Establishing more efficient platforms

There is no doubt that growing volumes in the cross-border distribution of funds across Europe have driven fund processing automation and standardisation, which are crucial to improve efficiency and timing in the industry. For third-party fund distributors that have seen the number of their counterparties rapidly increase, the manual workload and operational risk are no longer manageable.

The financial crisis may have led European banks to push their in-house products to improve margins, but this is generally seen as a short-term effect of the downturn. Last year’s trend to separating asset management and distribution is preparing a more fertile ground for open architecture and, consequently, for the need for increased levels of automation.

What the market downturn has generated is widespread attention to costs. “The financial crisis, almost in a perverse way, has had a beneficial effect on the take up of automation, as there has been a lot more focus on cost containment, both on the side of the distributors and the side of fund promoters,” says Lieven Libbrecht, director in the Investment Funds Product Management division at Euroclear.

Fund processing, which includes order placement, cash settlement and asset servicing, is provided as an integrated solution at Euroclear’s platform Fundsettle. Together with competitor’s Clearstream Vestima+ and its settlement engine CFF, these are the two main pan-European platforms, both Luxembourg-based, that position themselves as a single access point for distributors and asset managers. Both claim to offer cost savings and gains in operational efficiency to their clients, by providing a valid alternative to the so called spaghetti model – still prevailing in Europe – where every distributor has to develop automated processing links with each fund manager or transfer agent (TA) they need to liaise with.

“Distributors drive automation and fund managers tend to follow their distributors on the platforms they connect to,” says Mr Libbrecht. As it is extremely difficult for distributors to really estimate their internal costs of order processing, and because they may have the erroneous perception that sending a fax is free, in 2008 Euroclear launched a rebalancing scheme. This is a partnership with a number of leading fund providers who have agreed to sustain the costs of fund processing through Fundsettle for their distributors.

Worth backing

“Fund managers see that there is a market infrastructure that is worth supporting and investing in, and want to make sure that there is maximum automation that flows through it,” he says.

Automated links between the cross-border structure and the Euroclear group’s companies in Europe will improve. For example in the first half of this year it will be possible for cross-border promoters on Fundsettle to distribute to UK distributors, without having to make a second connection to the local infrastructure EMXCo, as this is now part of the group. The reverse link between Fundsettle and EMXCo allowing non UK distributors to buy UK funds already exists.

However, to liaise with fund managers who do not adhere to the Fundsettle rebalancing initiative, distributors bear all the costs of fund processing through the platform.

At Clearstream, the business model is slightly different as asset managers always pay between 10 and 20 per cent of the total cost, the remaining cost being borne by the distributors. Over the past couple of years, Vestima+ has doubled the number of funds on its platform, which now hosts 70,000 funds located in more than 15 different domiciles.

“We worked on getting as many funds as possible on the platform, in the recognition that the distributors we talk to are looking at one single central place where they could have one single access to the market for the funds they want to deal with,” says Philippe Seyll, board member at Clearstream. “What we are witnessing is a decrease in the average number of fund families that the distributor deals with, in order to reduce its operating costs. We believe this trend will continue.”

Distributors wanting to remove funds or change third-party asset manager and want to get an automated connection to them quickly will benefit from the increased number of funds on the platform.

Last year, order routing platform Vestima+ saw an increase of 12 per cent in the number of distributors to 450. This is clear evidence that organisations believe in the value of the hub model for the distribution of funds and the efficiency of managing risk through it, says Mr Seyll. Moreover, as the strength of the Ucits brand grows outside the European Union, new international markets are being opened.

“Last year, we got 15 new clients from Asia, and we want to get more,” says Mr Seyll, explaining that currently a quarter of the total distributors on the platform are based outside the European Union.

In Europe, there are other fund platforms that have set up their own standard sets to provide automated connectivity to distributors and fund managers, such as Allfunds in Spain, whose core business of fund distribution is combined with a number of administration activities to support the distributor side.

And new players are entering the market. One of these is Calastone, a UK-based independent cross-border transaction network launched two years ago, which is positioning itself as a settlement alternative to Euroclear’s UK&I Crest system. From the industry consultation process carried out with mutual fund industry firms, a gap in the settlement arena emerged, says Dan Llewellyn, head of market standards at Calastone.

The response was that the market asks for a primary market solution, rather than a secondary market solution, like the Crest model essentially is. This is because settling mutual fund transactions is a primary market activity where units are bought and sold directly with the issuer and where legal title is recorded on the fund managers’ register and not within a central securities depository (CSD).

“A CSD model that advises the register of the settlement of what changes to make on the register is seen as a complete duplication of efforts,” explains Mr Llewellyn.

The new settlement solution, which will be available in the first quarter of this year is a primary market model and, unlike other settlement venues, it does not dictate to clients what message protocol they need to connect to it, he says. This is the same philosophy adopted by the firm’s order routing platform, which went live in mid 2008 and has attracted interest of several players in different domiciles.

“Having to procure certain technology systems can be quite cost prohibitive for smaller players. Our model allows distributors to connect to fund managers in very low cost base,” says Mr Llewellyn. Unlike its competitor’s platform where each transaction is settled individually, participants will be able to settle bilaterally with their counterparties the net positions, he says.

“The advantage is that players will be able to pre-confirm their settlement amounts for a specific date and reduce the number of payments they make into the market, which has then a knock-on effect on reducing the amount of cash reconciliations and exception processing.”

Euroclear’s Mr Libbrecht, on the other hand, points out that Euroclear’s solution in the UK was developed hand in hand with the market players and all the big transfer agents and distributors use it, that their offer is much more solid and the Calastone model caters, at the moment, just to the UK market.

Nowhere near

Bringing in the point of view of a global asset manager, David Dibben, chief operating officer Global Fund Ranges at HSBC Global Asset Management, explains that having one platform as a single access point for fund processing, the way the US works, has been the goal for more than ten years, but it is not getting closer.

The challenge is that the multiple parties in Europe that conduct order management, clearing and settlement are all proposing themselves as a single access point, with none of them joining hands with other platforms, he says. Moreover, for the distribution part of the asset management business there are issues of visibility. Personalisation of service to the client would also be affected.

“As an asset manager we welcome the automation and the access to our manufacturing capability that the platform providers bring. Where the investment is made in the platform’s nominee account name, clearly we are less able to develop the relationship with the clients that invest through this route,” explains Mr Dibben.

“From an operating cost perspective, on the one hand, the fewer parties you have to interact with, the better, providing they are efficient, reliable and have sufficient capacity. On the other hand, the risk you then need to manage is that if there are too few competitors providing these services, this could lead to a loss of competitive pricing.”

For an asset manager, “it is important to be on as many platforms as it is prudent to be on,” because it is costly and it is important to assess that investors will actually come through that route, he says. The percentage of automated trades at HSBC, which was 25 per cent four years ago when Mr Dibben joined the firm, has now grown to 60 per cent. The back office is a key factor in determining whether a fund is sold or not in a bank.

“When I talk to my colleagues on the custody, fund accounting and transfer agency side, I say ‘your success is to be invisible to the client, because if the client does not see the back office operation, it’s working,’” he says.

A specialist in securities services at a large global private bank based in Switzerland explains that most of the bank’s international plain vanilla fund business is processed through order routing Vestima+ and clearing and settlement via CFF, but the bank continues to have direct links to high volume TAs, with whom it places orders directly by Swift.

“There is no doubt that many of the institutions will continue to use direct links with TAs, mainly due to the fact that if the bank has an account and holds the funds directly with the TAs, they are not charged with custody fees,” he says. He also adds that while 95 per cent of the Swiss bank’s plain vanilla fund is currently automated, in the hedge funds arena automation of fund processing is still, for many reasons “a huge headache”.

At bank Julius Baer, straight through processing started four years ago and now covers 85 per cent of the mutual fund flows in the long only space. The remaining 15 per cent is manual, due to local or small asset managers that operate by fax or paper, says Michel Mele, head of funds trading at the Swiss firm.

“We liaise directly by Swift with the individual administrators or transfer agents, as our costs are lower,” says Mr Mele. Fund clearing and settlement is done through the Euroclear group, but it would be more expensive to sign up to any platform such as Fundsettle or Vestima + for order routing, he says.

“Going directly to the asset manager allows us an immediacy of contact and better information for our clients, whereas if you place orders on a platform, you always have to get in contact with the asset manager through the platform,” he says.

The Swiss bank is moving from open architecture to the so called managed open architecture model, where the funds that are being actively recommended to clients will be sourced from a selected number of asset managers. But the decision itself was apparently influenced by cost considerations.

“In an open architecture model we need to meet any client demand to execute orders, but if we are more selective in the way we trade or execute, our costs are lower. Ultimately, what is important is that the fund houses we do business with are full STP, and we are looking to focus on those firms,” says Mr Mele.