A new working group intends to bring automation to the alternative funds market. But why should this plan be successful, asks Nicholas Pratt, when others have failed?
In September, an announcement was made that a working group had successfully developed a messaging framework to address one of the longstanding processing issues in the funds industry – the automation of alternative funds.
The Global Alternative Investment Association (GAIA) comprises seven members – a mixture of fund administrators, custodians and market infrastructures including Euroclear, Clearstream, Depository Trust & Clearing Corporation, JP Morgan and Northern Trust, all facilitated by consultant Idea Group, led by former Swift executive Bill Gourlay.
The group’s ambition cannot be doubted, as underlined by the choice of acronym – Gaia, the primordial Greek mother goddess. However, opinion is divided as to whether it is easier to give birth to the Earth and the universe than it is to remove faxes from the alternatives market.
“The objective of the group was to develop a set of ISO-based message standards for alternative funds,” says Gourlay. “For the last ten to 15 years, hedge fund administration was seen as too difficult to be automated. But as regulations like AIFMD [Alternative Investment Fund Managers Directive] have looked for more transparency, it is crazy that faxes are still being used. And I think investors would be surprised that this is still happening.”
This is not the first time the industry has tried to address the problem of automating alternative fund processing. Back in 2009, the Swift-led SHarP initiative fell by the wayside. On the one hand, the timing was unfortunate. There was little hope of generating enough industry involvement and interest in message protocols during a full-blown financial crisis.
The SHarP initiative also made the mistake of trying to do too much in too short a space of time and with too many participants, says Gourlay. “This time around we looked at the types of flow that could be most easily automated rather than trying to do it all in one go. We also decided to keep it small and tight in terms of membership and kept it to who we had to have in the room to be credible. We also kept the work confidential until we had something tangible to release.”
The messaging standard is initially applicable for subsequent subscriptions and redemptions, as opposed to initial orders. Whereas the latter process tends to involve a 60-page document full of legal and regulatory requirements around identity and tax status, the former process is simply a confirmation of status and one that can be easily automated.
The messaging formats have now been made public and are free for various participants to use and develop. Meanwhile the various GAIA members will now focus on testing the message within their own systems and ensuring it can be taken from their own back office to the messaging systems of their clients via Swift and any other network that might be employed.
Gourlay says that GAIA has taken a business-focused approach to the development of the messaging formats. The fact that they are based on the ISO 20022 standard means that they can be used by the same systems used for mutual fund messaging.
“To be able to use the existing mutual fund framework is really important,” says Gourlay. “It has saved the industry more than two years by using existing ISO 20022 messages rather than having to register new ones.”
SMASHING A MYTH
So what happens next? “We are currently testing to see if there is any gap in the business logic and we hope to be able to have live messages before the end of the year,” says Lauren Hurson, director and hedge fund product manager at Euroclear, an international securities depositary.
“There is a huge appetite for straight-through processing (STP) in the alternative space. Many firms have been looking at increasing automation for a long time. Third-party administrators do not want to deal with paper any more. We’ve also done a lot of work to get fund managers on board as well. We’ve smashed the myth that change is a costly process that is full of legal issues.”
The fund prospectus will set out the ways that investors are able to initially and subsequently subscribe, redeem and switch and most alternative funds will state that this can only be done via post or fax.
But with GAIA, for subsequent subscriptions and redemption orders, paper does not have to be filled out again, says Hurson. It is possible, via a side-letter or addendum, to allow the fund to accept electronic messages.
Next year the focus will turn to ‘switches’. Eventually the hope is that the automation of initial orders can also be addressed, says Hurson. “Previously regulators were not open to the idea of automating this process. A lot of emphasis was on the Know Your Customer elements. But with the likes of Esma [European Securities and Markets Authority] and AIFMD pushing for more transparency and more efficiency in the operational side of the market, I think we could reopen that discussion.”
Ever since it bought Citco’s hedge fund-processing business in Ireland in 2014, Clearstream, another international securities depositary, has looked to be part of any industry initiative hoping to bring more automation to the alternatives market, says John O’Mahony, head of product management, investment fund services at Clearstream.
For hedge fund investors, the benefit of automation may not be immediately visible, says O’Mahony. “It will be of more benefit to the TAs [transfer agents] and the custodians initially, but the end investor will benefit from the fact that their orders will get processed more safely and more efficiently than would be the case with a fax. The automation removes certain risks for the investor.”
The GAIA messaging formats will be added to the range of processing options that Clearstream currently offers. “We will now be looking to adapt our framework so that we can generate the automated message once we get that initial order processed and settled. After this we will then be able to send automated messages efficiently for any subsequent orders,” says O’Mahony.
Work has already commenced with market participants to align the messaging solution. Clearstream hopes to see a larger uptake across the market in the next 12-18 months.
EFFICIENCY FOR ALL
The next step is adoption. Technically the message format can be used across the entire hedge fund world from the largest administrator to the smallest investor, says O’Mahony. “It has the ability to create efficiency for anyone in the market.”
This includes the high-net-worth individuals (HNWs) that place only a handful of large-value orders every year and they are typically delivered via fax. There is no reason why this cannot be changed, says O’Mahony. “You also have to consider the risk involved with the process. Yes the HNWs are looking for high customer service, but that surely includes minimising the risk of manual processes. They want to be sure that they are in an efficient and risk-free process.”
So while the GAIA members are busy promoting the project, how have other providers in the space reacted to the news?
“It’s hard not to be in favour of anything that is trying encourage standardised processes and, in principle, we are supportive of the initiative,” says Paul Fox, chief commercial officer with Markit-Information Mosaic, a supplier of post-trade processing software to the investment industry.
The big task will be getting all the smaller players connected, says Fox. This involves a lot of investment. A messaging standard is a piece of the puzzle but it’s a long way from reaching efficiency. The messaging standard is the equivalent of a data format. There are market practice groups in every area of securities processing that will ultimately decide how best to interpret these message formats.
Although the GAIA members have made much of the fact that the message format can be used on existing mutual fund processing systems, others do
not see much of a crossover between mutual fund and hedge fund processing.
“There may be convergence with the likes of alternative Ucits funds and the two are coming closer together with more institutional investors looking to include more alternatives in their asset allocation, but the two markets are traditionally very different,” says Keith Hale, executive vice president, client and business development at Multifonds, which provides accounting and transfer agency software. This difference is most noticeable between mutual fund versus hedge fund distribution, says Hale.
“For example, an HNWI investor or family office investing in a hedge fund won’t have an automated connection, such as Swift, and given the small number of very high value transactions, they would expect the fund and service providers to happily accept their orders in any format such as faxed orders or email.”
However, mutual fund distribution is quite different, with banks and fund platforms dominating European mutual und distribution. Given the massive scale of distribution, STP is more important.
That said the institutionalisation of alternative funds, and the growth in popularity of absolute return funds like alternative Ucits products, is causing these operating models to converge. “As a result, GAIA is likely to be a slow burn rather a rapid change,” says Hale.
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