From peak to trough, the past decade was a painful period for private equity. But if the asset class crashed and burned during the 2008 financial crisis, custodian banks have since made it one of their fastest-growing businesses.
Private equity is a juicy opportunity for custodians, which are constantly on the lookout to bring automation to underserved areas and move up the value chain. Although there were $2.52 trillion in private equity assets in the second quarter of 2010, according to London-based alternative investment research firm Preqin, the business is still a cottage industry when it comes to the back office.
Regulatory reform and investor scrutiny are fueling the outsourcing trend. From taxes on carried interest to the Dodd-Frank Wall Street Reform and Consumer Protection Act, new requirements are prompting private equity firms to consider hiring outside firms for processing and advice. And in the wake of the crisis and the Bernard Madoff Ponzi scheme — which flourished because there were no third-party recordkeepers — institutional investors want private equity shops to have better practices and systems. If those firms are getting arm’s-length services from the big banks, then all the better.
With private equity accounting for as much as 20 percent of the global total, alternative assets under administration have swelled. Citco Fund Services’ alternative assets grew from $485 billion to $600 billion in the year ended October 2010, London-based hedge fund publication HFMWeek reports. Bank of New York Mellon Corp.’s alternative administration business jumped to $356 billion from $211 billion during the same period, while Goldman Sachs Group’s grew from $164 billion to $203 billion.
Some banks have made acquisitions to get their business off the ground. Last year, for instance, BNY Mellon bought Wilmington, Delaware–based PNC Financial Services Group’s global investment servicing division. Brian Ruane, CEO of BNY Mellon’s alternative investment services group, says the $2.31 billion takeover made sense because “what we were building they had already done.” The bank puts its assets under administration at $400 billion, making it the second-largest servicer of alternative funds globally. Private equity and infrastructure represents $40 billion of that total.
‘Transparency’ is the buzzword in the new world of private equity administration. Since the financial crisis, hard-hit investors have vowed to better understand how firms are investing their money. Ruane says BNY Mellon recently polled 102 general partners, limited partners and other industry players. The bank is tailoring many of its offerings around their responses. For example, Ruane explains, general partners say they’re getting increasing requests for sharper detail on portfolio companies, more clarity on returns and how a firm achieved them, and stronger reporting capabilities. Unless general partners splurge on technology and hiring experienced practitioners, they can’t deliver those things without contracting with a third party.
State Street Corp., which ranked third in HFMWeek’s survey with $342 billion in assets under administration, has added private equity capabilities as part of three acquisitions, most recently Channel Islands–based Mourant International Finance Administration in early 2010. The Boston-based bank turns the opaque private equity industry on its ear by giving investors previously hard-to-access information. Its back-office system links performance analytics — determining where returns are coming from — with accounting and administration. Clients can view performance and accounting data, such as a fund’s general ledger, then download it for board presentations and other reasons.
George Sullivan, head of State Street’s global alternative investment solutions group, says new regulations are also driving business. As a result of Dodd-Frank, banks may spin out private equity, forcing these stand-alone outfits to create their own infrastructure. As well, private equity firms need advice to stay abreast of new rules. “Regulations such as Dodd-Frank are making GPs aware of the complexity of the business and their inability to keep up,” Sullivan says. “Their burden is our sweet spot.”
