How does an asset manager try to achieve revenue goals and diversify business in a challenging economy, where growth is low? What’s an expedient and effective way to fill product gaps? Developing new offerings and sales organically takes time, hard work, and let’s not forget luck. For a firm that acknowledges these needs, desires to act on them and see results soon, the road often leads to one main strategy.
When an acquisition is on the table, operations due diligence is the centerpiece. The Operations Director typically heads the due diligence team.
Are there deal breakers? How best to derive synergies? Due diligence discovers.
The focus in due diligence is on two major objectives: (1) Validating the soundness, efficiency and potential of an entity under consideration; (2) Determining which operations, systems and resources should survive or be merged to achieve synergies and cost efficiencies.
Defining ‘Operations Due Diligence’
The scope of operations due diligence is, in a word, “comprehensive.” For it reviews the full range of operations of an investment manager’s back and middle office. That includes all things from post trade settlement through financial statement reporting. During this exercise, the due diligence team takes into account the impact the new entity will have on the buyer’s existing operations and ultimately if and how they should come together.
The due diligence process entails evaluating the target’s operating model and answering key questions. The best approach could be to staple oneself to a trade and perform a day-in-the-life walk-through for critical functions to ensure the acquirer has a comprehensive understanding of the operations ─ and risks ─ of the target firm. This inquiry includes:
Operations… Is there a disciplined approach to how trade instructions are captured and executed? Is the accounting function deploying scalable processes and making limited use of manual functions? Is there an unambiguous, documented pricing policy that defines what type of prices are used (bid, ask, mid, etc.), which vendors have priority and at what point an evaluated price is used by a fair valuation committee? The target firm should show proof of oversight procedures that validate the valuation done by external providers. Even with strong controls, a firm may make occasional mistakes; and, for that reason, the target firm should provide a record of operational losses over the last five years and how they were resolved.
Service Provider Oversight… Does the asset manager rely on a service provider to perform fund accounting? Most asset managers do. A review of these key activities should gauge effectiveness and accuracy. For a securities lending program, the due diligence team must understand how providers manage collateral.
Often, deals don’t move forward based on learnings derived from due diligence.
Compliance… Qualifications of the Chief Compliance Officer and staff must go under the microscope as well as relevant manuals and procedures and regulatory history. Focus on high risk areas to consider: current state of books and records, adherence to new regulations, most recent regulatory audits and results as well as capabilities of technology. In essence: is there a well-established “Culture of Compliance”?
Risk Management… A discussion with the target’s Chief Risk Officer, who monitors and manages risks across the firm, is warranted. A review of the metrics for the major categories of investment risk, operational risk and credit risk should be undertaken. Based on this segment of the due diligence, the acquirer must conclude that the controls, procedures and policies in place mitigate major forms of risk.
Technology… The focus here is on the current state and scope of the technology infrastructure, including internal, outsourced and joint platforms. How appropriate are the systems relative to strategies and asset classes? Does the firm have its own technology or rely on external sources? Is it using the most recent software releases? Can the target and acquirer’s systems integrate well or require manual work-around solutions?
Consideration of Operational Synergies
Potential realization of return on investment depends, at least in part, on achieving operational economies of scale. The acquiring firm will forecast the potential savings from consolidation and determine the implementation plan, along with which functions, systems and functions are to be retained, merged or retired.
The due diligence team’s objective is to present a realistic and achievable blueprint of potential operational synergies. In addition to the more obvious shared services functions, such as legal, finance and human resources, some of the more common areas of synergy include accounting platform, trading desks and fund administration.
Crystal ball aside, the prevailing view in the industry is for more mergers and acquisitions in the years to come. In that scenario, we should see the Operations Director and team wear a second hat as the “Chief Acquisitions Officer” on a more frequent basis.