Christine Senior asks whether funds straight-through processing will ever equal that of equities and bonds
The search for the holy grail of immediate delivery and payment for settlement of investment fund transactions across borders in Europe continues. Straight-through processing (STP), which is taken for granted in transfers of equities and bonds, remains elusive for funds, though progress continues step by step.
Investment funds have no equivalent for the central securities depository in the equity space which stands between buyers and sellers of equities and eliminates manual processing.
The whole structure of subscriptions and redemptions of funds takes an entirely different form from buying and selling equities. A subscription to a fund involves the creation of units, while a redemption involves their destruction. By contrast an equity, created at a company’s flotation, remains in circulation, merely passing from one holder to another as it is bought and sold. So there is little common ground between the two processes.
In addition, fund sales are subject to multiple hurdles raised by around 30 European regulatory bodies and tax regimes, and to innumerable different product providers each with their own individual ways of working. It is Luxembourg and Dublin, as centres for domiciling investment funds in Europe, that stand to benefit most from increased STP for funds, as they see the greatest demand from investors outside their own jurisdictions.
Barriers to full automation
But barriers to full automation block progress. One big obstacle is the distribution system, which needs to take account of commissions due, says Ivan Nicora, head of investment fund product management at Euroclear.
“At any point in time you need to know who has bought what for how long, and that will dictate how much commission is due,” he says.
But the push for more efficient services and the consequent cost savings is driving the process forward. One powerful influence is the effect of open architecture over the last few years, with increasing sales of funds from third-party providers.
“As soon as you begin to offer funds from other fund providers then there comes a point you have to be able to handle different practices, different time zones, different cut-off times,” says Nicora.
Euroclear’s own automated system FundSettle is one of the two leading platforms for cross-border sales.
Automation among distributors of funds has reached 100%, while on the other side STP levels have risen to over 90% for communication to and from the transfer agency community, says Nicora. More than 35,000 funds, spanning 22 domestic markets are eligible for processing on FundSettle, and more than 470 transfer agents are connected to it.
Fund providers must sign up to Euroclear’s standards to achieve full automation, but a two tier pricing regime is an incentive, he says.
Rival Clearstream’s system consists of two separate components which can each be used on a standalone basis: Vestima+, to handle the order routing, and Central Facilities for Funds (CFF), launched in March, to handle the settlement. CFF offers a post-trade solution for investment funds domiciled in Luxembourg and is currently being piloted by two firms, Schroder Investment Management and Pictet & Cie, but another ten firms will be added over the coming weeks.
Philippe Seyll, director of Clearstream’s investment fund business, claims this now makes settlement of investment funds comparable to the system already operating for settlement of equities and bonds.
“If clients want to, Vestima+ can take care of the generation of settlement instructions for settlement to take place in a centralised place called CFF. In doing so we are making the subscription and redemption process for investment funds very similar to the one that exists on the bonds and equities side.”
As well as reducing costs for participants, using automation also increases efficiencies by cutting out the margin for error inherent in a manual system. Transfer agents using CFF pay e4 per settlement, which compares favourably with other ways of settling.
“It is cheaper and more efficient, and at the same time it brings few reconciliation issues,” says Seyll. “Because CFF operates a trade-date matching process, which, if everything goes well afterwards, eliminates the need for reconciliation.”
Harley Murphy, head of offshore administration at Mellon, says the two systems differ in their structure, with Clearstream owned by Deutsche Böerse and FundSettle owned by users.
“While Clearstream has a large number of established clients across Europe the strategic appetite appears to be to grow use of its platform outside the EU, with new clients in Africa, the US and fast growing Far East and former Soviet block countries. Euroclear is more focused on members’ interests in the markets across Luxembourg, Ireland, Belgium, France and the Netherlands and has recently taken over EMX in the UK.”
But the existence of the two separate platforms is something of a hindrance to more automation. With the EC working towards more harmonisation of the European financial services market, Vestima and FundSettle face the EC’s code of conduct for clearing and settlement.
“If the move towards greater automation and standardisation is to take place without legislation being passed then future consolidation between platforms could be inevitable," says Murphy.
Euroclear and Clearstream are not the only organisations to have advanced the STP process for funds. The ISO standards from Swift have been a vital element. Its latest messaging system ISO 20022 is a system of 54 different messages that Swift has built in association with the industry to cover the flow of communication throughout the fund transaction process. Swift has taken a pragmatic approach, using what already exists to take the process forward, says Edward Glyn, commercial manager, investment funds, SWIFT.
“We have talked in detail with the types of organisation that will be using the standard,” he says. “Rather than debating at industry level what they think is the best thing to do, we have worked with the institutions themselves, with distributors, manufacturers and service providers and worked out how we are going to use the messages among one another to promote a harmonised and standardised community.”
The operational side of cross-border sales has been neglected, adds Bill Gourlay, regional head of fund markets at Swift. “People tend not to focus on this area of business because it’s not seen as the most exciting, but look at the amount of savings that can be made. We are looking at potentially e25-50 to process a fund purchase in Europe against literally cents in the US market or eurocents if you do it using a Swift message.”
Robert Head, senior product manager for mutual fund settlement at JPMorgan Worldwide Securities Services, comments that some participants can get by perfectly adequately without more automation. The big German banks can process settlement through an account with the international clearing system. “It can be book entry, they don’t need to take delivery of physical certificates, and they can maintain their relationship with their clients who may be retail or smaller broker clients,” he says. “There is no particular pressure from that part of the industry to resolve settlement because it’s working adequately for them at the moment.”
The UK market
The UK market faces its own problems, particularly from its complex distribution process. Gavin Davies, a business development director at Mellon’s asset servicing business, says only 10% of sales benefit from STP efficiencies, with the remainder split between post, telephone or even faxed orders. A forum of third-party administrators consisting of Mellon, Bank of New York, IFDS, BNP Paribas and Capita, together with platform providers, is striving to bring some consistency and standardisation to the market. One important decision has been to support adoption of the Swift ISO 20022 standard. Another initiative has been to divide the type of clients administered into types – direct retail, introduced retail (via an adviser) and institutional – and set an optimal model for dealing with each.
“For direct retail investors simple things can be done,” says Davies. “We are working with BACS in the UK to work out how the settlement cycle could be truncated so when investors make investments into a fund, instead of getting a cheque we do a one-off direct debit against an account as and when an investor trades.”
So will mutual fund settlement ever get to the same level of automation as equities and bonds? JPMorgan’s Head thinks it is possible. “I think the funds market will get to it,” he says. “The market may eventually move to a pan-European exchange for mutual funds with a connected settlement engine. If you had an efficient exchange mechanism you would need an efficient settlement mechanism, a parallel to equity and fixed income markets.”
© fe September 2007