Funds under fire
The funds industry is going through a time of great change, with a combination of regulation, cost pressure, consolidation and globalisation forcing many participants to take a close look at their business and operating models and consider what their future role in the ecosystem should be.
For some, this means outsourcing activities, creating opportunities for others – BNP Paribas Securities Services, for instance, has launched its global Dealing Services solution in the UK, providing institutional investors access to a global network of BNP dealing teams and technology, and covering all asset classes.
Introducing the service previously available in Hong Kong and Paris, Carl James, managing director of BNP Paribas Dealing Services UK, said: “The raft of regulatory requirements has, and will have, a dramatic impact on markets, market infrastructure and their participants. We continue to see the search for liquidity get ever harder as markets fragment and banks withdraw further from putting balance sheets at risk.”
The cost of technology is a big factor in the attractiveness of such offering, said Keith Hale, executive vice president of client and business development at systems vendor Multifonds. “Prior the financial crisis, there was a massive bull market; everybody wanted into every asset class and product, and just looked for technology to get into those markets almost without considering the cost,” he said. “Fast forward to now and people have realised that having a spaghetti of systems makes it a lot more expensive to maintain the underlying systems and operations so there has been a lot of focus on consolidation, including internally within banks. People have consolidated their platforms and we’ve been a beneficiary of that. People are seeing that having one platform is a lot better from a cost of ownership perspective of the software. And when you’re doing regulatory change, having to do it across just one system is a massive financial benefit from an operating model perspective.”
Regulatory change is one of the big issues in the funds area. In particular, the UK’s Retail Distribution Review and the European Union’s Alternative Investment Fund Managers Directive.
The former has had a significant impact in the UK, removing so-called trail fees – money paid by fund providers to financial advisers as commission for recommending products to consumers. The AIFMD is aimed at the hedge fund market and will involve considerable change at the depositary end of the spectrum.
On top of that, says Hale, there are reporting requirements coming in from other regulations such as the US FATCA and the Financial Transaction Tax that is being proposed in Europe and elsewhere.
“AIFMD is potentially a net benefit for the wider funds industry,” he says. “It will change the game a bit because it means more convergence between mutual funds, retail funds and alternative or hedge funds. The real shockers are regulations like FATCA and the FTT, which will end up hitting everyone in the funds industry – and will kill off any sort of export to Asia and Latin America. Why would you pay 10 basis points to a government that has nothing to do with you?”
In particular it will affect UCITS – Undertakings for Collective Investment in Transferable Securities – products, which can be sold freely in all EU Member States. “UCITS has been a pretty successful export from Europe to Asia, particularly in places like Taiwan. The FTT in Europe is going to hit that – funds domiciled in Luxembourg or Dublin are not going to be attractive to a Asian investo,r who will go for a local product,” says Hale.
The effect of all of these factors was the subject of a session at the recent Swift Business Forum in London. The background was neatly summed up by Stephen Mohan, managing director of the Cofunds fund platform: “I think there is going to be a great change in the value chain and we are all fighting for it.”
(Mohan has since left Cofunds to join Allfunds Bank, a B2B fund platform.)
This is manifesting itself in many different ways. “One of the interesting things on the risk side is that institutional businesses are much more aiming at discretionary managers and wealth managers,” said Mohan. “We are seeing that proportionally they are putting more and more of their assets into funds rather than into shares and distributing the portfolios in a more balanced way. At the front end, people are using model portfolios as a way of de-risking funds and using platforms, just to manage the risk issue.”
David Moffat, group executive, State Street/IFDS, said that UK retail funds have “become, by and large, “buy and forget” products” with people looking for multi-asset products, while in other countries there is “much more of a flow towards geographical- and asset-specific vehicles and the construction of portfolios for clients”.
Olivier Portenseigne, chief commercial officer, Luxembourg Stock Exchange, addressed the title of the session how do we move the fund industry into the 21st-century. “It is not an easy question,” he said. “The funds industry, from my point of view, is one of the least efficient industries I have ever seen, at least compared to other manufacturing industries.”
In order to move up the value chain – and provide risk management and market intelligence and operational support to asset managers – the industry needs to collaborate on certain processing aspects that are currently done redundantly in multiple organisations. Mutualising costs and collaborating on those services will allow us to move up the value chain.”
John Wallis, senior vice president, Brown Brothers Harriman Investor Services, said that cost was an issue, and agreed that collaboration will be part of the answer. “The average fund cost now in the US is 77 basis points and the average in the UK is 177 basis points. That’s quite a cost differential,” he said. “Some of that is going to be addressed through shared services, some of it is going to be through efficiencies and some of it is going to be through devices like Exchange Traded Funds. I think in the UK we are in a sort of petri dish: there is a very interesting experiment with RDR and whether that leads to a take-up in retail funds we will see, over the next five to 10 years, if ETFs take off. My own personal bet is that they will.”
The UK also faces changes to the way pension funds move between providers (see panel) that will result in significant operational changes in the industry.
Mohan was sceptical about the political timescales that have been invoked – one audience member said the industry had six months “to get its house in order” – and pointed to his experience with the development of the Tax Incentivised Savings Association’s TeX exchange, set up at the start of the year to help facilitate the electronic transfer of assets between platforms in compliance with RDR requirements.
“I was involved with that for nine, maybe 10, years and about seven of those years were about religious warfare before it was agreed generally what we had to do, then we had to go through the practicalities and the last year was to get everybody to do what they had to do,” he said. “We have just gone over the watershed where we have got to the point where you can move assets efficiently between platforms and fund manager. If you put the equivalent into the pension side, it would allow pot-following. It can happen, but it will take a long time to get people to realise that they have to find a way of everyone holding their noses and signing.”
Portenseigne said that getting vested interests to work together is a perennial difficulty. “This is an area that will require industry to come together but that’s not so easy,” he said. “There are questions of finance: who will play for it? Vested interests will protect what we call ‘profitable inefficiencies’.”
“Profitable inefficiency has ruled the day across any number of sectors,” said Moffat. “I think the industry is moving, but it’s probably moving at
Big Fat Pots – the big idea in pensions
The UK funds situation is skewed only by the Retail Distribution Review, which outlawed the payment of fees to advisors by funds providers – so called trail fees – but by wider political debate on the structure of the pensions industry. At the end of April it was announced that new rules would be introduced covering the management of pensions, which will create operational difficulties for the fund industry.
Pensions minister Steve Webb confirmed the government plans to introduce rules to allow workers to take their pension savings with them when they change job.
The average person has 11 different jobs during their career, and often leaves small amounts of money behind in a company pension scheme when they change employers, which in the long term means that they don’t track of all these pensions are not maximising their investments.
The government is concerned that its new policy of auto-enrolling workers into company pension schemes could make matters worse. It estimates that by 2050 there could be around 50 million dormant pension accounts held by former employers. To counter this, it plans to introduce legislation to allow an employee’s pension pot to follow them from job to job.
“When people change jobs they often leave behind a pension pot which becomes forgotten and which can even attract higher charges once they leave the firm. Instead of having lots of small pots all over the place, we want people to have a ‘big fat pot’ which will put them in a better pension,” said Webb.
a level that is not discernible to the general public or consumer. I really struggle to see how the commercial self-interest of companies that are struggling with margin pressures are going to suddenly turn into tree hugging consumerist organisations. This will be driven for them.”
Outside the UK, different pressures apply, though it seems likely that other European countries will adopt a similar approach to trail payments, commissions and rebates and retrocession fees, which are all seen to be unfair to the consumer.
“In Europe we are working with our customers to try to understand how the business model is changing and how strategic partners will start charging for services. There are a number of developments that we are doing around the infrastructure side and reporting,” said John Wallis, senior vice president, Brown Brothers Harriman Investor Services. “The problem we have as a global asset servicer is that, if the vision is to have a single platform that caters for global clients and global operating models, how that technology is can be switched on and off to cater for different markets.”
Given that the volume of European transactions fell 10%, and transactions are falling in unit costs each year, opportunities outside Europe are becoming increasingly important.
“The story is not Europe anymore; it is Asia and Latin America. Most companies we talk to have some desire to get into those areas,” said Wallis. “We have a big footprint there, and that’s where most of our growth comes from as a service provider and technology business. We innovate, but we innovate very carefully and try to focus on where there is a big efficiency gap in the market where we can do something meaningful. It is about careful innovation, not necessarily innovation for the sake of it.”