Why banks treat alternatives managers as second-class citizens

Posted on the 20th November 2019 by Hamish Anderson in Founders' blog, SME blog, Business, Finance, Founder Insights

Money Mover has now been an AIMA (Alternative Investment Management Association) partner for just over a year. I was chatting to delegates at its recent Spotlight on Raising Assets event in London and it occurred to me that I hadn’t ever explained why this partnership is so important to us and what we think it brings asset managers.

Most Hedge Fund ManCos are SMEs...

As a former prime broker (my last proper job was with HSBC Prime Services in Canary Wharf) I had some exposure not just to the investment transactions executed by the funds themselves, but also to the management companies running the funds. Whilst the funds may have had assets worth hundreds of millions, if not billions, of dollars, the management companies (‘ManCos’) were quite different. They were small businesses employing the personnel responsible for running the funds and the vast majority of them, especially the boutique managers in the alternatives sector, had fewer than 250 employees and a turnover of less than €50m. This puts them squarely in the SME (Small and Medium-sized Enterprises) bucket as defined by the EU.

...which may be specialised and sophisticated...

What separates fund ManCos from SMEs in other sectors is the financial sophistication of the management team. Given the nature of what they do, a hedge fund COO or CFO is likely to be fully conversant with interest rate and currency transactions and related hedging activity, for example. On the other hand, something that is consistent between fund management companies and similarly sized businesses in another sector is the treatment they receive from their banks.  

… but shouldn’t expect preferential treatment

The value of the assets under management (AUM) of the funds they control means that the funds themselves command institutional pricing on the transactions they undertake with their prime brokers and other market counterparties. It surprises new CFOs to find out that the same cannot be said for the transactions carried out by the ManCos. While the West End branches of Barclays or RBS (and yes, most ManCos do bank with the high street names) may sport leather sofas and marble floors, don’t expect to find special accounts tailored to your needs, much less the pricing or functionality enjoyed by your portfolio managers and traders. 

Just as for any other SME, the banks evaluate the ManCos according to their size and revenue opportunity and allocate them a standard online platform and relationship manager. The revenue drivers for business current accounts (BCAs) continue to be lending products such as overdrafts, working capital loans, asset financing and invoice factoring. However ManCos don’t buy capital equipment, their invoices are paid on time, they tend to rent their offices and are generally cash-rich so, the opportunities to lend them money are limited. It's for this reason that they may find themselves being treated like second-class citizens.

Speaking as a prime broker from a retail bank, this was always something that surprised new managers we worked with, especially former investment bankers who had never really had much contact with their colleagues on the corporate side.   

What this means to ManCo COOs and CFOs is that they may be less than enamoured with the online tools allocated to them by their bankers.

The daily grind

Let’s pause to think about a typical fund COO’s regular operational tasks, at least from an FX/cross-border payment perspective (as these are what I see most). A typical task list might look like this:

• Convert monthly management fee income from USD to GBP
• Manage distributions to overseas offices (in CHF, HKD, SGD…)
• Pay batches of non-GBP invoices from service providers (Bloomberg, fund administrators, lawyers...)
• Settle cross-border accounts payable (regulatory fees, conferences, travel...)
• Make payroll for non-local consultants and employees
• Remove accounting uncertainty by hedging key cash flows over year end

Our experience with the BCA platforms offered by most high street institutions is that they are generally tweaked versions of the banks’ personal bank account (PBA) platforms. This may be a quick and easy solution for the banks but is suboptimal for SME users since PBA-derived user interfaces, functionality and pricing/fee models are generally not flexible enough. The ring fencing stipulated by the Financial Services (Banking Reform) Act of 2013 has further served to draw a stark delineation between the services, technologies and commercial terms offered to PBA and BCA (retail) customers and those offered to commercial (wholesale) customers. 

What do we bring to the party?

Back in 2014, I turned my back on the loving embrace of my former employer and set sail in the uncharted and often stormy waters of entrepreneurship. The question that the Money Mover founders asked ourselves was simple. How could we use technology to bring SMEs the kind of transparency, functionality and pricing which had formerly been offered only to commercial and institutional clients? For us, transparency means not just full clarity on pricing (e.g. mid-market rates, effective rates and all fees) but also what’s going on with a particular transaction (i.e. has my conversion settled? When will my supplier receive its payment? Where is this particular transaction in its lifecycle?). Our ambition was always to provide the sort of tracking that you’d get from the best courier companies (your package has left the warehouse; it’s been loaded at Dover; it’s in London; it’s approaching your building…). We’ve achieved full transparency on the pricing side, much to the surprise and discomfort of our banking partners who would rather avoid grown-up conversations with their customers about pricing! In terms of updates, we’re making progress and inform users at all key stages, but are keen to bring additional speed and visibility over things like beneficiary credit confirmation. These benefits are now available via Swift GPI and we expect to release them to our users within weeks.

Functionality presented a different challenge. Expediency rather than customer experience tends to drive the development of bank systems. Encumbered by legacy systems and high engineering costs, the goal set by banks is to deliver something that functions. With the luxury of a clean sheet, we decided to turn things around, look at things from a user's perspective and build something that would focus on the specific requirements they told us about with an absence of jargon. We started by asking an enthusiastic and tolerant group of beta customers about the things they needed to do and then set about turning them into usable tools and features. Some of the things sound trivial but are difficult to give up once you’ve had access to them:

• instant, free access to MT103 wire transfer confirmations for suppliers
• payment history by beneficiary and templates to set up new ones quickly
• simple tools to set up payrolls and runs of invoices
• audited user access controls

Other functionality was more sophisticated but made it possible for our users to accomplish things online and within a single application which would have formerly required multiple systems and a call to the bank's treasury team:

• forward settlement for FX trades to lock in rates for known payments and receivables
• historical charts and exchange rate alerts integrated within the application

Price is still important

Excessive FX spreads and fees have long been used by the FinTech sector as clubs with which to bash the banks. In reality, it’s always been the opacity of the pricing as much as its magnitude which has troubled us. Back in September 2015, we asked Accourt, an independent payments consultancy, to do some research into the cost of international payments for SMEs. Accourt looked at the total transaction costs (i.e. FX margin and payment fees) offered by the major UK banks for a range of transaction sizes across different currency pairs. You can access the full report here, but here’s a snapshot of the results for a specific scenario:

The graph shows the total cost to convert GBP 50,000 into EUR, as a % of the transaction amount. Business current accounts were tested in each case. Research: Accourt & Money Mover, Sep-Oct 2015.

You would think that is is something that would be quick for banks to address if they so wished. They could, but choose not to, as there’s no regulatory requirement to disclose FX margin and it’s a highly profitable business in a world of diminishing returns. While we haven’t commissioned a similar international payments report recently, we still carry out a ‘Payments Review’ for the majority of new users. This consists of analysing some of their historical payments and backing-out the margins by comparing with the prevailing mid-market rates. Looking back at recent reviews suggests that, while the pricing applied to SMEs is more variable now, the average total cost still exceeds 2.2% (it was 2.43% back in September 2015).

Time to challenge the status quo!

So what conclusions can we draw from the above? Just because your bank is the default choice for your financial transactions doesn't make it the best. SMEs of all shapes and sizes are still being lumped together by the banks and a shiny Mayfair office is no guarantee that your alternatives management company is getting access to the best tools and services.

It's usually free to set up an account with the most innovative alternative providers, and you will almost certainly benefit from improved pricing, transparency and functionality. Seek out a specialist provider which understands the alternative asset management industry and compare its offering side-by-side with your bank.