Market Dynamics Underscore Demand for Back-Office Data Consolidation and Automation

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1 A Confluence Whitepaper Market Dynamics Underscore Demand for Back-Office Data Consolidation and Automation Transparency and Control Top List of Key Drivers In the wake of uncertainty and evolving market dynamics resulting from the credit crisis, this paper takes a look at the multiple reasons why data consolidation and automation continue to top the list of initiatives for strategic risk control, cost reduction and scalability in the back office. Executive Summary The need for back-office data consolidation and automation has never been greater. In the wake of the global credit crisis and its damaging effect on the economy, transparency and control have taken on renewed emphasis for mutual funds, hedge funds, and other types of managed investments and are driving the creation of enhanced reporting and disclosure standards and best practices. While debates over valuation practices continue, one outcome is clear: more stringent regulation and oversight is on the horizon and that regulation will require even more reporting transparency and stricter process controls, along with enhanced compliance monitoring. The emphasis on transparency and control comes at a time when fund administrators are dealing with a myriad of back-office process and control issues from administering new, often complex instruments to meeting the challenges of global regulatory and accounting compliance. In totality, these issues require levels of flexibility and control which can no longer be met by disparate systems and manual, time-consuming and error-prone data management processes. Now, with budget cuts making a profound impact on staffing, already short-staffed back offices dealing with these challenges will be stretched beyond imaginable capacity. Faced with these challenges data consolidation and automation are no longer wish list items for fund administrators. They have been driven to the top of the strategic priority list. Market Drivers of Back-Office Data Consolidation and Automation A growing list of trends is driving back-office data consolidation and automation across multiple aspects of fund administration including financial statement preparation, expense management and portfolio compliance monitoring. These drivers include the following. Demand for greater transparency Lack of process control Proliferation of new products Global regulatory and accounting compliance CONFLUENCE 2008 Confluence All Rights Reserved Page 1 of 8

2 Demand for Greater Transparency While the industry awaits ongoing regulatory response to the credit crisis, fund companies are already viewing greater transparency as a means to regaining investor confidence. And they anticipate that compliance controls around the generation of marketing, performance and financial reporting materials will be more important than ever including controls to ensure the precision and accuracy in both reporting and disclosure. Complying with the impending demand for greater transparency will necessitate improved and increased financial, accounting and marketing reporting disclosure. Meeting these disclosure demands in a timely and efficient manner will place new burdens on fund administrators and require unprecedented flexibility and control in the back office. More frequent and more timely disclosure are reflective of this type of market environment, which is really unprecedented. At the heart of the issue is the universal need for enhanced data management processes. Disparate systems and error-prone, labor Michael Herbst, senior intensive manual processes can no longer live up to the task. mutual fund analyst Without a solution that supports data consolidation and automates Morningstar labor-intensive manual processes, fund administrators will lack the agility to adapt to the plethora of new regulations and swiftness of change. Plus, with staffing cutbacks a paramount concern and unfortunate reality, automation will provide the necessary scalability to absorb the increased workload associated with added reporting disclosure without adding staff. What the Global Credit Crisis Will Mean to Fund Companies In a September 18, 2008 panel discussion at the NICSA East Coast Regional Meeting, Donna Glass, partner at Deloitte & Touche, itemized recommendations for the financial services industry, placing improved transparency and disclosures and strengthened risk management processes at the top of list as noted below: Improve disclosure transparency and disclosures Strengthen the risk management process Change the role and use of credit agency ratings Reform the mortgage origination process Strengthen liquidity risk management Strengthen supervisory policies for capital and liquidity assessment Source: Ignites.com. Donna Glass, partner at Deloitte & Touche, NICSA East Coast Regional Meeting, 09/18/2008 Even without regulation, increased disclosure is already taking place. According to a recent Ignites article, some fund firms are revealing holdings information sooner than required in an attempt to ease concerns over market turbulence and exposure to companies leveled by the credit crisis. i In fact, some fund companies are releasing holdings information within 15 to 30 days of the end of a quarter, even though the SEC requires them to update holdings information within 60 days of the end of the quarter. More frequent and more timely disclosure are reflective of this type of market environment, which is really unprecedented, said Michael Herbst, senior mutual fund analyst at Morningstar in the article. Page 2 of Confluence All Rights Reserved CONFLUENCE

3 While more timely holdings disclosure has its benefits, it also places a burden on fund administrators to produce quarter-end holdings reports with rapid speed a task that is daunting without an automated holdings reporting solution. Lack of Process Control Administrators of both regulated and unregulated investment products are already feeling added pressure as investors, regulators, compliance officers and fund boards demand greater scrutiny of fund administration practices and expect improved process controls. This holds particularly true among service providers where fierce competition is driving differentiation through process control and operational excellence. Research by a major accounting firm found that over 90 percent of spreadsheets larger than 150 rows contained at least one significant formula mistake. The Value of a Single Platform for Fund Administration 84 percent of executives were concerned about manual processes affecting their ability to control process errors. Until recent years, fund administration consisted of a collection of multiple disparate processes, mostly manual and often redundant. Technology, where present, was adopted on a function-by-function basis with little if any consolidation of data or integration of systems. On any given day an analyst may collect and confirm data to create and deliver a variety of financial, regulatory or marketing reports from a NAV report or a performance report to a portfolio compliance test result or fund fact sheet treating each report independent of another. And, while each report may use the same data, each has been generated independent of the other, with source data being collected and confirmed separately each time. This process proliferation results in multiple redundant and time-consuming work-flow processes as well as increased risk of manual error since the same data is collected, confirmed and reported multiple times. The scary reality is that spreadsheets are still used pervasively in the back office. A June 2008 Confluence proprietary survey of fund administration managers and top executives found that half of the companies interviewed use spreadsheets for more than 25 percent of their fund administration work and 76 percent want to decrease their reliance on spreadsheets. And that s not surprising especially when factoring in the risk of error associated with spreadsheets. Research by a major accounting firm found that over 90 percent of spreadsheets larger than 150 rows contained at least one significant formula mistake. ii The same Confluence survey found that 84 percent of executives were concerned about manual processes affecting their ability to control process errors, such as performance calculations and holdings reports. The survey found that data consolidation is a top priority for fund administrators. In fact, 49 percent of the fund administration leaders surveyed indicated plans to centralize their data and more than half of those planned to do so in the next 12 months. By consolidating multiple back-office processes such as holdings reporting, financial reporting, post-trade compliance and expense management onto one platform supported by a single central database, fund administrators gain unprecedented control over the end-to-end processes associated with the collection, creation, confirmation and delivery of regulatory, financial and marketing reports. CONFLUENCE 2008 Confluence All Rights Reserved Page 3 of 8

4 The key to back-office control lies in streamlining and automating data management processes and report generation from the collection of data, the creation of reports, the confirmation of report data and the delivery of reports to regulators, auditors and investors. By consolidating data into one central database, fund administrators gain greater control over their data, since it is validated once and stored to be leveraged for multiple purposes. And, by leveraging a single technology platform for all regulatory, financial and marketing reporting, administrators eliminate the redundancies of process proliferation and benefit from greater control across all of their reporting functions. Proliferation of New Products In recent years, managed investment products have become more complicated to administer, as new types of instruments such as hedge funds, hedge fund of funds and exchangetraded funds (ETFs) create reporting complexity. In the hedge fund industry, for example, where outsourcing of administration is largely the norm, the complexity of the task has created increased competition among service providers. This competition, coupled with regulations like FAS 157 and FAS 161, which require added disclosure associated with complex securities and valuation methodologies, has created a new wave of demand for automated data management solutions. The use of more complex derivative securities is forcing mutual funds to provide greater in-house reporting transparency through automated technology as well. Desktop spreadsheets and faxed contracts will no longer cut it as their mutual fund clients adopt more complex trading strategies and develop more derivative-dependent products in coming years, says Stephen Bruel, an analyst with TowerGroup and author of a recent research note on the OTC derivatives market and risk control. iii Desktop spreadsheets and faxed contracts will no longer cut it as their mutual fund clients adopt more complex trading strategies and develop more derivative-dependent products in coming years. Stephen Bruel, analyst TowerGroup Global Regulatory and Accounting Compliance Global fund administrators are expected to support the regulatory requirements and accounting standards of multiple countries for multiple currencies. For financial reporting, a single fund analyst may be responsible for preparing financial statements that are compliant with generally accepted accounting principles (GAAP) as defined in the U.S., Ireland and Luxembourg as well as other regulations such as IFRS, MiFID, Sarbanes-Oxley and Basel. It is a task too daunting and complex for spreadsheets and manual processes. Just consider the complexity of the following. By 2011 almost every country around the world could be using IFRS to some extent, including the United States. Global corporate governance - In the U.S., the Sarbanes-Oxley Act set a precedent by placing an increased emphasis on good corporate governance, making it essential that mutual fund administrators demonstrate control and oversight. Today corporate governance is a priority around the world, with dozens of countries having adopted corporate governance codes or laws. Global hedge fund reporting - Hedge fund administrators face a unique subset of regulatory reporting challenges. In addition to increasing calls for more stringent regulation, techniques are still very much determined by country. In Europe, for example, regulation of hedge funds differs considerably between countries in terms of their marketing, their taxation, and even the customers that are able to invest in them. iv Page 4 of Confluence All Rights Reserved CONFLUENCE

5 Global accounting standards - Global regulatory and accounting compliance is not only complex, it is evolving. Take IFRS for example. According to a recent Deloitte & Touche publication, Technology Implications of IFRS Adoption for U.S. Companies, by 2011 almost every country around the world could be using IFRS to some extent, including the United States. While the adoption of IFRS will effect change across multiple corporate processes and practices, technology will be a prime area of impact and infrastructure evolution. The Deloitte publication went on to say that adding manual processes for capturing the data and performing reporting will likely only add complexity to the changes the organization will face. v The task of global regulatory and accounting compliance is simply too complex and daunting for spreadsheets, manual processes and dependence on teams of knowledge workers. As global fund administrators can attest, spreadsheets and labor-intensive tasks and work-flow processes just aren t scalable on a global level. And disparate systems and independent data silos create operational inefficiencies and risk of data integrity error. Fund administration technology that leverages a single data source and automates complex financial and regulatory reporting requirements for multiple countries and across multiple currencies improves risk control, accuracy and timely reporting. Conclusion The wake of the credit crisis will be felt profoundly in the fund administration back office, where the increased workload to meet investor and regulatory demand for improved transparency and disclosure is being intensified by budget cuts and staff reductions. Almost overnight the crisis has brought new meaning to the concept of doing more with less in a world where adequate staffing was already an issue. It is no longer a debate manual processes, spreadsheets and disparate data silos and systems lack the flexibility and control fund administrators need to meet these heightened demands. And they cannot support the proliferation of new product types as well as the complexity of global regulatory and accounting compliance. In the face of these challenges fund administrators need speed, flexibility and control and they need it now. The necessity to consolidate and automate fund administration processes onto a single database and technology platform has never been greater. About the Author Dan Torrens, vice president of product management, leads the Confluence product management team, which is responsible for the definition, commercialization and marketing of all Confluence products and services. Joining Confluence in 2001, Torrens provided a vision of a unified fund administration platform. Under Torrens' leadership and commitment to market-focused product development, Confluence developed the Unity platform, the industry s only unified platform to automate fund administration processes. Torrens has twelve years of product management and fund services experience. Prior to Confluence, Torrens spent four years at BISYS Fund Services (now part of Citi) as manager of financial administration. He was also a fund accountant for Federated Investors. Torrens holds a Bachelor of Science degree in Accounting from West Virginia University. He also held a Series 7 License and is Pragmatic Marketing Certified (PMC) as well as a Product Development and Management Association (PDMA) certified New Product Development Professional (NPDP). CONFLUENCE 2008 Confluence All Rights Reserved Page 5 of 8

6 About Confluence Founded in 1991, Confluence is a global leader in fund administration automation. Confluence helps investment management companies gain unprecedented control by automating the fund administration process including the collection, creation, confirmation and delivery of investment product data while maintaining control of the process. Results are lower costs, reduced risk, decreased reporting turnaround times and the scalability to automate more processes without additional resources. Confluence solutions are used by 40 percent of the leading global investment managers, and more than 60 percent of U.S. mutual funds. The Unity platform from Confluence addresses a wide range of problems from performance measurement to financial reporting for a full array of domestic and international managed investment products, including mutual funds and variable products, as well as hedge funds and other alternative investments. Major fund companies such as T. Rowe Price and Russell Investments, and service providers such as The Bank of New York rely on Confluence. Headquartered in Pittsburgh, PA, Confluence serves the international fund industry with key locations in London and Luxembourg. For more information, visit or e- mail info@confluence.com. Confluence Headquarters 600 River Avenue Pittsburgh, PA Tel: Fax: Confluence United Kingdom 50 Gresham Street London EC2V 7AY UK Tel: +44 (0) Fax: +44 (0) Confluence Luxembourg 12 Rue Leandre Lacroix L-1913 Luxembourg Tel: Fax: Page 6 of Confluence All Rights Reserved CONFLUENCE

7 i Ignites, DWS Discloses Portfolio Holdings Sooner, November 4, 2008 ii The American Institute of Certified Public Accountant s (AICPA) Journal of Accountancy, 2006 iii Alt Strategies Create Need for Systems Upgrades article published on August 6, 2008 by Hannah Glover iv GNews.com Hedge Funds: Industry Trends, Nii Barnor, Datamonitor 30 Oct 2006 v Technology Implications of IFRS Adoption for U.S. Companies, Deloitte Consulting LLP, CONFLUENCE 2008 Confluence All Rights Reserved Page 7 of 8

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