It sounds incredible, but sadly, it’s true. The cost to process a subscription or redemption order in a UK unit trust or OEIC can cost as much as 30 times that of a share transaction. How is this possible? It’s because most of the back-office work is done manually.
This is about to end.
Investment fund processing automation is taking hold of what is now a very fragmented, manually intensive and risk-prone market. Euroclear UK & Ireland, the central securities depository, and EMXCo, the UK’s leading provider of fund order routing, are combining forces to deliver the benefits of processing automation and standardisation to those who invest in funds domiciled in England, Wales, Scotland and Northern Ireland.
In addition to gaining substantial cost savings and mitigating operational risks, the UK fund market will also be able to shift from the norm of ‘cheque-in-the-post payment’ to fully secure book-entry settlement of fund units and cash. Moreover, full settlement of unit trust and OEIC transactions will be able to occur on T+4, i.e. four days after order placement, which is significantly shorter than current industry practice.
Lengthy paper trails
Today, investors typically send their orders via phone or fax to their financial advisors, who in turn add more paper to the chain when instructing the fund distributor to subscribe to or redeem a holding in a fund. Further downstream, the fund management company accepts and confirms these orders via a mix of proprietary electronic channels and/or fax, email or post, and will only settle the order upon receipt of a cheque for the right cash amount. Then the legal register has to be changed by the third-party administrator using physical forms to reflect the actual movement in or out of a fund.
This administrative nightmare will disappear with the introduction of automated fund-transaction processing.
Following work done by the Investment Management Association (IMA), together with both HM Treasury and the Financial Services Authority (FSA), a change in UK law has eliminated the need for paper-based procedures in transferring title in UK authorised funds by third-party administrators. In essence, product providers will no longer need to maintain paper records, such as renunciation of title or stock transfer forms.
Reduced risks
Settlement risk is greatly decreased because there is no manual intervention from the moment a fund order is placed by IFAs or fund supermarkets using the EMX Message System for order routing, to the moment settlement of the redemption/subscription order occurs at Euroclear UK & Ireland.
Furthermore, reporting and exception management is handled in a fully electronic way via the central processing hub. The fact that fund units can be sold and cash recouped within four business days makes for a very attractive proposition for investors that may not have considered buying into a fund due to the cumbersome and timely exit periods, should they need to change their investment strategy quickly.
Multi-faceted benefits of automation
The investment fund industry has gone through some stressful times recently. However, according to the European Fund and Asset Management Association, for the first quarter of 2009, positive net inflows into UCITS funds totalled £19 billion, compared with net outflows of £124 billion in the fourth quarter of 2008.
While the green shoots of recovery are welcome, cost and risk reductions are still top priorities for asset managers and distributors alike. Previously relegated as a back-office issue, fund unit processing is now highly topical and influential in gaining distributor support. Many have turned to neutral, third-party processing solutions to achieve greater operational efficiency at the lowest possible price.
Commission solution
One of the biggest headaches that distributors face in not being automated is correctly calculating and receiving commissions. When done manually, this is a painstaking process, as at any point in time distributors, fund promoters and others involved in the transaction need to know exactly who has bought what and held it for how long. Parameters like these dictate the commissions due. Furthermore, as investment strategies increasingly go beyond domestic market funds, distributors often need to manage complex client account arrangements across different markets and time zones for commission calculation.
In electing to use an automated processing hub, all of these commission-based challenges can become a great deal easier. The central hub automatically collects and routes orders from the fund distributor to the relevant fund promoter’s third-party administrator (TPA). Some processing hubs enable TPAs that are linked into the hub to precisely see the portion of activity that has emanated from individual distributors for each and every fund for which the TPA runs the books. Much improved reconciliation capabilities are part of Euroclear UK & Ireland’s new service. Position tracking will not only be more accurate, but more timely as well, improving the overall process and removing expensive errors.
Efficiency gains
Via the use of an automated infrastructure, TPAs can accurately calculate commissions due and payments can be credited electronically and expeditiously to distributors and others in a matter of days. This is in contrast to delays of weeks, or sometimes months, in cases where the TPA has to collect a stream of different reports from a variety of sources before being in a position to manually calculate commissions on a spread sheet.
Promoters are growing impatient, and rightly so. They are applying pressure, particularly given current financial market conditions, on distribution partners to embrace automation which will reduce errors and speed up commission calculations. Fortunately, many distributors are listening and making processing automation a top priority.
Already, more than 50% of the European fund industry that links the sell and the buy side have accepted the age of automation. They have been convinced of the tremendous value and cost savings to be gained through economies of scale and automated transaction processing.
While cost savings are an economic necessity, an equally important driver is the ability to process unit trust transactions in the safest and most efficient environment possible – a definite win-win situation for all.
Pressure for change
Heightened regulatory focus is expected both in the UK and mainland Europe, which will also have an impact on how firms manage operational risks. Calls for better risk management in our industry have become impossible to ignore, partly because there is regulatory power behind them. Thus, we are seeing wider recognition that our industry would be better protected through automation. Infrastructure processing hubs are proven solutions; they are cheap and address many of the areas of concern.
The financial crisis has shown that the unthinkable is conceivable. How much more of a warning do we need to change the way we work? It is clear that automated infrastructure processing hubs have passed the test.
Tim May is chairman of Euroclear UK & Ireland
