A chain is only as strong as its weakest link. Investors expect every step in the fund transaction processing life-cycle to be robust and transparent. Does this call for superhero powers or is there another way?
It is a changed world since 2008. The advent of the Alternative Investment Fund Managers Directive (AIFMD) and UCITS V has generated an intense oversight for fund managers and explicit liability for custodians. That, in turn, has put the spotlight on other service providers such as transfer agents. New ‘know your customer’ (KYC) rules have increased the compliance challenges for distributors and fund managers alike, as well as put a premium on transparency in fund transaction processing. As a result, institutional investors are increasingly demanding full asset segregation.
In the UK, the Financial Conduct Authority’s new Client Assets Sourcebook (CASS) rules demand heightened levels of clarity and efficiency in the movement of cash from the investor to the fund (or vice versa) and in the subsequent reconciliation of holdings. Firms must be able to show they have the systems and processes in place to protect client assets, and that everyone from senior management downwards understands the rules/regulations and how their firm is complying with them.
SEAMLESS COMPLIANCE IN A SEGREGATED ACCOUNT STRUCTURE
An effective fund processing solution has to accommodate all of these different requirements, delivering seamless compliance for its users. In order to meet the CASS requirements, there must be transparency at every stage of the process, and KYC requirements state that compliance checks should occur at each stage in the processing cycle rather than rely on any ‘after the event’ messaging to correct mistakes on the part of distributors or fund managers. Furthermore, there is a real need to meet the increasing demand for segregation. The question is, ‘Do you have a solution in place to meet this requirement?’
Naturally, systems built specifically for the investment funds industry will have the necessary compliance checks built into every stage from pre-trade onwards. Each fund manager has a number of sub-accounts, each of which corresponds to a different distributor. Not until the fund manager has authorised the opening of a new account at its transfer agent can a new distributor execute an order – thus minimising the potential for ineligible investors in the system from unauthorised distributors or an intermediary such as a transaction bank.
This is radically different from the omnibus model, which requires parallel reporting by each participant in the chain – which can only come after the event.
To deal with an ineligible investor, the fund manager must unwind the transaction.
“There is a substantial frictional cost here,” says Elisabeth Meyers, Director, Global Product Solutions for Investment Funds at Euroclear. “Worse, retrospective fixes can be damaging to a relationship.”
Transparency at every stage of the transaction cannot be overestimated. As well as meeting regulatory demands, it improves the accuracy of the information and makes the system more resilient to errors. “It is also worth noting that the fund manager gets a clearer picture of when and to whom new fund units have been sold and does not have to wait for the generation of claim and exchange reports or the reconciliation of transaction flows,” says Ms Meyers.
TA MONITORING AS PART OF THE PROCESS
Driving risk out of the fund processing life-cycle is about more than just the settlement processes. It is also important to ensure that every party in the transactional chain operates to the same high standards. That requires those involved in fund transaction processing to work not only with fund managers and distributors but with the TA’s too. Although, there is not necessarily a contractual relationship between the provider of settlement services and a TA, fund distributors will often turn to that provider for help in assessing the calibre of the TA’s own operations and systems as well as other aspects of its business. This is particularly relevant where funds of funds are involved.
The leading industry initiative in this area is a collaborative solution between a group of depositary banks and consultants – Thomas Murray – and is intended to help custodian banks demonstrate that they have undertaken the due diligence work on TAs (as required of them under the AIFMD). At Euroclear, we consistently monitor the 700-plus TAs with whom we operate as part of our risk management processes. Whenever we have concerns, we immediately bring them to the attention of the fund manager.
In summary, a transparent, segregated processing environment offers participants a degree of control that is impossible to achieve in an omnibus structure. It has the potential to offer an element of future-proofing. The maintenance of tight control and full visibility over cash and assets is central to much of the current regulatory effort, and will remain so for some time to come.
©2015 funds europe