As the private equity industry has grown and matured, so have the operational, regulatory and reporting demands on the asset class. This has been particularly challenging for those managers with leaner back-office teams, who have had to focus resources on the core business of finding and backing great businesses and management teams. This model, which has served managers so well for so long, is now pushing against its limits.

On the regulatory front, US managers are bracing for the implementation of new SEC rules that will oblige managers to produce audit and quarterly performance reports and provide more detailed disclosure on fund expenses. In Europe, meanwhile, managers are readying for the rollout of the next version of the AIFMD II in 2026, which will add to compliance disclosure and reporting requirements. In addition to a higher volume of regulatory disclosure, managers are also navigating the complexities of working with an increasingly international and diverse investor base and the accompanying increase in requests for bespoke, tailored investor reporting. For managers with the scale to invest in large back-office infrastructure adapting to higher disclosure and reporting volumes has been manageable. For other managers, however, existing operating models simply cannot ramp in the same way.

Fund administrators: key partners for long-term success
As private equity evolves, regulation increases and investors become more sophisticated, certain fund services providers are emerging as key partners in the midmarket and will have a crucial role to play in the sector’s long-term success. Rather than facing a scenario where €10-15m of capital expenditure has to be ploughed into upgrading the back-office capacity – at the expense of the core front-office functions of deal sourcing and execution – smaller managers can turn to fund administration partners to support their back-office obligations and free-up resources to focus on transactions and value creation.

Fund administrators, working with hundreds of managers across multiple jurisdictions, have the economies of scale and operational synergies to invest in fund accounting and reporting, regulatory expertise and technology platforms at levels that would be impossible for a single manager trying to carry the load in isolation. Outsourcing back-office functions to regulatory and reporting experts, who have the technology and human capital to handle more complex and intense workflows, gives managers the comfort that their obligations to investors and regulators are being addressed by expert service providers that know the market and have the muscle to scale-up capacity to meet intensifying back-office demands.

Enhancing technology capability is an example of how fund administrators are adding value for clients. In addition to opening access to best-of-breed industry software offerings and realistic price points, fund services partners also have the size and resources to build and maintain proprietary technology that can help clients to operate more efficiently. Alter Domus’ Digital Workflows Application, which uses AI and automation technology to handle the increasing volume and complexity of reporting and transaction flow, for example, is available to clients and can help managers to secure significant operational efficiencies.

Opportunities emerge from challenges
Partnering with a fund services provider to boost back-office bandwidth is not only a defensive play for managers. Harnessing a fund administrator’s service capability can help to unlock new sources of liquidity and new investor bases.

With liquidity for example, a slowdown in exit volumes in the face of higher interest rates has seen managers explore continuation fund vehicles as an alternative exit route to secondary buyouts, as well as trade sales and IPOs, to realize distributions for investors. Fund administrators can help managers to undertake continuation fund deals more frequently and in higher volumes. In addition to complex deal execution and organization, continuation fund vehicles also require ongoing administration and reporting.

Fund administrators can scale-up support to assist managers, as continuation fund deals are secured without placing the additional demand of back-offices. The back-office heft of a fund services partner also opens up pathways into non-institutional investor bases. The administrative demands of raising capital from individual investors – typically through private wealth feeder funds, or semi-liquid funds and open-ended structures, such as Europe’s emerging ELTIF regime – can be a non-starter for managers with small back-office teams. These structures require more regular reporting of portfolio NAV and the capacity to provide liquidity for capped redemptions during fixed windows. Client onboarding and compliance volumes also ramp up significantly when capital is raised from large numbers of non-institutional clients rather than the limited groups of institutional investors that are the norm in closed-ended private equity funds.

Managers can turn to fund administrators that are already operating at scale to digest the additional know-your-client, cashflow monitoring and reporting workflows that come with raising capital from
non-institutional channels.

Partners for the long-term
Shifts in what investors and regulators expect from private equity managers, the types of investors
managers are raising capital from, and the exit pathways available in a more sophisticated market, are reshaping how the asset class is thinking about its back-office requirements. This transformation is particularly challenging for smaller players, but through long-term partnerships with fund administration experts, managers can share the administrative load of operating in a more mature industry and stay focused on what they do best.

Mike Janiszewski, Chief Operating Officer, spoke to PEI Fund Services report about the value of outsourcing administrative functions to respond to the increased market demand from individual investors. With about half of global assets under management (AUM) held by individuals, private fund managers are keen to tap into this vast potential. Large asset managers, like Blackstone, have ambitious goals for increasing their retail capital offer. However, accommodating individual investors in alternatives, presents significant complexity- complicated structures, dealing with varying regulations, individual tax burdens and increasing back-office administration.

Mike opined that “Taking on investment from private wealth investors will require a step-change in middle- and back-office infrastructure” Private markets have responded to this already and multiple investment structures are being adopted to accommodate the differing needs of individual investors, as well as new distribution channels and digital platforms. At AD, we have been specializing in this for the past 20 years; delivering for our clients via a combination of jurisdictional, technological and administrative expertise.

Ultimately, leveraging technology for automation and data streamlining must come alongside partnership with third-party providers who can harness new tools for great success. Reach out to to find out more.

Interview

Q To what extent do the SEC’s private fund rules impact the secondaries industry and how have these changes

been received?

Tim Toska: The US Securities and Exchange Commission’s new private fund adviser rules are certainly far reaching and there are significant changes involved. But, as it relates to the secondaries industry, it is the mandatory requirement for a fairness opinion or valuation in every GP-led secondaries deal that is the most directly relevant. There are also new disclosure requirements around material business relationships and activities, which must be formally documented and posted to a portal. In many instances, both are already happening, but the rules mean there is now a regulatory requirement to take these extra steps in what might well be a time sensitive transaction. That can always be a cause for concern. Managers want to be able to proceed with  deals in as frictionless a way as possible. That said, compared to some other aspects of the rules, these provisions are unlikely to keep many awake at night.

Q Could a clearer regulatory framework around GP-led  secondaries be welcomed, particularly when it comes to ensuring LPs are comfortable with these deals?

TT: Absolutely. This is a fast-growing market, and it has been exciting to see GP-led secondaries emerge as a valid avenue for generating liquidity, alongside traditional M&A and IPOs. But there are clearly some inherent conflicts of interest that need to be carefully managed because the last thing anyone wants is for questions to be asked in hindsight, should a deal not turn out as planned. These are not arms length transactions and so they lend themselves to being second guessed. Increasing the regulatory framework helps eliminate any of that doubt and so from the perspective of the ongoing growth and maturity of the sector, I think it is largely to be welcomed.

Emily Ergang Pappas: It also goes long way towards ensuring all investors are in the same situation. Yes, there were many funds that were already including fairness opinions in their deals and going the extra mile in terms of transparency, but now investors in every fund will be afforded that same level of protection from potential conflicts of interest. The codification of best practice means all investors are now in the same boat.

Q What modifications have we seen since the initial rules were proposed and where are we now in terms of when the rules will be enacted?

EEP: We are in a unique position as fund administrators in that these rules don’t technically apply to us, but they will apply to most of our clients and will affect the services we provide. We are therefore keeping a close eye on how things develop. There are a number of lawsuits that are ongoing, and no-one is entirely sure what the timelines are likely to be, but we are certainly paying close attention. I would agree with Tim though that this rule is not as controversial as some of the others. We have been heavily focused on the quarterly statement rule, for example, because there is a lack of clarity there and because it impacts our role as administrators particularly. There have already been some modifications made between the proposed rules and final rules when it comes to secondaries, with greater flexibility to choose between either a fairness opinion or a valuation. Beyond that we are in a wait and watch holding pattern, considering what the eventual outcomes are going to mean for clients.

Q Given the GP-led market’s growth, is it reasonable to expect it will be subject to greater regulatory scrutiny going forward, beyond these specific rules?

EEP: The short answer is yes, absolutely. Anytime something grows in size and popularity to this extent, particularly when it involves readily identifiable conflicts of interest, it is inevitable that the SEC and other regulators around the world are going to want to put some parameters in place to ensure investors are adequately protected.

Q Against this regulatory backdrop, how are you seeing the GP-led secondaries market evolve?

TT: I would say that the GP-led secondaries market has now reached a stage in its maturation journey where it sits side by side with other strategies. Certainly, in terms of deal volumes, GP-leds have been at or about 50 percent of the overall secondaries market for the past few years. In fact, there has been insufficient capital available to meet demand from GPs, who now view this as a viable exit route and means to generate liquidity in an environment where liquidity has been in short supply.

Q Will that growth trajectory continue unabated as and when M&A markets return?

TT: I believe that it will. There will always be reasons for GPs to pursue this type of deal, regardless of what is happening in the broader macroeconomic environment. It is true that a revival in M&A will lessen the need for GPs to turn to continuation vehicles to generate distributions for investors. However, there will always be sectors, or segments of the market, that are facing structural or economic hardships and where secondaries capital is required.

Furthermore, there will always be situations where the timing just isn’t right for a GP to exit, despite the fact it is running up against the limits of a fund’s life. Due to the intense growth in volume and awareness over the past few years, GPs know these GP-led deals are something they will always have in their back pocket.

Q The GP-led market is widely believed to be one of the most undercapitalized corners of private markets. How do you see the buyside evolving going forward?

TT: The secondaries market, and GP-led secondaries in particular, are undercapitalized relative to the supply of transactions in the market. But I don’t necessarily view that as a negative. In fact, in many ways it can be viewed as a positive, because it ensures buyers are able to originate and diligence opportunities in a disciplined manner rather than feeling any pressure to put money to work. Of course, we don’t want to see that undercapitalization continue forever. But it is no bad thing for supply to outpace demand as the asset class matures. That will help ensure everyone concerned has positive experiences, including LPs that decide to roll and the new investors that come in. The more of these win-win situations that we see come to fruition, ultimately leading to successful realizations over time, the better it is for the asset class in the long term.