Setting standard for processing fund trades

According to statistics from the European Fund and Asset Management Association (Efama), at the end of 2007, the European investment funds industry accounted for 33.2 percent of the E17,800bn global fund market, second in size only to the US funds industry which had a market share of 46 per cent.

Both regions have experienced dramatic growth over the past decade. Nonetheless, there remain stark differences between the two largest fund markets. There are for instance, over 50,000 funds in Europe as against less than 10,000 in the US.

While around 70 per cent of the European fund market is still concentrated in proprietary funds where banks and insurance companies sell their own products to clients, in the US, over 80 per cent of the mutual funds business is focused on third-party products.

The differences are particularly evident in the fund processing space, which encompasses order management, settlement and custody. The US enjoys the benefits of a single market, single currency and single set of rules for mutual fund processing.

It also has a single industry utility for processing and settling mutual fund orders, Fund/Serv run by the Depository Trust & Clearing Corporation (DTCC). Europe, on the other hand, continues to struggle with over 20 different markets each with their own rules, tax systems and settlement structures.

Adding to the complexity is the fact that these markets do not follow a common processing model. In markets like France and Germany, fund settlement and custody services are provided by the local central securities depositories (CSDs) on a DVP (delivery versus payment) basis. The UK, Luxembourg, Ireland and a few other markets follow the transfer agent (TA) model, where order routing, settlement and asset servicing are handled directly by fund distributors and transfer agents through a bilateral exchange of information.

Anecdotal evidence from industry participants suggests that the complex spaghetti of linkages and interfaces required for fund processing in Europe not only lead to high operational risk but can in some cases increase costs to over E100 per trade. A study carried out by consultants Deloitte last year estimated that the average cost of buying or redeeming a fund across borders in Europe is E62. The DTCC in contrast charges a mere 7.5 US cents per transaction on their Fund/Serv platform.

IMPROVING THE SITUATION

A pan-European fund processing infrastructure remains a distant dream. However, with the easing of regulatory constraints, and the consequent growth in cross-border transactions (Efama estimates that cross border fund transactions represent around 20 percent of total transactions in the European Union) and third-party distribution volumes, several initiatives are afoot to improve cross-border funds processing.

Most notable among these are fund platforms developed by the leading international central securities depositories (ICSDs), Euroclear and Clearstream.

FundSettle from Euroclear, which was launched in 2000 provides an integrated order routing and settlement solution for the cross-border market. Ivan Nicora, Director and Head of Investment Fund Product Management at Euroclear says that the platform is connected to over 500 European fund houses and over 200 distributors across Europe,

“FundSettle was launched at the end of 2000,” says Mr Nicora. “The first few years were about educating the market. Between 2004 and 2006 there was huge growth in volumes driven by the development of open-architecture, third party fund distribution. But from 2007, the pace of growth was lower than expected, due essentially to the financial crisis.”

Clearstream too started out with a bundled order routing and settlement product, similar to FundSettle, but now offers two separate solutions, Vestima+, and the Central Facility for Funds (CFF). Available since 2005, Vestima+ is an open order routing platform, which currently provides access to over 40,000 funds from around 200 fund houses.

CFF is a post-trade solution providing one single set of settlement and payment instructions for all participating firms, transfer agents, fund distributors and fund promoters. It was launched in May last year and was targeted primarily at investment funds domiciled in Luxembourg, the largest market in Europe for cross-border funds, but has since been rolled out in Belgium, Ireland and most recently, the UK.

With its coverage of Europe’s most important investment fund domiciles, CFF is fast becoming Europe’s infrastructure of choice for cross border settlement of investment funds, claims Clearstream board member Philippe Seyll. “In Luxembourg, we have 40 transfer agents on board, which cover 90 percent of the market. In Belgium, three of the major transfer agents accounting for around 75 per cent of the market have decided to use our solution.”

Vestima+ can be used without CFF and vice versa, Mr Seyll points out. “Unlike FundSettle we offer an open model that is preferred by some distributors and transfer agents.”

Both Euroclear and Clearstream have in their own way contributed towards improving efficiencies in cross-border fund processing, remarks Gary Janaway, Head of Luxembourg Fund Services at Schroders.

“FundSettle was developed specifically to meet the needs of funds processing. Clearstream on the other hand, have adopted their settlement platform to meet the fund industry’s requirements,” says Mr Janaway.

“Personally, I believe it is personal choice as to which is the better. However, I think that combining the automation of order routing and settlement is more efficient that just automating the order processing.”

CFF, notes Mr Janaway, has no doubt helped streamline the settlement of investment funds traded on Vestima+. Currently over 85 percent of flows on Vestima+ are settled on CFF.

Despite the presence of these fund platforms from Euroclear and Clearstream, and other proprietary solutions from various custodian banks, manual processing is still rife in the funds arena.

Deloitte estimated in their study last year that STP levels in the industry was a “low” 47 per cent.

The study focused on the cross border mutual fund distribution in Europe’s two major markets, Luxembourg and Ireland which together manage close to E3,000bn in assets and account for over 90 per cent of the cross border trades.

According to Deloitte, Europe’s cross border investment funds industry could save 30 percent of processing costs and gain over E300m by streamlining trading, settlement and custody.

“The use of telephones in domestic markets and faxes cross border is quite common,” remarks Mr Janaway. Apart from using fund platforms that act as a hub between promoters and fund distributors, he says funds are very often processed through bilateral communication.

“There are bilateral interactions between promoters and distributors either through telephone, faxes, Swift messages or FTP (file transfer protocol),” he says.

The main benefit of a fund platform, says Mr Janaway, is that it offers a choice particularly to distributors. “If a distributor needs to connect to a large number of promoters transfer agents, then they are more likely to choose a platform as one entry point with multiple connectivity rather than set a series of bilateral connections.”

Mr Janaway points out that the take up of fund platforms has significantly slowed down in the past year primarily due to the sensitivity of distributors to the fee charged for the usage of fund platforms. “Cost has been a barrier for many distributors,” he remarks.

Euroclear’s Mr Nicora concurs. “Cost is constraining many distributors and the situation will not easily improve in the current economic condition,” he says.

To overcome cost concerns and entice distributors to sign up to its platform, Euroclear has over the past year come up with a series of incentive schemes in conjunction with fund promoters. Last year it launched its FundSettle Premier label which qualified certain funds for priority treatment, faster processing and more efficient settlement.

Distributors distributing funds with this quality label had to pay 25 per cent less in fees. In September this year, it announced a new initiative that represented an almost 100 per cent reduction in price for distributors, with the cost being borne by the fund promoters.

“Euroclear is rebalancing fund processing costs by sharing the benefits that FundSettle already provides to hundreds of distributors, transfer agents and fund promoters. Under this scheme, promoters pay in the range of 1 basis point. Fund distributors will get the service almost for free, paying about 1 Euro per transaction. There is no fee for them for asset servicing,” explains Mr Nicora.

INCREASING INTEREST

Thus far eleven amongst the largest fund houses such as JP Morgan Asset Management, Robeco and Schroders have subscribed to this programme. They represent about one-third of the volumes on FundSettle. “We expect the coverage to increase. On the distributor side too there is increasing interest,” says Nicora.

Mr Janaway notes that another reason for low uptake of fund platforms is that most of the large players have already automated and are connected to the platforms. “Many small pension funds or banks that do buy funds may only trade several times a year. In that case they would prefer to stick to the paper orders or go through an intermediary such as a custodian that is automated. Either way the paper order still exists, whether it is passed to an intermediary or directly to transfer agents.”

While Euroclear tries to increase adoption by reducing costs, Clearstream is staying away from the cost discussions. It is instead focusing on offering value added services to its customers, which it intends to announce in due course.

While fund platforms try to reinvent themselves, Mr Janaway believes that although adoption levels on these platforms might have slowed down there is a gradual increase in automation especially in cross-border funds domiciled in Luxembourg. This he says, is being driven by Swift’s XML messages. “We are seeing an increasing use of XML message formats from Swift. The increase has particularly been in the past year because of growing use of SwiftNet messages for funds,” says Mr Janaway.

Mr Nicora acknowledges the importance of Swift’s harmonisation initiatives. Euroclear and Swift work in a complementary way, he says. However he points out that while Swift has developed a number of messages dedicated to funds processing, it is essentially a messaging infrastructure and many processes go beyond its purview such as settlement.

He says that the growth of third party fund distribution in Europe will drive the use of fund platforms. “In the US, more than 80 per cent of transactions are on third-party funds. In Europe third party fund distribution picked up only at the turn of the century and is as low as 20-25 per cent today.”

Ivan Nicora, Euroclear