Banks and providers face brave new world

The participants Operations and technology round table, June 2006, Grand Duchy of Luxembourg

• ‘Our relationship with private clients is still linked to technologies like telephone and fax in order to send us the order to go on the market. We try to be more efficient in front of the market but it is more difficult in front of our clients’ - Edouard Bokuetenge, head of network management, Banque Privée Edmond De Rothschild Europe, Luxembourg

• “We have been forced to have a regional approach” - Mohammed Eddequiouaq, senior vice president, securities services business development, Natexis Banques Populaires

• ‘The national authorities are promoting independent advice. How can you be independently advising your clients if you just propose internally made vehicles and push your own products?’ - Jean-Francois Fortemps, chief executive officer Luxembourg, Fortis Investments, Luxembourg

• ‘Private Banks are now demanding more intelligent tools’ - Rajesh Mirjankar, director, Infrasoft Technologies, London

• ‘If the process that is being set up is automating one side of the market only, and leaving the rest with difficulties in terms of processing, the costs will find their way back to the investor’ - Ivan Nicora, director, investment fund product management, Euroclear, Brussels

• “The volumes of orders in external funds were very limited and French retail banks did not see the point of developing open architecture because they were making so much money selling their own funds – why open the box when it is not required? - Frédéric Pérard, head of global fund services product, BNP Paribas Securities Services, Luxembourg

• Panel Moderator: Yuri Bender, editor-in-chief, Professional Wealth Management, London

Yuri Bender: Welcome to the second annual operations and technology round table, organised by Professional Wealth Management and supported by Financial Times Business. The event is once more being held in Europe’s premier cross-border investment funds centre. Our aim today is to determine how an increasingly open architecture affects operations at private banks and fund management groups. We will examine the challenges of third-party fund processing, the need for paperless solutions and the new post-Ucits III environment for fund producers, distributors and service providers. To begin with, how has the pressure on private banks to advise on and sell third-party funds to their clients affected the workload of operations staff? Edouard Bokuetenge: When we started to distribute third-party European mutual funds we saw a direct impact on our operation, due to the fact that a great part of this industry is based on obsolete technology such as fax, telephone and mail. But it was also due to the great number of counterparties we used to deal with. So we have seen a negative effect of this measure on all our front and back office departments. We quickly reached the point were we were dealing with more than 150 transfer agents (TAs). But this kind of situation contradicts the policy of our bank, which is to reduce as much as possible the number of counter-parties. The decision of our executive committee has been to launch a request for proposal in order to see if we could find a global custodian for our European mutual fund. Vestima and FundSettle were quickly short-listed, and at the end of a long process, we chose Euroclear’s FundSettle, because currently, they seem to be more mature in their approach to the project. We were really impressed by the high level of technology they had developed, starting from a blank sheet. Yuri Bender: Many private banks, particularly the smaller ones, seem scared of the new technology required to efficiently sell third-party funds. They are also worried about scrutiny and about having external consultants coming in and looking at their systems, which is a large expense. Their investment has really been in relationship managers rather than technology. Can you reassure them about costs and how painful or painless the installation and consultation process actually is? Rajesh Mirjankar: IT solutions for smaller banks will still be a challenge in terms of costs, particularly for a full state-of-the-art blended model. Having said that, there are some key assurances for banks in terms of how they can adapt solutions. There will be changes in critical aspects. One aspect is customer profiling systems, where the profiling was previously largely on asset type, while now it needs to be based on funds. The challenge for private banks will be to provide enhanced client reporting which currently is limited due to unavailability of stock level information on funds. There will be changes in the customer profiling for risk ratings to accommodate a fund-based model as well, since they are currently based on an asset allocation model. There will also be changes to the back offices systems which now need to support customer ledgers and also bank ledgers to reconcile with fund managers. Compliance will continue to remain a challenge while banks try to adapt open architecture with limited information on funds and at the same time demonstrate how they have been successfully mapping the portfolio allocation in line with the investment goals of customers. Our solution to the market, provides service enablers for customer portals, fund manager and broker interfaces etc; product processors including core back office, portfolio management and net asset based billing; and data processors that provide customer profiling, enhanced client reporting and performance measurements. Our focus is more on business process automation, rather than just transaction automation, thus making it easier for private banks to adapt our solution to meet their needs. Yuri Bender: Securities services providers traditionally work with manufacturers rather than distributors. Are private banks and retail banks increasingly joining the client base, asking providers to help provide back office solutions that link external funds to clients? Frédéric Pérard: Yes, we can see that more and more and it is coming from two angles. First, in the UK, which is a very specific market where the distribution through IFAs [independent financial advisers] has changed due to a recent change in the law. You can now go to open architecture instead of being locked to one fund manager. Therefore, increasingly, banks are looking full support solutions for all the products they can sell and they are moving to the concept of wraps. We are providing capacity to all positions at the client level. In the past, investments made in funds were very much driven at client level with no consistent asset allocation and specific research on funds. That led to an important number of portfolio lines for a private bank and a huge number of relationships with TAs to maintain, hence lack of interest for service providers to support this business with a small level of assets and a huge number of lines. The development of open architecture and segregated portfolio management have reduced the number of funds families distributed by banks, hence a greater focus on the capacity to manage efficiently trailer fees arrangements. Finally, private banks are becoming increasingly important as fund distributors and do represent a new niche of clients for us to support and to replace progressively the pure historical TA business. Yuri Bender: Can the likes of Vestima and FundSettle help the situation progress? Do they make things any easier for you to do your job or are you competing directly? Frédéric Pérard: Today, it depends on how you position Vestima and FundSettle. On one side, they can help. As long as they are platforms in a specific market. For example the one that Euroclear is implementing in France for fund execution can be helpful because we need integration of execution and settlement. On the other side, when they position themselves as execution platforms at the ICSD [international central securities depositary] level, they are definitely competitors, so they do not help. If you come back to an asset allocation and try to optimise the fund allocation, if you link to 20 names in this industry, you are safe. Today, we could even say a platform is not required because linking ourselves with 20 names through messages already works pretty well. From my perspective, I would say that we do not save a great deal as service providers by using Vestima or FundSettle on our side. Yuri Bender: In the not too distant past you have tried to cooperate with other players in the market on industry wide solutions, but you always ended up working on your own internal solutions, which you found preferable. Why has this happened? Frédéric Pérard: In France, we have tried to work with others, including Natexis Banques Populaire, to implement what already exists with the French FundSettle platform today. At the time, it was too soon and people did not see any point in having this kind of platform. The volumes of orders in external funds were very limited and French retail banks did not see the point of developing open architecture because they were making so much money selling their own funds – why open the box when it is not required? We were all in the same situation. Now our clients are coming to the banks saying they want to invest in those funds. You have to do what your clients ask you to do. The development of fund of funds and fund mandates has increased the number of external orders. From there, we have decided to go with the solution that has come from the local CSD. I think the market was all for an integrated, neutral solution. We made comparisons with the solutions used in the US and Germany. There is also an initiative in Luxembourg with Clearstream. Everyone was going around the table and spying on their neighbours. They all want to be involved but, ultimately, since Luxembourg is a transfer agent market and different from France, everybody was saying, ‘Transfer business is my business for the next century and I do not want to get rid of my business.’ Today, people realise transfer business is becoming a no money business. Instead, we are moving to distributor support, where you can keep track of the position in funds for retail and private clients. You basically aggregate the position at the client level and then you execute global orders. The market is changing there and, for me, it is no longer transfer agency. Hence, if you do that, the next challenge for the Luxembourg market – and this is where it is progressing because people have realised the need – is to go for a mix of the models in France and Luxembourg. You have super transfer agents to take care of trailer fees and an integrated execution and settlement capacity. Yuri Bender: Natexis Banques Populaire were very much involved in the original French initiative, and now you have witnessed what Euroclear has done, creating one of Europe’s more efficient fund markets. Is it really that good from a user’s viewpoint? Mohammed Eddequiouaq: We have always been driven by the needs of our customers. To do this, we have tried to see if we could do it alone or build it with some of our colleagues. We have been trying to build this with BNP Paribas in the French market to try to create a straight through processing (STP) platform to solve the problems we are facing as a vendor or as a service provider to our customers. Our customers were financial institutions, such as private and retail banks, including our regional Banque Populaire network. We have always been driven by the need to service those clients, providing them with either tools or solutions. For a long time we have also been a global custodian or global provider for our customers, financial institutions and private banks. We found that we had to build dedicated tools for those customers, including, for example, the FundSettle tool, because we were at a point where we had to reconcile the needs of our customers with our own operational risk management problems. That is why we have always been driven by those needs, including providing our retail regional banks with multi-management tools or with third-party fund distribution platforms. Yuri Bender: Everybody in the industry talks about the need for automation in third-party fund transaction processing. What will it take for the entire market to move to complete STP? Does the initiative have to come from the distributors rather than the processors and the manufacturers? Ivan Nicora: There is a similar need on both sides. Ultimately, if the process that is being set up is automating one side of the market only, and leaving the rest with difficulties in terms of processing, the costs will find their way back to the investor. That is probably one of the key elements that drove the development of FundSettle when it started five years ago. FundSettle is the newest product in Euroclear. Like many others, we started being involved in servicing funds more by accident than anything else, with clients bringing their investment funds to Euroclear when they chose us to service their fixed income and equity assets. As volumes grew, there came a need for automation. Funds still have very specific functionalities. We thought that while there would be harmonisation with other asset classes, for example equities and fixed income, at some point in time we realised that the level of immaturity of the fund industry was such that it would take a long time before such an alignment between asset classes would happen. That is why we decided to build FundSettle, where we leverage the infrastructure that we have as much as possible, while incorporating all of the necessary specificities of the fund industry. Second, there are many counterparties and transfer agencies involved. Many have their own way of dealing. Standardisation in that sense is the goal, but it could probably not be set as a prerequisite before the market could automate transaction processing. The objective that we had when we started the service was that there was a need to rationalise, but it would take time. We thought it would not be easy to force all market participants to convert to standard processes, so in the meantime we could stand in the middle and, by concentrating volumes, get to a point where we could leverage the volume to justify some form of automation. That is exactly what happened over the last few years. As we built volumes on our platform, we created justification in terms of operational workload for us and for our users, who were getting increasingly concentrated volumes of transactions from FundSettle to start automating. Today, when you look at the volumes we deal with, over 90 per cent of the transactions are processed on a completely automated basis, without ever touching the transaction manually. Our aim was to position the service as a way to automate the industry, but to do that as an infrastructure, focusing on the core execution side of the business. We in-source order-routing, settlement and some asset servicing. Our objective is to concentrate volumes on these back office processes, justifying the investment, automating, and, coming back to the point about the distributor and manufacturer, leaving both sides to concentrate on adding their value to the transaction. Yuri Bender: In Europe, are we actually moving towards the infrastructure solution like the funds in the US, owned and governed by the user community? Ivan Nicora: That is our vision, but Europe remains a set of individual markets and there is a need to provide each of the individual markets with a solution fitting their own model. France has been working with a model built around the CSD for 10 years, even on the funds side, and it was a natural extension to build our fund-processing services along those lines. Other markets, for example Luxembourg or the UK, are built on a different framework. We believe the ultimate goal may be for Europe to select one model, but that is the goal, not the path. In the meantime, we need to have individual solutions to fit the needs of each individual market while making the differences between markets invisible to users by dealing through a single hub like Fundsettle. User governance is an essential element to the success of our vision, since it enables us to deliver solutions that are truly meeting market needs. Earlier, you asked why other market initiatives failed in the past. Certainly, there was an element of competition in that service providers were asked to pool their specific talents and added value into the same basket. User-governed solutions help to avoid this trap. Yuri Bender: What are the fundamental differences in the nature and the scope of the existing processing platforms and solutions? Ivan Nicora: There are two ways to look at it and the first is the scope of the services – how far do the platforms go? EMX in the UK is providing a solution to standardise and automate, but they focus exclusively on the placement and routing of orders. Other solutions have tried to add to that, some with the settlement piece while others have gone further, for example FundSettle, by combining all the routing, settlement and asset servicing but limiting it to core processing. There are platforms that have emerged which are going even further, for example, in terms of negotiating commissions on behalf of underlying clients and taking advantage of the pooling of assets that can gather on their books to negotiate better fees. This is obviously having a tremendous affect on the rules of the game between distributors and manufacturers. Yuri Bender: How would you describe the specific and changing needs of a large branch network such as the regional Banque Populaire chain in France? In the past, they were using internally managed products from Natexis Asset Management. But Natexis Asset Square – the multi-manager arm – is really gaining prominence in France. How will that tool be used by the regional banking networks, and how will that change the technology requirements of the banks now that links are needed to a big variety of external managers on the platform? Mohammed Eddequiouaq: In fact, the demand has improved, as has been the case with other banking groups. At the earlier stage, those banks were relying on the internal offer provided by Natexis Asset Management products and services. Over the years, we have seen more and more regional banks asking for new products and offers coming from external managers. We have been forced to have a regional approach. We have created two dedicated entities, one dedicated to the multi management area with Asset Square, which has more than ?4bn assets under management for the needs of the regional Banque Populaire network. On the other side, we have seen more appetite for new funds or new fund of funds, which is why we have also created Axeltis, the third party fund distribution platform. It offers our banks – and external clients – services including legal and commercial negotiation of distribution agreements, and administration and financial management of these agreements. This is the way we have implemented those tools to answer once again the specific needs of those regional banks. We have also interfaced our tools with the tools of dedicated subsidiaries, so that they can have the tools of a custodian to route and execute orders. Yuri Bender: It is very interesting to look at Fortis in the context of this discussion because you have relations with your own retail and private banking network and you have a strong range of products sold through this network. But you are also very keen to see revenues obtained from increasing external distribution. When you visit other private banks, potential external clients in Luxembourg and the surrounding area, are they really ready to sell external funds? Do they have the mentality, the technology, and the resources to do this properly? Jean-Francois Fortemps: It is going more and more quickly in the right direction. This is based on three main points. The first is a demand from their clients to find solutions other than the one that they have been provided with for the last 20 years or so. The second is mainly in the private banking arena and it is due to legal changes. The national authorities are promoting independent advice. How can you be independently advising your clients if you just propose internally made vehicles and push your own products? This is increasingly under the scrutiny of national bodies. This has pushed those banks to open to third party distributions. Third and more importantly, there is a financial rationale for these developments. No asset manager can pretend to be the best in all cases. There are some areas where you will find a better offer than your internal offer. When we are visiting our distribution partners, there is always one product where we can convince them that they should shift to our own product. This is a financial rationale on behalf of the clients but it is also a financial rationale on behalf of the banks – being active in all asset classes. Now, there are so many new asset classes given to the clients that it is very difficult to develop this expertise internally – CDOs, structured products, convertibles etc. If you want to develop the new asset classes that are asked for by clients, you need a team of 15 or 20 specialists. Can you afford this if you only have ?100m or ?200m of assets under management? There is a need for expertise and this is the kind of expertise that an asset manager can bring. Within Fortis Investments, we try to bring to those clients a limited number of asset classes that we can currently provide – 17 investment centres covering 17 asset classes and bringing, hopefully, 17 solutions to those clients. We do not pretend to cover all of the assets and there are some products where Fortis have to go for another provider. That’s why we developed Fortis Multi Management, a company dedicated to select the best external fund managers. If it is a promising asset class, perhaps we will develop it. With 17 solutions, I think we are already amongst the big providers. Yuri Bender: When you are developing these solutions together with your clients and working out which products to provide for them, do you also examine whether they have the correct support systems and technology in place to be able to deal with you on the most effective basis? Jean-Francois Fortemps: We have to provide them with the right solutions for effective dealings. We try to be as clear as possible in our process, to be as good as possible in our transfer agency business, and to this extent we have been a little particular since we did a joint venture with Crédit Agricole. A few years ago, we developed Fastnet in order to pool this combined AUM and to offer efficient and cheap solutions to our partners. We tried to simplify their lives. Having said that, when we go to them, there is a technical issue that we have to solve. The only problem we still have is regarding trailer fees and properly identifying the final clients. With the development of the nominee account – and this is more and more the case under the Luxembourg organisation – it is really difficult to identify the final distribution partners. This brings two or three problems. First, it is a lot of efforts to pay our distribution partners properly, which is a problem for both of us in our relationship. Second, the information flow that we have to take care of is perhaps not going to the right institutions. I am referring to information like new prospectus, change in manager or in investment process. We need to get access and we need to know what and to whom we sold. Usually we have this information but it is not easy to get it. It would help us if it was easier to get this information. Third, an internal problem is recognising internally the effort of this sales force against other sales forces and distinguishing the good and less good people. Yuri Bender: Are many private banks asking for sophisticated technology soltutions so they can work out what they are selling and to whom? Rajesh Mirjankar: Private Banks are now demanding more intelligent tools. We have seen an increase in demand from private banks for systems that can map the customer goals to what is out there in the funds supermarket. The system that we provide creates a flexible model adapting a multi-manager model for funds along with a model portfolio approach, where you determine the allocation of funds based on the customers’ investment profile and risk appetite. Edouard Bokuetengue: We have solutions for the technology in front of the market, with FundSettle, Vestima and BNP Paribas, providing a good solution. Then there is the different solution concerning the relationship that we have with our clients in order to provide them with the service. It is clear that it is still, from our perspective, linked to technologies like telephone and fax in order to send us the order to go on the market. We try to be more efficient in front of the market but it is more difficult in front of our clients. Yuri Bender: How do the Ucits III regulations affect the work of service providers in terms of reporting to clients on new instruments and filing information on a timely basis? Frédéric Pérard: From my perspective, it places pressure on deposit banks, trustees and fund administrators. I think that some markets in Europe due to regulation and Ucits III have discovered that OTC derivatives still exist. Most asset managers are not equipped from front to back to manipulate these instruments in the right way. France has been a money driven market compared to others for a long time, where it was either forbidden or they were more equity oriented. For others, the demand is now the capacity to process very complex instruments. There is a shift within our client base from the old asset manager type, which was mostly equity, to people coming from investment banking. These guys manipulate all instruments, understand them and expect you to understand them too. Secondly, from a servicing or regulatory perspective they expect to provide and implement valuation for these instruments. This is where you can see the demand to develop ad hoc services on that side and we are currently recruiting quants to provide these services. Now, we also have to provide capacity to evaluate all complex derivatives, as a fund manager or investment banking operation could do. This is a major change because the more you go into value chains, the more important the technology is and the more the skills of the people matter. These guys arbitrate you between fund managers and broker dealers. In years where business is good, there is no way you can match the bonuses that these guys would receive on the fund side, and in the years when it is bad, you can try, but it is a bit of a challenge.