This article was sponsored by RBC Investor & Treasury Services and appeared in the May 2019 issue of PERE magazine.

Once a small corner of the fund administration space, depositary services have grown substantially over recent years as they became essential to any alternative asset manager seeking capital from European investors under AIFMD rules. And, as private equity real estate firms become increasingly complex organizations, with more diverse investment strategies and larger pools of different types of investor, depositary services have had to keep up with and, in many instances stay ahead of, the pace of change.

PERE spoke to Priya Nair, managing director and global head of product management for private capital services at RBC Investor & Treasury Services, to find out how the depositary role is changing and how providers can help transform the way private equity real estate firms operate.

PERE: How has the depositary’s role evolved over the past few years?

Priya Nair: One of the biggest changes we have seen was clearly the implementation of AIFMD, which requires managers regulated under the directive to appoint a depositary to provide an oversight and safekeeping function. Yet this has not just driven business toward depositary service providers, it has prompted much more thought and consideration among fund managers and third-party service providers around the extent and type of outsourcing that can be achieved. For example, US managers that have traditionally leveraged Cayman and/or Delaware may not have outsourced much, if any, but may have had to review this operating model given the need for a depositary if they are seeking European capital. That leads to discussions around what services beyond those related to depositary functions might make sense, particularly given the greater need for more sophisticated technologies for reporting and overall running of an efficient firm.

PERE: How are depositaries responding to this shift?

PN: Private markets have really come of age in the past few years. Fund managers now have scale, increasingly broad investment mandates, wider pools of investors, more structures and, overall, far greater complexity in their businesses than before.

For depositaries, that means we need to have a broader understanding of areas such as ownership structures, investor expectations, how structures interact with each other and appropriate reporting needs. We really have to understand individual client strategies.  This is not just about looking to deliver the right products and services to them but, as a depositary, taking on the liabilities – we have to develop appropriate risk-adjusted frameworks to serve our clients and, of course, to understand what we as a business are taking on.

PERE: What is it you are seeing in private real estate in particular?

PN: Private equity real estate increasingly encompasses a diverse set of investment strategies and that has a bearing on what we as the depositary need to understand. As the asset class diversifies across a range of investment types and geographies, so too does the regulatory requirements, which increases the complexity of remaining compliant. The depositary needs to be able to cater to these variances, which can be subtle but still different.

Real estate fund managers are also exploring additional ways of outsourcing their middle as well as back office in order to increase their overall efficiency while combining cost and time savings. Within this industry, the underlying trend is to stay focused on the core business cycle across three key phases: fundraising, investment and divestment. As they come under increasing pressure for more detailed reporting, they are looking for solutions that work across the fund life cycle. So, in addition to the need to meet compliance requirements for institutional investors, managers are turning to us to provide help with areas such as investor servicing and management, cash management and valuation/reporting – the plumbing of these funds.

PERE: What are managers looking for in a depositary in today’s market?

Nair: depositaries  need managers that understand their business

PN: Clearly, managers need a depositary that understands their business – not just the asset class, but one that understands the firm itself and, importantly, the investment strategy. They are also looking for clarity on what a depositary’s risk-adjusted framework approach is. Given that firms are facing a squeeze on margins and fees, managers are looking for a depositary that can provide the most appropriate service at a suitable price.

As a consequence, many are no longer just looking for a provider but more of a partner that  understands their needs and proactively looks to support their business growth by proposing robust value-add solutions.

Pricing naturally reflects the depositary’s risk and liability assessment of a client and so if we have a deep understanding of what a fund’s investment strategy is, we can arrive at smarter pricing while taking account of the funds’ life cycle. We are therefore seeing much greater variation in pricing, which is fine-tuned and bespoke to individual clients.

Managers are also focusing much more on ex-ante investment controls – they want more flexibility from depositaries to allow them to invest without delays. Depositaries need to be mindful of how they can facilitate controls to reflect how quickly a client wants to enter the market.

PERE: How is the debate around full depositary services versus depositary-lite shaping up?

PN: As the interpretation of the rules under AIFMD varies, as too does the comfort depositors are taking on when using these services, often it can be an iterative process with the client. Regulators have taken a different view on this, too. The original interpretation of the rules was that a depositary would offer full-fledged services across different jurisdictions – given that European institutional investors all have similar needs from a depositary – alongside fund administration duties. Yet there are other interpretations which suggest that, as long as you do enough to comply with the regulations, you can have a slimmed-down version of depositary services as a standalone; that is, without fund administration. It is still unclear where we will end up.

There is another school of thought that suggests the depositary role will continue to be needed, but it will evolve to include administration services and there is scope for greater value-add to clients as depositaries can help professionalize reporting and data management. I think what we will see is the emergence of multiple models for the different requirements of clients according to their investor base and investment strategies, whether funds are offering co-investment and so on. The role of the depositary will evolve to reflect the variation in requirements and this will be enabled by technological developments.

PERE: You mention technology – how are private real estate firms deploying this?

“As firms increasingly want to focus on core activities, we see a role for us building long-term partnerships where we have multiple touchpoints with clients.”

Priya Nair

PN: Firms are starting to evolve their platforms to deal with increasing complexity. They are beginning to apply similar operational principles to their own organizations as they apply to their investments.  Fundamentally, they are looking at how to optimize their organizations through outsourcing and gain access to new technologies to benefit from digitization and the automation of manual processes.

In addition, there is a lot more discussion and implementation of technologies such as blockchain in private equity real estate. They are looking at this as a way of disintermediating multiple parties in the process and creating a single source of truth. That is quite an exciting development.

PERE: What future developments do you see for depositary services?

PN: As firms increasingly want to focus on core activities, we see a role for us building long-term partnerships where we have multiple touchpoints with clients. As depositaries, we are already collecting and storing large amounts of data on behalf of our clients – we can be creative here. If we can evolve to be a partner to private funds, offering comfort that we are storing their data appropriately, we can start to offer more analytical services to help with a firm’s core functions. We can be part of their digital journey and the extent of the arrangement could be quite deep – there are already some large private market players partnering with law firms so that they become almost an extension of their own organization, and there may be scope for this for depositary and fund administration service providers too.