in the illiquid private debt space as funds fill the void left by the banks, which face regulatory constraints on their lending, yet many also invest in more liquid strategies. We have to ensure we are monitoring these investment types. This requires a high degree of expertise on the part of the depositary because clearly there is a large difference in profile between liquid and illiquid debt strategies.
What are GPs looking for in a depositary in today’s market?
Clearly, they need a depositary that understands their business – not just the asset class, but one that understands the firm itself and, importantly, the investment strategy. They are also looking for clarity on what a depositary’s risk-adjusted framework approach is. Given that firms are facing a squeeze on margins and fees, they are looking for a depositary that can provide the most appropriate service at a suitable price.
As a consequence, many are no longer looking for a provider but more of a partner that understands their needs and proactively looks to support their business growth by proposing robust value-added solutions.
Pricing naturally reflects the depositary’s risk and liability assessment of a client. So if we have a deep understanding of what a fund’s investment strategy is, we can arrive at smarter pricing while taking account of the fund’s life cycle. We are therefore seeing much greater variation in pricing, which is fine-tuned and bespoke to individual clients.
GPs are also focusing much more on ex-ante investment controls – they want more flexibility from depositaries to allow them to invest without delays. Depositaries need to be mindful of how they can facilitate controls to reflect how quickly a client wants to enter the market.
How is the debate around full depositary services versus depositary-lite shaping up?
As the interpretation of the rules under AIFMD varies, as too does the comfort depositors are taking on when using these services, often it can be an iterative process with the client. Regulators have taken a different view on this, too. The original interpretation of the rules was that a depositary would offer full-fledged services across different jurisdictions – given that European institutional investors all have similar needs from a depositary – alongside fund administration duties. Yet there are other interpretations that suggest that, as long as you do enough to comply with the regulations, you can have a slimmed-down version of depositary services as a standalone; that is, without fund administration. It’s still unclear where we will end up.
There is another school of thought that suggests the depositary role will continue to be needed, but it will evolve to include administration services and there is scope for greater value-add to clients as depositaries can help professionalise reporting and data management. I think what we’ll see is the emergence of multiple models for the different requirements of clients according to their investor base and investment strategies – whether funds are offering co-investment, etc. The role of the depositary will evolve to reflect the variation in requirements and this will be enabled by technological developments.
As a relative newcomer to the market – certainly in Europe and Asia – how are private debt funds approaching outsourcing more broadly?
While we are seeing a shift towards the back and middle office being outsourced in areas such as private equity, the story is slightly different with private debt. Some newer managers are opting for platforms that enable them to launch without building out whole teams. Yet for others, the fact that private debt funds are generally smaller means that outsourcing may not yet be cost-effective.
For those that are outsourcing, they are looking for partners with enough knowledge, experience and understanding to help with the plumbing and that can help them create transparency across the liquidity spectrum and deal with the characteristics of where they invest. While in private equity the nature of investments tends to be reasonably similar, in private debt a bilateral SME loan is very different from a large senior leveraged loan that has been syndicated. Debt is a more complex instrument than equity because of where it sits in the capital structure. Private debt managers are having to think about how they provide appropriate reporting to investors that provides transparency across the whole portfolio. It’s currently challenging for them to find that perfect solution.
What future developments do you see for depositary services?
As firms increasingly want to focus on core activities, we see a role for us as building long-term partnerships where we have multiple touchpoints with clients. As depositaries, we are already collecting and storing large amounts of data on behalf of our clients – we can be creative here. If we can evolve to be a partner to private funds, offering comfort that we are storing their data appropriately, we can start to offer more analytical services to help with a firm’s core functions. We can be part of their digital journey and the extent of the arrangement could be quite deep. You already have some large private market players partnering with law firms so that they become almost an extension of their own organisation, and there may be scope for this for depositary and fund administration service providers, too.