Developing a new business model for TAS

The fund industry is growing fast. During the period from January 2005 to September 2006, international fund centres like Luxembourg and Dublin have shown a percentage increase of total net assets of 57 and 58 per cent respectively, compared to 27 per cent for Europe. Statistics show that the majority of this growth comes from net inflows. In Luxembourg, for example, 65 per cent of assets have come from cash inflow, as opposed to market appreciation. But with the consolidation at distributor level, and the growing number of funds of funds and multi-managers, assets are rising faster than accounts. As a consequence, the average transaction size is increasing and so is the risk of processing large transactions manually, observes Paul O’Neil, head of European shareholder services at State Street.

The current transfer agency (TA) business model, which relies on transaction based fees, is therefore being put under huge pressure. Mr O’Neil questions whether in the TA space service demands and associated risk are commensurate to the level of compensation.

Rising risk

“My average trade is a quarter of a million dollars and rising, my risk is rising but my per-trade amount is not,” says Mr O’Neil. “If I make a mistake on one trade, it is going to take me more and more trades to recover that.” While fund promoters are “opening up” to discussing this issue, Mr O’Neil proposes that “it would be time for a transfer agent to come to some level of asset-based compensation.”

Asset-based compensation model or not, what is sure is that transfer agencies have to change their business model in order to stay in the business, echoes Bill Scrimgeour, head of regional strategy and business development, Asia-Pacific, at HSBC institutional fund services.

“Transfer agents have traditionally relied on inefficiencies in the market to earn fees. Up until now their job has been passing paper from desk to desk or from office to office,” states Mr Scrimgeour. “As electronic means replace this value, TAs need to examine their business models to remain relevant.”

One such potential model is the information arbitrage model, sometimes called the information intermediator. “The TA takes electronic feeds from multiple sources, enhances the data and makes it available to the investor base, adding value by providing service and transparency to the investor or hands-off the enhanced data to multiple interfaces.” Mr Scrimgeour says that this typically happens as service providers move from the physical to the virtual value chain and involves moving up the chain. “Importantly, in the information arbitrage model, the buck stops with the TA in the value chain.”

While there have been various mergers and acquisitions in the industry recently, indicating that the market is maturing, a greater level of consolidation is therefore forecast. This will lead to the emergence of few large globalised TAs and to some regional or boutique transfer agents who will provide a different, although not identified yet, level of services, says Mr Scrimgeour.

On average, across the industry, staff represents 60 per cent of the total costs of a TA business, technology accounts for 40 per cent, he explains, but it should be the other way round. The level of spend on technology needs to increase exponentially to face the complexity in dealing with multiple different distributor channels, reporting standards and types of funds increase, and to be able to cater for all the different requirements of a mass market product. At the moment, however, to the growth of the number of investors that TAs look after, it corresponds almost a linear growth in the number of staff hired. As TA staff and skills are in very short supply, TAs’ costs are bound to go up.

But the ability to spend on a new generation of technology is limited by the amount of capacity in terms of finances and skilled staff. “I would suggest that over time, this situation is going to drive consolidation in the transfer agency industry,” predicts Mr Scrimgeour.

A question of scale

In fact, transfer agency is a volume driven business and scale is needed to be able to compete in tomorrow’s world. Scale, which according to Mr Scrimgeour is a minimum of one million transactions processed per annum, leads to a reduction of unit costs and to higher profitability. “You need to be going down the cost curve now, to be able to meet any future demand from clients to reduce the margins and to be able to compete effectively in the future.”

Standardisation and straight-through processing are key, “because you can push your volumes through your business model at fixed cost, which allow to take the transaction prices down, so that you can theoretically charge your clients less.”

So, it seems, it is in everybody’s interest to collaborate on straight trough processing, as it is the end investor who ultimately gains.

What is stopping the industry players to collaborate on taking that forward? “I think people are generally receptive to trying to find a formula. The key issue is where is the cost and who is going to pay for that cost,” says Mr Scrimgeour. “ I don’t think that has been satisfactorily resolved right now.”

Bill Scrimgeour, HSBC