Nicholas Pratt looks at an initiative to trade investment funds on Germany's stock exchange that could bring down costs associated with transfer agency.
The cost, transparency and efficiency of the fund processing chain has been a constant issue and has divided opinion. Opinions are not unanimous when it comes to the best way to achieve improvements.
Different viewpoints are inevitable given the variety of fund structures and investor types. There are also a number of intermediaries involved in the processing chain, all of which add value of some kind, but which generate cost. So it is unsurprising that some intermediaries in the chain are looking to provide new forms of either distribution, settlement or execution in order to give investors more options for processing funds.
One of these options is to trade funds on a stock exchange and this is something that has been developed jointly by Deutsche Börse and by Clearstream, its settlement and custody division. Vestima+, the automated order routing service provided by Clearstream, will offer investors the opportunity to connect to Xetra – Deutsche Börse’s electronic trading system – and to clear these trades via Clearstream’s post-trade infrastructure Central Facility for Funds (CFF). Any current users of Vestima+ will be able to consolidate their mutual funds business with their exchange traded funds (ETFs) activity.
“We started this because our clients requested an alternative way to access investment funds,” says Philippe Seyll, head of investment fund services at Clearstream. “They want to avoid waiting two days for executions to be confirmed, particularly when it comes to redemptions. If a manager has made the decision to get out of a certain fund and invest money somewhere else, the faster that happens, the better. They want certainty and the ability to invest in something else immediately.”
For Xetra, it is simply an extension of its distribution network, says Rainer Riess, managing director, Xetra market development at Deutsche Börse, making it more accessible to overseas investors and to increase the volume on the exchange for both retail and institutional markets. “The immediacy of execution, high level of transparency, straight-through nature of the processing and the cost efficiency are all big attractions,” says Riess.
It is common in the traditional, transfer agent-based distribution model for managers to pay between 300 and 500 basis points per transaction for front-loaded fees. By trading directly on Xetra, the total cost of execution is closer to 100 basis points. Whereas the institutional market is more about tailor-made, closed funds, the real-time execution in volatile times will be both more efficient and less costly for retail investors, says Riess.
Funds traded on exchanges could also be of interest to investors outside Europe, particularly in Asia where there is a growing interest in ETFs, but particularly in Ucits funds. In 2010, more than €100bn worth of assets were traded from Asia in the cross-border funds centres of Ireland and Luxembourg. The problem that Asian investors have with traditional distribution channels is that they are high on expense and low on efficiency.
“If a fund manager in Asia gets a new client with a new portfolio, it may contain ten different funds,” says Seyll. “If they insist on keeping this portfolio, then all the information on these ten funds has to be gathered. Alternatively, if the fund is liquidated, a similarly arduous process has to be undertaken. Either way, it works out as being very expensive. However, simply going through Vestima+ makes these processes easier and cheaper.”
The time-zone difference is an important issue for the increasing number of Asian investors that are using European funds more as trading instruments than long-term investment vehicles. “For Asian investors, the average holding period for a fund is between three to six months, rather than one to two years as it is in Europe. Consequently, Asian investors want more timely information regarding the price of their funds and do not want to wait overnight before they can get a quote,” says Seyll.
The service was announced in January 2011 and is already fully operational. There are a few clients in Asia and Europe testing the system and the hope is that these initial flows will capture more as the clients become public (possibly some time in Q3 of 2011). The order book turnover in the 2,800 mutual funds listed on Xetra reached €1.69bn in 2010. Meanwhile, Vestima+ processed more than €130bn of plain money market fund assets. Xetra also holds the largest share of the ETF market in Europe (37%) with more than 800 listings and a 2010 order book turnover in ETFs of €154bn.
The vanilla money market funds traded on exchanges would be of most interest to Asian investors, while in Europe, the large number of ETFs available on Xetra would be the main attraction believes Seyll.
“Vestima+ would be a way for mid-sized banks to gain access to the ETF market,” he says. “This access can be difficult because you need to hire a broker in each market. But if you use Vestima+ for your primary market trades, you may as well use it for ETFs as well because it enables you to access multiple markets. For example, you can buy an ETF on a German exchange and then sell it through a French exchange.”
Clearstream’s exchange project will initially involve its Deutsche Börse stablemate Xetra, although Seyll says it is not an exclusive project and Clearstream is open to talking to other exchanges and execution venues. Ultimately, the hope is that Vestima+ users will be able
to connect to the international stock exchange of their choice via an execution agent. However, should the NYSE Euronext and Deutsche Börse merger be completed (as it is expected to be), there might be little need to involve any venue outside of what would be the biggest exchange in the world and one that will house more than half of the world’s ETF market (57%).
Clearstream and Xetra are also hoping that the exchange initiative will lead to a greater use of funds as collateral. “There is around €700bn of collateral in funds right now and if that was made available it would allow investors to collateralise in a more efficient way,” says Riess. “Given the pressure on banks to hold greater capital in reserve, the use of collateral will be more important than ever in the next few years.”
The users of the funds as collateral service are mostly arbitrage traders and fund of fund managers, says Seyll. “The crucial aspect in any deal involving collateral is timing. You do not want to be undercollateralised at any point. If a fund is traded on an exchange, you get the certainty and transparency about the funds value and you have the ability to use that fund immediately for collateral purposes.”
Not all participants in the funds market are in favour of trading funds on exchanges. Some see a fund as a financial product designed to act as a long-term investment vehicle and not as an instrument that can be traded on a short-term basis. The concern is that efforts to bring more innovation to the funds market through the likes of ETFs and the use of funds as collateral may affect the core properties of a mutual fund.
Seyll says the argument is irrelevant for Clearstream. “I am a plumber and I need to offer whatever the client wants, which is an easy way to access the ETF market and an alternative way to buy and sell cross-border, money market funds. We have 85,000 funds now on Vestima+. Whether the clients asks us to buy into a fund on Vestima+ or a fund on a stock exchange makes no difference to us because we make the same amount of money on both transactions.
“We have launched this service purely because our clients have been asking us for an alternative. When that demand gets bigger, we will be there to capitalise on it.”
©2011 funds europe