The technology imperative

In the face of increasing regulatory pressures and investor demands, fund managers must ensure that their reporting and communication technology is up to scratch. David Miller of eFront explores the key issues.

The environment in which private equity firms operate is changing rapidly. In common with the financial services sector in general, regulatory demands on alternative investment funds are becoming more stringent and wider reaching. At the same time, firms face greater levels of investor activism and demands for improved reporting and communication structures throughout the private equity value chain. These new levels of transparency are placing pressure on business operations as a whole – record keeping for archive and audit, valuations and the way in which information is held and then disseminated, are all under scrutiny.

For the typical private equity firm managing a multiplicity of functions with a relatively small team, these are formidable challenges that must be met with increased operational efficiency. This will almost certainly require greater leverage of advanced technological solutions. However, implementation of technology should be considered in the broader context of the firm’s activities rather than simply being regarded as a compliance box-ticking exercise.

This feature looks at the changing demands that new regulations and active investors are placing on private equity firms and examines how technology can be employed not only to meet these demands but to produce best practice and operational efficiencies. It also discusses the various technology deployment options available to private equity firms of all sizes and looks at the key considerations for technology selection.


The alternative investment sector is increasingly the subject of scrutiny. Numerous regulatory initiatives and investor demands are putting the industry under immense pressure.


Under this act, advisers with more than $150 million of assets under management must register with the Securities and Exchange Commission (SEC) before the end of the first quarter of 2012. Once registered, these firms face additional disclosure requirements to protect investors and assess systemic risk and will be subject to the SEC’s auditing processes in both of these areas. Registered firms are also required to disclose information ‘deemed necessary’ by the SEC and to submit Form PF. This annual filing requires significant detail and disclosure on investor funds and assets managed, including but not limited to:

• use of leverage, both on- and off-balance sheet;
• counterparty credit risk exposure;
• valuation policies and practices; and
• all side arrangements and side letters (to investors).

Although firms can be assured that the confidentiality of submissions will be protected, the processes for maintaining and producing required information and records will remain a source of concern for many.


The Foreign Account Tax Compliance Act (FATCA) comes into effect in January 2013 and will require US taxpayers with specified foreign financial assets that exceed certain thresholds to report those assets to the IRS. These assets can include any fixed or determinable annual or periodical (FDAP) gains derived both outside and within the US. The Act will require foreign financial institutions (FFIs) to report directly to the IRS information about financial accounts held by US taxpayers or by foreign entities in which US taxpayers hold a substantial ownership interest. This is likely to expose complex investment structures, including layered investment vehicles and shell entities, to greater transparency requirements.


Non-regulatory bodies are also adding to the demands made of private equity firms. In order to align general partner (GP) and limited partner (LP) interests, the Institutional Limited Partners Association (ILPA) is increasing its demands for the adoption of standardized reporting. In 2010, ILPA released the first version of its templates for call and distribution investor notices and added similar templates for the investor quarterly report in 2011. To complete these standardised forms, or even slight modifications of them, GPs and fund administrators must organise and supply a significant amount of information regarding investor positions.


The changes to the regulatory and disclosure landscape, accompanied by increased investor activism, place increasing pressure on private equity firms. The common theme is improved transparency. In line with the financial services sector as a whole, private equity firms are facing an increased need to maintain accurate records of the investment process and demonstrate that communication and activity is conducted in compliance with the regulatory requirements. Responding to this demand for transparency requires the establishment of recognised, understood and repeatable processes.

This is the source of the technological challenge. The current environment where data is casually stored in ad hoc formats, such as emails and spreadsheets, or in multiple point solutions, negatively impacts archiving, reporting, auditing and compliance capabilities, rendering these functions inflexible and inefficient. The following examples illustrate these effects:

• Electronic communication.

Non-permanent forms of communication, including email, instant messaging and phone calls, often hinder efforts to meet the level of archiving and auditing demanded by the new transparency requirements. Using ad hoc communication formats to distribute information to investors can be much more complex to audit than a platform which integrates, secures and centralises the processing and administration of these communications.

• Reporting.

Although reporting systems work well as a standalone solution, they can be more powerful when combined with front office and fund management applications. This allows investors to access greater amounts of information in more usable formats. Integrated solutions can also facilitate adherence to reporting guidelines as the majority or all of the information needed for the reports can be sourced from a single system.

• Archive and audit.

Maintaining a communication archive is, in essence, a mandated liability. However, private equity firms can benefit from integrating email and instant messaging systems, eliminating undesirable manual transfer and consolidation of data. Since individual systems each have their own audit trail, an integrated system with a single audit trail can significantly improve and streamline the audit process.

• Fund management.

The primary goal of a private equity firm is to run the business in a way that ensures delivery of superior returns. Equally important is the ability to communicate the status of a fund’s investments with investors. Compliance considerations are layered on top of these fundamental operational needs. Inflexible technology can hinder firms’ abilities to be compliant. Furthermore, when individual asset classes are managed through individual systems, enhancements needed to meet current and future compliance requirements will need to be repeated. This can double or triple the effort expended to meet new mandates or regulations.

All of this means that the systems which private equity firms and administrators use to optimise and streamline their operations should also provide the means for meeting compliance requirements.

For example, investee portals that are integrated with fund management and accounting solutions and which offer standardised reporting will perform two essential functions: streamlining operations and providing an easier way to audit the data gathering process. It also gives GPs more detailed insight into their activities and enables more detailed analyses at both an individual company and portfolio level without imposing burdens on the entities themselves.

Similarly, web-based investor portals enhance communication with LPs while providing GPs with more control when data is published to investors. Facing growing demands from LPs to receive more information, in more usable formats at a time of their choosing, investor portals optimise data tracking from source to report while providing version monitoring and audit trail automation.


Having established that there is a pressing need for the right technological support within private equity firms, the next question is what form that support should take and how best to deploy it.

The first and most critical question is that of longevity. Although regulators have set targets for the maintenance of company records, external communications and the archiving and auditing of data, the way in which compliance requirements may be applied in day-to-day practice is yet to be finalised. Amendments are being made to regulatory initiatives on what seems like an all-too-frequent basis and firms must therefore ensure that any system deployed offers sufficient future-proofing against further changes from both a compliance and operational perspective.

This in turn raises the question of the merits of best-of-breed solutions, whereby firms take a ‘pick and mix’ approach to solutions and vendors versus a more integrated approach where an end-to-end solution comes from a single vendor. Like all other investment sectors, technology for private investment has been through its own evolutionary process from generic desktop tools through to point solutions for discrete business functions to integrated solutions.

A private equity firm’s regulatory and operational needs span many disciplines from CRM in the front office through to fund management in the middle office and accounting and reporting in the back office. As business functions are becoming more integrated with compliance requirements, firms need the means to manage internal and external communications while meeting the audit demands across all of these functions.

A single solution may not necessarily meet all operational and regulatory needs. Indeed, the industry appears to be at an evolutionary point where it is increasingly rare that a solution would exist in isolation from other interconnected applications.

Furthermore, a technological infrastructure that consists of multiple single solutions will demand constant iterations of fundamental processes including updates for compliance functions. This adds time, cost and effort to operations that, in turn, may limit the ability to adapt to future operational needs. For similar reasons, end-to-end, integrated solutions make it easier to introduce customised features or functions that will deliver a more personalized solution to meet specific business needs, potentially enabling firms to develop and sustain competitive advantages. Such solutions therefore provide a more amenable environment for managing the upgrade process while requiring less headcount.


The next consideration is whether to outsource or deploy a ‘Software as a Service’ (SaaS) solution, a hosted model or an in-house implementation. There are administrative firms that provide outsourced technology solutions for running various aspects of a private equity firm’s business and one of the benefits of using a certified fund administrator is that GPs are able to pass on certain costs directly to LPs. However, a number of other issues must be considered such as the ability to customise the chosen solution, information security and the ability to run models, reports and access and export data when desired.With an in-house technology deployment, the firm retains its ability to make desired customisations rather than waiting for feature and functionality updates to be completed by the provider of the hosted service.

Similarly, firms are not dependent on the provider for obtaining new and refreshed data and are free to adopt and implement their own processes rather than attempting to adapt their workflow to the provider’s operational model.

However, technology choice is often a function of budget. The SaaS licensing model offers reductions to capital expenditure and requires significantly less, if any, in-house project management and development resources. Once implemented, maintenance, upgrading and support remain the responsibility of the service provider.

Another advantage that the SaaS model offers is that the responsibility for keeping up with technological advances, the latest protocols and new standards also falls to the vendor. It is the vendor who takes on responsibility for ensuring that the system remains fully compliant, thus providing an extra set of eyes and ears on potential changes to the regulatory, operational and technology landscape. For firms with limited headcount and whose managers and executives are ‘multi-tasking,’ this extra resource can be a source of significant value.


Regardless of their chosen implementation model, firms will still need to work with one or more technology provider(s). This relationship is as critical to the success of the project as the functionality and capability of the systems chosen. The ideal relationship between vendor and client is a collaborative partnership that sets, and works towards, common goals with the ultimate aim of solving specific business problems. This is an often overlooked but critical factor. The history of failed technology implementations is littered with confrontational relationships based on a divisive ‘us and them’ mentality.

There are also a number of essential best practices that the implementation of technology of this nature demands such as reference checking, understanding a product’s roadmap, proactively managing contract expiration and trial periods. Indeed, implementing a system with limited scope can help ensure that promises on one side and expectations on the other will be met. However, conditions have to be right for a trial to be appropriate or necessary.

Finally, the right service level agreements (SLAs) need to be established to set expectations for, among others, issue resolution. Firms also need to understand and keep maintenance contracts up to date in order to receive periodic updates and fixes to the inevitable unexpected features that appear in sophisticated technology solutions. The length of the contract period should also be considered: lengthy contracts are often beneficial, especially from a price negotiation perspective, but firms should be fully aware of what to expect when contract renewal approaches and plan accordingly.

Again, the size of the private equity firm is a factor. Smaller firms have fewer in-house resources therefore they tend to become more dependent on their chosen supplier. The benefits of a partnership approach here are clear but may be more challenging to secure because of diminished bargaining power. The solution will likely be found in a vendor who takes a partnership approach as standard, regardless of the size and resources of their client.

This does not excuse larger firms from conducting the due diligence required for system and partner selection. With their dedicated resources, these firms have the advantage of being able to monitor technological advancements from both their current suppliers and from other vendors in the market. However, they almost certainly need to leverage the expertise and knowledge of their chosen vendor for customisations to the system. Once again, the partner approach can offer a significant advantage by vetting the private equity firm’s vision to produce a better, more optimised or realistic approach to a future solution.


Technology has become a key requirement for private equity firms and its management a critical function. There is little doubt that selecting the right technology is a solution to the challenges facing the private equity industry and provides the means to optimize operational efficiency. Increasingly, technology is available which addresses the specific and unique needs of both GPs and LPs therefore liberating firms from more generic tools with limited capabilities.

However, firms can only reap the full benefits of technology if they select a solution that is appropriate for their needs and circumstances. The size of the firm, its available capital and in-house IT resources should all be considered.

Equally, firms must consider the agility and flexibility of the technology and of its provider. Financial services as a whole remains a fast-changing environment – new guidelines, directives, standards and expectations will continue to arise. The alternative investment sector is now party to this; there is nowhere to hide. Therefore, private equity firms must have one eye to the future when selecting technology, ensuring their ability to focus on their core business is not compromised in meeting these new demands.