Josée Denis, BNY Mellon Asset Servicing: Your first question is a good one because we are currently taking stock of 2009. Most of us around the table are going through a strategic planning exercise for 2010/2011. We ascertain the lessons learned from 2009 and consider how best we can build forward to support the fast-moving train that is the global fund industry in the next two to three years.
It’s always good to recognise, from a practitioner’s perspective, the business evolution of our clients over a year’s time and how we best supported that business. This highlights the key service offering requirements that we had to work on in 2009. Overall, I think the major focus in 2009 was on global cross-border fund servicing, specifically to support cross-border fund distribution. As we look at the competitive landscape in the asset servicing space, particularly global fund services and the RFP [request for proposal] activity in 2009, those requests did not diminish compared to better years. Even throughout the financial crisis, although difficult both internally and externally for all of us, the RFP activity did not stop.
This reflects that asset managers continued to believe in growing their assets and were still reviewing their strategic intent and business development requirements, even though transaction volumes were going to be low and that the funds business wasn’t going to grow as much. Having said that though, looking back at the few mandates that have been won/lost last year, most involved big fund groups that were looking to review their current service model and/or outsource what they were doing themselves to focus on what they do best: asset management. It was really those global cross-border fund groups that took the opportunity of this downturn to review their asset servicing strategy and say, ‘Do I want to continue doing the middle office and back office myself? Am I happy with my current service provider?’
The asset servicing competitive landscape has grown steadily over the last few years, particularly for Luxembourg domiciled funds. Most of us global fund services players have had to set up from five to 15 locations in the world to serve Luxembourg-domiciled funds that are distributed globally today. Clearly the appetite and need for global cross-border service provision is here to stay. Asset managers continue to review their asset growth strategies in line with their investment products range and the target countries and regions they wish to expand in. The service provider is thus no longer considered just a back office that maintains the administration of a fund but a key partner to handhold them in their global distribution strategy.
As practitioners, we now have to provide a dedicated distribution support service that ranges from providing local/global regulatory and tax expertise of key markets to having sound knowledge of local distributors and investor profiles, local product requirements, distribution channels, etc, in order to assist fund managers in their business development thought process. All the while having to continue to deliver a seamless operating platform across all jurisdictions where we serve these fund groups.
Tim Gandy, JP Morgan Worldwide Securities Services: If you look through the whole process there are two areas that need to be considered. One is around record keeping. For example, was everyone in the best position to know what their Lehman’s exposure and other exposures were at the time the collapse happened?
The challenge is whether you have everything on one global platform or whether it is across different platforms in different locations. As the crisis moved on, the other issue was difficulties around pricing, particularly bonds. That led to fund managers looking at their core responsibilities and core capabilities and coming back to consider outsourcing.
We’re seeing that even groups that have considered this before and came to a decision are now revisiting it. Due to the illiquidity in the market, many funds had to be suspended and the administration teams within the fund management companies came under immense pressure, and pricing of certain assets, as we all know, has been a huge challenge to everybody.
So we are seeing that outsourcing is back on the agenda and is very high on that agenda. Clearly the demands for what you can provide will be a test for all of the service providers, especially on the reporting side. The other issue is risk awareness. While risk awareness has always been there, clearly the profile is much higher and regulatory focus and market demands are there. There certainly is momentum and it’s gathering pace.
Funds Europe:â€ˆWhich is a good thing for your industry.
Gandy: It’s a good thing. It will throw up challenges clearly, but we’re there, to service the client base.
Fabrice Godefroid, City Global Transactions Services: What I’m hearing here around the table is very much in line with what we believe are the sort of issues we’re facing. In 2009 we sponsored an independent study by Create-Research. In it we asked 230 asset managers across 30 countries what they plan to change about their business. One of the conclusions was that today we are at a tipping point. We’re going to do things differently than how we used to do them. We understood that the asset managers will be more focused and that there are going to be a lot more alliances on the asset management side. So, how does that translate into our business as the back office providers? We believe that we need to look at transforming our shop from manufacturing to distribution. This is key, but it needs to be done in a smarter way.
If I take the example of Asia, Asian investors today have an appetite to get into the Brazilian market. If you go into Brazil you’ll see that they’re missing liquidity. So the question is how do you build the bridge between the distributing depository in Asia, bringing money into the process of IPOs and bringing the liquidity into Brazil?
We need to be fully integrated, which brings us to another question: are you on one platform or do you have many platforms?
We believe that we should be common at our core with custom where it matters. The key is to find the right balance.
Martin Bock, RBC Dexia Investor Services: We take more a high-level approach on how we can position these services to best serve our clients. On the one hand, RFPs have not stopped in 2009 and also in these first few weeks of 2010. Outsourcing is back. It never really stopped, but it’s back in a different way.
It’s not just outsourcing for outsourcing’s sake. You spoke about middle office, there’s a lot of discussion about what exactly is middle office, and what exactly, as a fund promoter, do I want to outsource? Why and to whom? And it’s not only to whom it’s outsourced but also how it’s done, how I’m getting the feedback, how I am getting my reporting.
You need to be able to not just look at your small Luxembourg market for your Luxembourg product but consider the geography where it’s distributed and offered from Luxembourg.
We took much more time explaining to our clients, not only ‘yes we do it’, but ‘how do we do it, how can we deliver transparency to you? How can we engage also with you in something that caters to your needs in terms of reporting?’
So in the end we saw outsourcing much more as a positive trend towards trust. I’m not selecting someone I pay to do something, but I’m selecting a partner that has an impact on the quality of my products, on the reputation my products have in the market, and then also on their success.
At the beginning we were a bit sceptical, we thought this [the crisis] would be the end to outsourcing and everyone would insource. Actually it turned out that this was not true at all, on the contrary it’s like you’re more valuable, even if you do back office or middle office, it’s a very important element of the value chain.
We talked about the pricing issues that we had during the crisis, we talked about Lehman. We probably all have clients that had relationships with Lehman. This is what really tested the infrastructure of the market to see if everything was ready and working in real life. It was supposed to work on paper, and clients and service providers really worked as partners to overcome the crisis, this probably helped to rebalance the relationship between all the actors within the industry.
That’s why we are seeing more of this partnership approach than we were seeing before.
On the product side there is a trend that we are starting to see, which is the convergence between the hedge fund markets and the mutual fund markets. This has accelerated because for good or bad reasons, hedge funds have been under the spotlight throughout the financial crisis. The assets are gone so they are looking for new sources of revenue and now they’re trying to tap the mutual fund market. Those clients work differently to the more traditional asset managers here in Luxembourg, so we have to adapt to those new needs and this new way of working.
Godefroid: Do you mean the convergence of the products or do you mean the offshore funds being redomiciled in Luxembourg or another fund centre?
Veillet: The trend is more for the hedge fund manager to tap into the Ucits market, so what they do is they adapt their hedge fund strategy to a Ucits constraint.
Godefroid: We’re certainly seeing this, and have seen for some time. There has been significant interest from investment managers in this area. Some investment managers have pushed their Ucits III fund structures as far as they can in order to secure another solid distribution channel.
Denis: I completely agree on the fact that hedge fund managers are reviewing their product strategies and looking at converging to Ucits III-type products that are more adaptable and accessible to the market. From my perspective, the investment products landscape has changed in that we have seen a sharp increase in the use of sophisticated Ucits, which basically reflects a strong exploitation of permitted Ucits III strategies. This helped to drive the distribution expansion in this space and the increasing convergence with alternative fund products. We have seen an increasing growth of these sophisticated Ucits over the last two to four years with Ucits developments proposing long/short strategies, commodity indices, hedge fund indices, etc. From an asset servicing perspective, we have evolved from a traditional fund administration service offering to a fund administration model that today supports sophisticated Ucits as well as specialised funds, such as real estate funds, sharia funds and ethical funds.
Gandy: There’s a lot of education for us to do for this type of product [sophisticated Ucits] because those clients are obviously not used to the constraints of the Ucits environment.
Godefroid: We are seeing promoters move their strategy into a more regulated structure, such as a Ucits, in order to take advantage of the increasing damand for more regulated products in the alternative investments arena.
This flow is clearly in favour of Luxembourg. We are seeing an increasing number of offshore businesses redomicile their funds into Europe, converting them to more regulated structures. Of course, this is increasing confidence amond investors.
Bock: One of the big advantages of a regulated framework, be it Ucits or another one that may be being drawn up for hedge funds, is that there is a lot of trust in the market for these products. Though probably not entirely justified, there was a lot of mistrust around the unregulated over-the-counter product – about its transparency and the underlying assets it invested in.
So this [the move of hedge funds to a Ucits framework] is a very positive sign. I can only reiterate it is also business that Luxembourg needs to capture much more of because this is what we are very good at – providing frameworks and maximising the potential to take them abroad.
Denis: Going back to the question on what has changed for us practitioners, I think the education piece is quite important. In order to support this evolving fund administration service offering to a specialised and sophisticated funds model, you must ensure that your operating model adapts to the specifics of the products you now have to serve. Most important, there are no tailor-made solutions in this space and one size does not fit all. A key consideration as well is that you must have ‘specialist administrators’ that understand these products and the administration requirements of these. Maintaining and servicing a sophisticated Ucits is very different than a mainstream long-only fund.
Most of us practitioners serving these new emerging fund types have had to segregate our operations teams in line with these products and educate internally as to the key operating differences between a long-only funds versus these more sophisticated Ucits.
Gandy: They [sophisticated Ucits products] are, by definition, more complex, which means more questions around the pricing arrangements. The Alternative Investment Fund Managers Directive (AIFM), whatever final form it may take, will change the landscape again.
At this point in time, this is giving the hedge funds the opportunity to come in through Ucits. If practically all unauthorised funds come into an authorised arrangement under AIFM, then they will be able to go after broader strategies than Ucits allows. So we have to try and take into account what changes to the landscape will arise from this.
Godefroid: Also, the CSSF [Commission De Surveillance Du Secteur Financier – the Luxembourg regulator] is asking the industry about how that type of business is now entering the Ucits space.
If we return to Ucits IV quickly, there is one key difference between Ucits III and Ucits IV. That is the way they’ve been processed. There’s no deadline, there’s no obligation. It’s an option, it’s there, you can use it or not, you can consolidate your business, you can change your management company domicile, but there is no obligation as there was with Ucits III. I suspect that the industry will follow the options given: consolidation, management company reconciliation and so on, but this will not happen at the speed we were expecting a year ago. It’s going to take time.
Gandy: There has to be a compelling case for it. There are so many other points of focus at the present time; with regulatory changes, and taxation, etc. Certain aspects of Ucits IV will lend themselves to some situations. For example, fund range consolidation looks attractive but they still have the taxation issue to be dealt with.
The master/feeder arrangements are another, so from a distribution aspect, this can be a key issue. On the regulatory side you need to look at what Ucits IV brings in relating to the depositories. For example, that they have to have arrangements to share information on a look-through basis in master/feeder funds, which was an issue in the Madoff scandal.
Those are key initiatives we would all want to subscribe to, but one of the difficult things is the question of when Ucits IV will bite, particularly on the redomiciliation of the fund managers. Does it have to bite? The status quo can prevail.
Veillet: There’s a question mark that is hanging on the answer to the question of how and when Luxembourg is going to close the Madoff issue. And how and in what form are we going to get some clarification on the responsibilities of the depository bank across Europe? That might be one of the issues that decides whether Luxembourg is going to come out as a winner of Ucits IV or not.
Denis: I have a more positive view on the potential impacts of Ucits IV to the Luxembourg fund industry. I see Ucits IV has an opportunity for Luxembourg to finally be recognised as a distinct global fund administration centre with over 25 years of experience in global cross-border fund servicing, today supporting over 55 countries of sale and the associated legal and regulatory reporting, investor and distributor servicing, etc. Take for instance the management company passport. Some think that this may well push asset managers to think of administering their products in a domicile that may be cheaper than Luxembourg.
We already have various Alfi working groups looking at Ucits IV across many subjects. From a pure investment management operations standpoint – be it custody, fund accounting, cash management and transfer agency, for example, and particularly on the transfer agency and fund distribution support side, the Alfi TA Forum working group is currently defining guidelines on the migration of funds business from one fund administration service provider to another from a domestic standpoint. This exercise over the course of this year will then enable us to review the migration of funds business to and from Luxembourg to another EU jurisdiction in order to ascertain all of the legal, regulatory, operational and quality assurance implications of Ucits IV and the management company passport. That is what we, practitioners of the industry, also call ‘operational readiness’ when Ucits IV is transposed into Luxembourg law.
Bock: Ucits IV is a toolbox and while I fully agree that there is no specific deadline, I think that’s a big advantage. Ucits III was more product oriented, many promoters were only looking at their product strategy and then they were so focused on deadlines that it was just about ticking boxes.
We have conducted interviews not only with our clients but also with asset managers in the industry, and most, virtually everyone, has started to look into Ucits IV, but not just reading the text but asking what does it mean for me? How can I use these tools? We asked the question, ‘what would be the criterion on the basis of which you would decide to concentrate funds on a certain jurisdiction, which doesn’t have to be Luxembourg, it can be any jurisdiction?’ What came out clearly was, ‘it’s not where I have my headquarters, it’s where I find the best expertise for my products which are not local products but which I need to distribute’, and these are the strengths of Luxembourg. Luxembourg would have a big advantage because it’s much more about the providers in offering the solutions to support the mergers, the master feeder structures, rather than just thinking we are already there.
Godefroid: I am based in Luxembourg and can confirm that the feeling in our company was the same. However, we chose to go one stage further. There is no point in comparing Luxembourg with any other domiciles as we are confident it will continue to be a leading funds domicile. The same goes for Ireland too. What is important is that we continue to give our clients with ranges of products in both domiciles access to the services and geographies they want in the right timeframe.
Through our global operating model our clients have the support of local service experts as well as our global centres of excellence. Therefore a fund promoter only has to choose the domicile that will fit their product’s characteristics or distribution requirements while our ‘follow the sun’ approach to processing gives them the latest fund/portfolio analysis. Our clients know that irrespective of the domicile of the funds, we can support their distribution needs via our single European hub which is made up of four or five hundred people who speak the local language of the fund domicile. With so many uncertainties around Ucits IV, such as the where and the how, it is essential investment managers have all the options available to them.
Gandy: I quite agree. It underlines the need to have a global platform but then be able to face off specifically to each market. Let’s use Ucits as an example. You’ve got the main core of regulation and then you have additional local requirements. We’ll have to see once we get through the current consultation process how far that codifies the rules, but I’d anticipate we’ll still have local add-ons specific to each jurisdiction. You’ve got to face off to each of those and then consider what type of funds they attract to that jurisdiction to be able to offer the right service. From all of our bases we obviously want to get as good a core as possible, so a global platform is a very key driver.
Veillet: For the last five years we’ve built a platform that services our clients in exactly the same manner. Regardless of the domicile being Italy, Ireland or Luxembourg, they have the same reporting, thanks to our ‘hub and spoke’ organisation, but we prefer to speak about a centre of excellence because we don’t obviously hold everything at the same place. We put a lot of emphasis on the local presence also because we believe that you can have a hub to a certain extent but you still need the local feeling to serve the client.
Funds Europe: Some of you mentioned depositories and the next question is about the role of the depository. How did you respond to the best practice guidelines issued by Alfi, regarding the safekeeping of assets held through the traditional custody network? Would you say they formalised what was being done already or were there any changes to be made in the way business was carried out?
Denis: Hopefully there was no need for major changes. This industry is longstanding and mature. I see these best practice guidelines as a validation exercise tool. Depository and custody is considered a commoditised industry that is standard and pretty straightforward. Hence we’ve been used to a somewhat standard operating model for quite a number of years. This focus on the roles and responsibilities of the depositary bank was a welcomed refresher call. This focal point on the safekeeping of the assets function provided us all with a chance to revisit the servicing model in place. In my opinion the guidelines were very well received and brought all the industry participants together to exchange and share a common view. It was good to have this reminder as to what our expected roles and responsibilities truly are and to confirm these to the financial services industry.
Gandy: The very basic issue is that the Madoff scandal should not have occurred. The industry should have had the controls in place to deal with this kind of situation.
What we have to look at is that as the fund management industry has looked for new investments and new markets, as your sub-custodian network increases then there may be different challenges in different markets.
I don’t like the word, but yes it is commoditised – to that degree this should be ingrained in everything that we do.
It [the Madoff scandal] has raised the profile of what we do with the fund managers. They may not have had such a focus on ‘what is the sub-custodian network out there and how do you ring fence these assets?’ It is something that we’ve all always subscribed to and dealt with, but to me it is a reaffirmation of everything that we should have always been doing since Ucits first came out.
Denis: One very good outcome is that it brought much more emphasis on fund managers to ascertain their own underlying responsibility, particularly if they ask to have their assets maintained and managed outside a designated sub-custody network. At the end of the day the fund managers have the ultimate responsibility as to whom they choose and this guidance clarified this.
Bock: It not only clarified, but it has also codified what we do. It’s a code of conduct, even if it’s a Luxembourg-based code of conduct. You can use it in discussions with third parties, especially those that previously had tended to say, ‘You have to use that custodian because I want to use it too’. It gives you, not only the arguments, but more background in saying, ‘look there are some criteria under which we have to work’. The document is to no-one a real surprise, but it’s really a confirmation of good standards and that raises the quality of the industry in general. Although everyone was practicing economic research on where the sub-custodians are allocated, it reinforces it and gives it some foundation.
Veillet: It’s a pity we needed to have Madoff to open a discussion on the clarification of the responsibility of the depository bank. I do not like the word commoditisation because even if it might be true that some parts of custody are really commoditised products, that tends to completely remove the fiduciary part of the job, which is where our responsibility as a depository bank is, our responsibility to the end investors, and in that respect the industry has dramatically evolved.
New asset classes have emerged and some of those asset classes are maintained outside of the traditional sub-custodian network and it has never been really clarified what the responsibilities of the depository bank are for those assets. I agree that the Alfi paper should not have come as a surprise for anybody in the industry, but it’s urgent that there is a position taken at the European level regarding the responsibilities of the depository bank.
Funds Europe: Is there a concern that there will be responsibilities placed on the depository banks that aren’t appropriate?
Veillet: The problem is not so much what type of responsibility we’re going to put on the depository bank because at the end of the day what you need to consider is the cost and the benefit of what is going to be decided. If we say the depository bank is fully responsible at first demand for everything, obviously custodians will have to take that risk into account in their pricing model and somebody will have to pay that cost.
Denis: And it’s not going to be such a commoditised industry anymore.
Veillet: Exactly, it’s not going to be commoditised anymore. It’s a cost versus benefit analysis.
Bock: As far as responsibility goes, what is exactly safekeeping and restitution? The Alfi document is a good starting point and I fully agree that the issue needs to be raised at a much higher level, the European Union level.
Veillet: Yes. We said that Luxembourg is well placed for Ucits IV, which is true. Operationally we’re probably the best place for Ucits IV, but there’s still a threat for Luxembourg. The fund manager can say, ‘Okay, I want to go to a domicile where I will find service providers to partner with’, but at the end of the day he still needs to sell those products to the investors; if the investors don’t want the Luxembourg Ucits anymore because it’s not clear what the responsibilities of the depositary bank are and more generally how well they are protected, the asset managers might have to find a new solution. So we need to clarify that definition as fast as possible.
Gandy: Looking at the Ucits consultation and the AIFM, and having seen a huge swathe of industry responses, everyone is making the strong point that Ucits was introduced in 1985 and the types of underlying investments have changed a lot since then.
Therefore it is a good time to have a review. That review needs codification, as you say, Martin, around what exactly is involved, and if, from a depository custodian point of view, we’re going to be asked to deal with new issues and assume greater responsibility, then there is a challenge. Will the industry be prepared to pay for this?
I anticipate that there will be the two classes; one will be what can be called safekeeping, and the other will be record keeping and monitoring from the fiduciary point of view.
What you need to ask is whether the depository, in its fiduciary capacity, is comfortable that those assets are held to the order of the fund and whether they comply with the investment guidelines of the fund.
But it has to be remembered that when fund managers make the investment decision, part of the consideration around that decision relates to the market it goes into, such as the market infrastructure, and insolvency laws, etc, in that marketplace. If it does move outside of what the depository can offer then that is the point where that responsibility should change.
Funds Europe: Would the approach be on an asset-class-by-asset-class basis?
Veillet: We have a big fund of funds business so we are dealing with multiple transfer agents. It’s a very simple example but it’s exactly the same thing. If a client invests in a fund for which the transfer agent is RBC Dexia, should I be held liable for the fact that RBC Dexia is performing or not? I’m just taking your firm as an example, Martin.
Godefroid: I have slightly different views. We contributed to the Alfi best practice document, which we fully support as a member of the industry, but to me this was just creating a sense of urgency to have a documented approach.
So now the question is, ‘Do you need regulation to be changed to enhance the diligence or control requirements of the custodians?’ The way we see it is that there is more to come in terms of regulation.
For us, there are two sorts of providers. One is the banks and custodians who don’t own their network and the other is those that do. Those custodian banks with their own network are more able to adapt to new or pending regulation, thus posing a lower counterparty risk, while those without their own network will need to price their service differently due to their different risk exposure.
Global custodians who own their networks probably have controls in place that are over and above what the regulation is asking for. However, the regulatory changes will capture the gap in the coming months/years and
force those without their own network to change their business models in order to remain competitive.
Denis: Most of us are global custodians around this table so I would say it’s the smaller guy, those niche markets that do not have the regulatory support or the framework to be able to ascertain and fully acknowledge the underlying responsibilities that they actually have and should have.
Funds Europe: Almost everything that we’ve spoken about refers to the Madoff scandal. So how about we speak specifically about it. A custodian I spoke to said, ‘We would have never allowed Madoff to be sub-custodian to the extent that he was’. Would you say the same goes for your organisations?
Bock: One hundred per cent. It’s surprising how anybody appointed Madoff given all the due diligence, the ongoing monitoring and controls, the risk assessment that is involved. How does it happen?
Denis: How did it happen? That’s the point.
Bock: It is a shame that the collective blindness Madoff managed to pull off was associated with Luxembourg. I wouldn’t associate this specific issue to Luxembourg, but leaving the technicalities aside, what Luxembourg should probably avoid is this eternal niche offshore image, where nothing seems to really be regulated, which doesn’t correspond to reality. Madoff is much more a wake-up call to polish the image of Luxembourg and not give the ammunition to its critics.
Denis: Luxembourg does have a few envious neighbours.
Bock: Of course, that’s exactly it. This is an excellent opportunity for Luxembourg to polish its image and to be considered more as a solution centre rather than just an offshore location.
Denis: Madoff was ultimately a US scandal that affected related parties worldwide. Obviously Luxembourg had some assets that were held here but it’s minimal compared to the total assets under management of the industry as a whole. Having said that though, by having the spotlight on Luxembourg under such a major scandal, it did open the door to our envious neighbours who now thought they had a reason to point the finger.
Luxembourg industry participants should be proud at the quick responsiveness of all industry players involved. All our companies had a global/local Madoff taskforce in place within days with weekly updates across all participants and trading counterparts all over the world. The Luxembourg fund industry took the situation in hand at the onset by setting up a dedicated Alfi Madoff taskforce, composed of industry leaders who worked very hard to communicate updates on a regular basis as well as delivering a mid-term report and a final report as guidance to all of us.
What is important here is that Alfi involved all the players in the fund industry’s value chain in this important endeavour: the asset servicing practitioners, the asset managers, the lawyers, the regulators, etc. As an industry, we all worked together towards a common goal.
Gandy: The very basic question was how long did it take an organisation to see whether it had exposure to Madoff. The answer to that question came straight back as ‘No’, because we would not have gone down that route. If we’re running our organisations the way we want them to run, we have our closely controlled network management. If somebody wants an arrangement that’s outside of that, then it is looked at as an altogether different potential risk position. We would need to investigate and undertake due diligence on the suggested parties and arrangements to ensure they meet numerous standards and criteria. But before this, and very importantly, we would question why we would want to support an arrangement outside of our normal practice. So the answer to this question was very easy, and very quickly, ‘No’.
Denis: It also provided an opportunity to look at ourselves, particularly to put more emphasis on protecting the investor as well as how we sustain this industry as a whole, the asset servicing side. Alfi now has a dedicated Alfi Investor Forum in place. Aside from the typical agenda of latest product developments and regulatory changes, this year’s Alfi Spring Conference will focus on investor protection and new developments within the infrastructure of this industry. I think this is innovative and very positive in that it responds to the industry’s need to bring forward two of its critical elements: the investor, the driving force behind the fund industry and the infrastructure/service provider, the participant that sustains the funds’ life cycle.
Veillet: Madoff was first of all a US scandal that involves fund management and it seems that some people managed to transform that into a Luxembourg depository bank problem. The depository bank is not, and should not be the only safeguard for investors. We have the board of directors, we have the auditors... it’s normal that there is some spotlight on the depository bank but it should not be the only actor to be under the spotlight in this case.
Godefroid: Yes, but the industry regulators are approaching it the other way around, but they’re going for the depo bank.
Veillet: Yes, so we need clarification anyway.
Gandy: We’re talking about Madoff being used as a sub-custodian. It does highlight the need for ‘look through’. Ucits IV is addressing this. In a fund of funds, master feeder environment, you need to be able to look through and make sure there actually are assets in the master or the underlying fund it’s invested into. All fund of hedge funds and funds of funds should have been looked at to question if they are as comfortable as they should be. This is directed to the fund manager, the Sicav board, and also the depository.
Funds Europe: Let’s put Madoff aside and move on to talk about more positive developments. Will Luxembourg be successful in attracting fund managers to domicile Chinese QDII funds here? If so will the custody & asset servicing roles be stretched significantly or do processes fundamentally stay the same?
Gandy: Things have obviously moved forward, we have the Memorandum of Understanding you referred to. The market there went very quiet during the crisis and there were no allocations from the CSRC to the local domestic custodians. They’ve made some allocations in the last few months and the structure is to invest in well-performing foreign funds. Looking at the current exposure and penetration that Luxembourg funds have in Asia, the region already has a comfort level around such funds, so I would expect that to be the case. The unanswered question at the moment is the volume and when.
Denis: BNY Mellon in its commitment to this industry regularly sponsors and takes part in the yearly Alfi and LuxembourgForFinance (LFF) financial road shows, colloquially called ‘economic missions’. The latest one being the LFF Asia Tour last October where we covered Hong Kong, Singapore and Beijing. Asia, specifically Hong Kong, Singapore, Taiwan and Japan, are mature markets for Luxembourg-domiciled funds hence the importance of these economic missions to update key markets on relevant topics on the Luxembourg financial centre and the investment fund industry. The hot topic of this last Asia tour, particularly in Beijing, focused on QDII schemes. We described QDII schemes in the context of using Luxembourg Ucits for indirect sales to Chinese investors. Luxembourg Ucits are eligible for QDII portfolios and can be promoted by banks, fund managers and securities firms in China. We believe there is a positive trend and huge potential for the future in QDII schemes where Luxembourg, as a fund domicile, can be used by international groups to obtain exposure to the Chinese market.
Letting Alfi statistics speak for themselves, where most foreign-domiciled funds distributed in Asia are Luxembourg funds, what is also interesting to note here is the increase of Asian asset managers that currently have a Luxembourg-domiciled fund product range. To date, there are 16 Asian asset managers who hold 200 funds with assets under management of approximately US$34bn (€24.8bn). This trend is not set to stop. Most of these AuM are currently serviced by Luxembourg-based administrators, who have fund servicing hubs across various Asian countries, particularly in Hong Kong, Singapore, Taiwan and, most recently, Malaysia.
It should be pointed out that most of us practitioners who have servicing hubs in Asia also serve domestic products such as QFIIs and QDIIs today. We assist in the structuring and launch of these products and follow with the administration of these, as required. We service these fund types within time zone, local language and support the local operating requirements.
Funds Europe: So, since you already service these types of funds, from other locations, would you say it wouldn’t stretch your capabilities much, were they to be domiciled in Luxembourg?
Denis: No. For us it is another product type that we are required to serve but let us not forget that it is a new emerging product and we must ensure that we have the optimum administration and servicing capabilities to support these.
Bock: And to be able to understand. There are specific needs that are to be understood and I can also confirm I don’t see an extreme difference. I come back to the education. China is very focused on itself, it has a booming market and Asia, as a region, is a booming economy. It’s about fostering a trust [among Chinese investors] that investments outside of Asia can also have some effect. That’s where Luxembourg can bring its brand name in. Hong Kong will also try to attract QDII schemes. It’s also about having a more international approach to distribution and dedicating efforts to making products as attractive abroad as they are in the domestic market.
Godefroid: Today the vast majority of foreign funds domiciled in Luxembourg are distributed in Asia. The Asian funds market is still evolving and as yet there is no real Ucits equivalent. As such, asset management companies are using Luxembourg-based Ucits to access Asian markets.
Moreover, as Asian markets open up and invest outside of their region we will see monies return to Ucits funds. Any upward movement in this area is seen as business as usual for a global provider such as Citi. What is important for managers with a global distribution focus is that they have a partner with a direct presence in all regions who can implement their cross-border Ucits distribution strategy while continuing to manage costs and launch new products.
Gandy: Having been to China and discussed with the CSRC and asset management companies, the CSRC has put the responsibility of trustee on the domestic custodian, for which you have to have a domestic custodian licence.
This is a new area for them because they’ve had that responsibility before but only for domestic assets and subsequently they’ve gone into Hong Kong. With QDII, they’re able to go on a much wider basis so they will be looking for funds that they’re comfortable with, that are in a regulated environment. Also from the likes of our organisations they’ll be looking for assistance in how they discharge those responsibilities on a wider basis. So from a Luxembourg point of view, there’s a lot that can be given into that market to assist it in its growth.
Denis: China is a very dynamic country and is seen as a new frontier for most global fund groups today. From an investment funds perspective, a lot of communication and education has already happened across numerous financial conferences in China over last three to five years. The Chinese are quite knowledgeable on investment products; however, there needs to be some hand holding when it comes to the asset servicing aspects of this industry. Luxembourg players can and do play a major role in this knowledge-sharing process today.
Gandy: Particularly regarding pricing and things of this nature, which they’ve not had to deal with before, such as global portfolios.
Funds Europe: Where do participants stand on the EC’s intention to centrally clear OTC derivatives? Does the location of the CCP matter to Luxembourg?
Gandy: Clearly within the EU this is one of the tools, and potentially the major tool, to control OTCs. We’re almost back to where we started in the discussion: what is the exposure? Where are the record keeping and control processes?
Again, the whole focus is going to be around how all of these are recorded. There are one or two processes and systems out there, but it seems there will be regulation introduced this year, it will make it mandatory that if you do not clear through the CCP you’re likely to have to put up more capitalisation behind it, which is again added incentive to drive it down the CCP route.
These have existed before but from the buy side, the access hasn’t been there. From an asset servicer point of view, we will support what our clients want. One of the questions will be ‘geographically, what is the impact?’ The EU has made a very strong case that it must be in Europe for European assets. All of us within the industry will welcome this additional control environment.
Godefroid: But isn’t it a sort of a paradigm shift away from the traditional view that derivatives are financial instruments for professional use and thus require only light-handed regulation? The Commission proposes a comprehensive approach that will ultimately enable markets to price risks properly. We cannot afford another situation where the risks of the financial sector are ultimately borne by the taxpayer.
I’m sure the industry will support it. While it is an ambitious and convergent international regulatory outcome it is in line with the objectives agreed at the G20 meeting last September. The expected enhancements in market integrity and oversight will be for the benefit of everyone. Overall, I would expect the legislation surrounding these issues will fundamentally change not just the derivatives market, but will have many spill-over impacts into other parts of our businesses.
Veillet: I think the issue goes beyond the CCP for OTC derivatives. We believe the financial crisis gives us a unique opportunity to rethink the market infrastructure in Europe, which has not grown the way the industry wanted it to. It’s still very fragmented, operationally; it’s not as secure or as STP as we would have liked it to be. We believe that we should work on the whole market infrastructure, define what we really want and begin working in that direction.
When we speak about putting a CCP for this, a CCP for that one of the dangers is that we’re going to end up with a market that is even more fragmented with lots of different CCPs. If this happens what about the interoperability between all those CCPs? And the additional risks that it will bring?
Bock: It’s a framework and though I’ve nothing against frameworks, it just depends how it’s designed. We have talked a lot about regulation. I don’t think that regulation should control everything, but regulation and Ucits are the proof of test, among others, that by putting a smart framework in place which leaves some flexibility is welcome. Regarding the CCP, for us it’s not really a question of yes or no or where, but it’s the right design. If you have ten CCPs for the same type of product it will probably be a mess.
Gandy: What politicians/regulators are looking for is reporting, to see the exposure which wasn’t there before. It’s the transparency. What may happen is that they’ll come out with a regulation, we’ll see a number of them set up and then we’ll see them starting to merge together, in a progressive process.
Bock: You just need to make sense of the transparency, because in the end sourcing a lot of information is one thing, but you need to be able to draw certain conclusions from it. Of all of the various challenges we will face as providers or as actors in the asset management space, it’s good to have the expertise to make sense of all the information you are gathering and draw the right conclusions, maybe even anticipate something. This is something that goes across all these topics; what do we make out of all of this? Not just what have we learned?
It’s easy to say, ‘I fell down these stairs and I will never fall down these stairs again’. But you need to learn something more…
Veillet: Like, what could be the next staircase we could fall down?
Funds Europe: What about your outlook for 2010/2011. What are the issues you think will be critical for Luxembourg?
Gandy: Luxembourg has a very good brand. Ucits itself as a brand needs to get through this regulatory change. We need to make sure we have a proper working model that assigns the responsibility in the right places so that we don’t do anything to damage the Ucits brand. But overall, considering the infrastructure and the way it works, Luxembourg is in a very good position.
Godefroid: The increasing importance of global distributor support reflects Luxembourg’s heightened role as a hub for international retail fund distribution. Ucits is still the only truly global fund product, but only by having the full service offering on hand and the right expertise available in Luxembourg and your target region can we continue to make Luxembourg a success in the future and meet future challenges head on.
Bock: Also, it’s about Luxembourg being able to position itself as a centre of excellence in exporting the know-how. It’s not just about being present locally but it’s more a knowledge hub and not just an outsourcing hub.
These are exciting times because there are lots of opportunities to prove ourselves as providers, as Luxembourg. Apart from attracting business, I think this is what is key for 2010 and 2011.
Denis: All of us around this table have put in a lot of investment over the last 10 to 15 years, to become a global fund services platform which ideally put Luxembourg on the map as a global fund administration centre of excellence today. This is something for which we can all pat ourselves on the back. But we can never be sitting on our laurels. The fund services industry is a fast moving train in that it has to continuously absorb all the elements that impact not only the global fund industry but financial services as a whole.
For instance, the advent of T2S [Target2-Securities] and the imminent changes to the CSD model will bring great infrastructure changes across Europe and the asset servicing world as a whole. As practitioners, we’ve always managed to be on that train and kept up as best as possible with the developments. That’s not going to change any time soon.
It’s about time though that the industry recognises that service providers put in a lot of investment, across all operational dimensions – people, organisation, processes and technology – to continuously strive to be at the forefront of the developments of the global fund industry. With infrastructure being a key theme at the Alfi Spring Conference this year, it is indeed an opportunity for us to bring this forward.
Veillet: We will see an attitude that will be much more balanced between the asset managers and the service providers. The term service providers will probably find its full meaning now.
Denis: As mentioned previously, the service provider is no longer considered just a back office that maintains the administration of a fund but a key partner that support an asset manager’s asset growth strategy, emerging investment products, servicing their investors and global fund distribution framework, anywhere, any time in the world.
Veillet: Yes. During the crisis we demonstrated that we were more than just back offices. The crisis brought substance to our claim. For 2010 we think we will continue to see consolidation in the industry among clients and service providers.
- Josée Denis, vice president Emea sales & business development, BNY Mellon Asset Servicing
- Fabrice Godefroid, head of securities and funds services, Citi Global Transactions Services
- Tim Gandy, managing director global head of fiduciary & compliance services, JP Morgan Worldwide Securities Services
- Martin Bock, head of product management, RBC Dexia Investor Services Luxembourg
- Régis Veillet, head of sales and client relationship, Société Générale Securities Services Luxembourg