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Outsourcing at hedge funds on the march

Date: Friday, January 9, 2009
Author: International Herald Tribune

It used to be that if you wanted a job done properly, you did it yourself. That no longer holds for the administration of hedge funds.

The practice of doing middle- and back-office administrative work in-house, especially prevalent in long-established U.S. funds, was already on the wane.

But Bernard Madoff's alleged fraud, abetted by his self-contained operation, has accelerated the march toward outsourcing.

Exhibit A this week is Millennium Management, the old-school hedge fund firm run by Izzy Englander. All its funds are now going to be administered by GlobeOp Financial Services. That means that tasks like reconciling cash positions and trades, some pricing and asset value calculations, sending clients statements and so on will now be handled outside the firm.

Millennium's move partly reflects a hardening investor mood expressed most decisively - if belatedly - by Union Bancaire Privée, the Swiss bank. Following big losses on investments managed by Madoff, the bank said it would no longer invest in funds that did not outsource administrative functions.

The idea is that an independent administrator, earning only service fees and not reliant on any one fund, has no incentive to let anything slip  by.

Funds that outsource trading and custody-related functions should give investors even more comfort, because that gives administrators different sources of data to cross-reference - although investors should, of course, still do their own  homework.

By contrast, Madoff's investment outfit, albeit not quite a hedge fund, was buried within his market-making firm, so he acted as his own administrator, prime broker and custodian. That appears to have allowed him to fabricate consistent-looking documentation that fooled even those of his investors who did some digging.

Millennium was far from alone in doing its grunt work in-house, and there's no suggestion anything at all was amiss. Moreover, hedge fund managers may get something out of outsourcing administration, too. With investors and regulators demanding more and more transparency, it can be a blessing to hand paper-pushing tasks to someone else with state-of-the-art technology.

Then the managers should have more time to do for themselves what they are supposed to be best at: investing. - Richard Beales


Eastern Europe's big gas drama shows once again that Russia and Ukraine need each other badly. The double monopolies - Russian natural gas and Ukrainian pipelines - make a compromise hard to reach. But they also make it unavoidable. Ironically, the peculiar intensity of the current version of the annual dispute could also be an opportunity to solve it once and for all. A deal is possible.

Russia is right to demand that Ukraine pay something closer to the global market price for gas. The original offer from the state-owned Russian company Gazprom was based on a reference price of $250 per 1,000 cubic meters, or 35,315 cubic feet. That's up from the $180 Ukraine paid last year, but still well below the $400 or more that other European countries have to cough up.

Gazprom's $250 offer looked well below-market a few months ago, but probably not for much longer. The price of contract gas is usually set by the market price of oil, with a few months' delay. Barclays Capital reckons that in the second quarter of the year, the gas bill of Gazprom's Western European customers will decline to about $230.

That gradual phase-out of Ukraine's gas subsidy gives both Moscow and Kiev an opportunity to sign a multi-year contract - the norm in the industry. That would please Russia more than Ukraine. But Russia has offered something in exchange - a $3 billion top-up on the transport tariff it pays for pumping its gas in pipes that run through Ukraine. Kiev should take up the offer.

Western countries have leverage in this dispute. The European Union may be powerless to clear up the country's long-running political mess, but Ukraine borrowed $16.5 billion from the International Monetary Fund two months ago, and could well want more money soon. The EU can and should make aid and cooperation with Ukraine conditional on Kiev making payments on time and shoring up its derelict gas infrastructure.

Russia is richer than Ukraine, but could do with more international goodwill. It should accept an international arbitrage mechanism that would speed up the resolution of future conflicts. And, ideally, help prevent them altogether. - Pierre Briançon