As the sophistication of data content, delivery and consumption increases, so does the complexity of the terms governing its use. And while firms go to great efforts to source the right data at the right price, they also need to pay close attention to the fine print of their contracts, says Mauro Viskovic, partner at Kranjac Manuali & Viskovic, an attorney specializing in corporate and securities law.
Hedge funds are increasingly using quantitative analysis to price securities, which involves collecting and analyzing as much market data as possible. These firms enter into license agreements with various data providers that govern the use of the data. But if not carefully reviewed and negotiated, these agreements can have hidden prices and pitfalls.
For example, many funds are surprised to learn that after spending exorbitant sums on a market data license, they do not own the data—neither during nor at the end of the term of the license—but merely have the right to use it while the license agreement is in effect and they pay the subscription fee. A significant consequence of this distinction is that, on termination of the license agreement, the firm must purge the data from its systems and certify this to the data provider—who typically has the right to conduct an on-site inspection of the fund’s systems to confirm this.
But to the extent that the information has been incorporated into the firm’s models, purging this data may be problematic. In addition, they may wish to retain the results derived from calculations that used the data, for example, to identify historical correlations in the market. This makes it important to negotiate an exception to the purging requirement that would permit the retention of derived or resultant data. Firms should also seek an exception that allows them to retain data to the extent required for regulatory compliance.
Similarly, agreements should specifically state the intended use of the data, to explicitly permit the adviser to use the data in its quantitative investment models—otherwise, broad boilerplate restrictions about the use of data may be deemed to actually prohibit the use of the data in such models.
License agreements generally prohibit reproduction of the data, as providers understandably want to prevent unauthorized redistribution of their intellectual property—though advisers can request permission to copy the data onto magnetic or optical media for backup and disaster recovery purposes.
Another critical issue for hedge fund advisers is preserving the confidentiality of their investment models and any other sensitive proprietary information—such as confidential information related to their investment strategies, portfolio holdings and investors—which advisers employ substantial safeguards to protect. Data providers, though, insist on broad audit rights to confirm that the advisers comply with their license agreement—such as to ensure that the adviser is not understating the number of staff using the data to reduce per-user license fees, and is not redistributing the data to third parties. Such audit rights would give data providers access to not only the trade secrets of the adviser but also the data of competing vendors that the adviser is contractually bound to protect. Therefore, it is vital that the agreement contains adequate confidentiality protections and restricts audit rights to inspections that only monitor compliance with the license agreement.
Another issue is the cost of conducting the audit. Funds can ask the data provider to pay for the audit—unless it reveals an underpayment of subscription fees beyond a stated percentage—and conduct it in a manner that minimally disrupts their business and aims to limit the number of on-site audits during the license term.
As with any type of vendor arrangement, advisers need to be focused on the price of the data subscription, which can increase at any time. In that event, an adviser should request the right to terminate the license in the event of any fee increase or a fee increase above a certain percentage.
Another case when advisers should be able to terminate the license agreement is in the event of a third-party infringement claim—even if the vendor makes curative changes to eliminate any infringement, since altering the data may make it less useful to the adviser. For example, when funds license data from an outside source, they run the risk that the data is actually owned by a third party that has not authorized the license, exposing the adviser to a potential infringement claim. For example, often the supplier does not own the data, but merely licenses it from a third-party and sub-licenses it to the hedge fund. If the “master license” between the data provider and the owner expired or is terminated, the data provider would infringe the owner’s rights if it continues supplying the data to the fund, so the adviser should obtain an indemnification provision in the license, whereby the data provider agrees to protect the adviser from any such third-party infringement claims. This should also override any boilerplate limitation of liability provisions in the agreement.
From the data vendor’s point of view, the license agreement typically indemnifies them against any losses arising from an adviser’s use of the data—though advisers should ensure that this excludes any losses attributable to the data provider’s gross negligence or willful misconduct.
With so many factors to consider, market data license agreements can have numerous pitfalls for hedge fund advisers. All agreements are different and must be painstakingly reviewed by a qualified attorney to identify potential stumbling blocks and mitigate risks. But negotiating key provisions in license agreements will help minimize fallout and hopefully eliminate the potential for expensive and time-consuming disputes.
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