The financial industry has made great strides in introducing straight-through-processing (STP) – handling the paperwork which accompanies any trading of shares, bonds and currencies and involves the front and back office of the buy- and sell-side, and reducing it into one touch of the button. However, while automating the back-office end of the investment industry – particularly clearing and settlement – has to a great degree already taken place, when it comes to funds, and particularly cross-border funds and hedge funds, progress has been much slower. This is somewhat surprising because a funds transaction has to go through a similar set of steps as, for example, a standard equity, just with different names. Instead of buys and sells it has subscriptions and redemptions, instead of the buy and sell-side it has distributors and transfer agents or fund administrators.
Also, fund owners still want to calculate fund values on a regular basis, so the comparable process to asset reconciliation and then marking to market is, in the investment fund world, the calculation of fund price based on the value of underlying fund assets.
The problem lies in trading across borders – funds trading within one country, particularly the US and some European countries (notably Germany), have almost fully adopted STP – because such trades involve different standards on both ends. This can be particularly complicated if it involves funds domiciled in less-regulated offshore centres.
Andrew Tucker, chairman of Brown Brothers Harriman Europe, estimates that the uptake of STP in cross-border funds is only in the high teens or low twenties in percentage terms, and almost non-existent when it comes to hedge funds, which are to a large degree still unregulated and trade fairly non-standard instruments.
In terms of the bulk of the cross-border fund industry things are also about to move forward with the introduction of a new initiative from SWIFT called SWIFTNet Funds. SWIFT is the industry-owned cooperative supplying a secure messaging service and interface software. The system has been used by banks for over 30 years, but has grown over time across the financial industry and is now used by some 7000 financial institutions in over 190 countries.
The SWIFTNet Funds initiative is addressing the automation challenge by providing electronic, machine readable, message standards, jointly developed with the industry for common domestic and cross border flows.
Re-architect operations
“With the SWIFTNet Funds business service in place, firms now have the opportunity to re-architect their operations processes to create a truly straight through process,” explains Alastair McGill, managing director of SmartStream Technologies, which provides software for the remodelling of operations processes.
The SWIFT initiative is in the process of being tested and pilot programmes involving several large banks will start in January, according to Alberto Fontana, managing director at Financial Tradeware. He estimates that some of the major players will start using the initiative by the end of the first quarter of 2006.
Moving forward, while being initially costly, the initiative has the potential to hugely improve the cost efficiency of running a fund, because it can free up the manpower to use elsewhere, according to Mr Fontana, who reckons that a basic level STP packages can cost as little as €10,000.
On the hedge funds front the situation is also about to change as more and more regulation is introduced in both the US and Europe. European offshore centres like Luxembourg and Dublin are likely to be most affected, according to BBH’s Mr Tucker. As more transparency will be required by regulators anyway, such funds will begin to find it easier to bring in STP.
Because of their lack of regulation so far, hedge funds have not been able to use the SWIFT system, but one way around it is to use an outside provider that is a member of SWIFT and can then handle the paperwork of other parties, according to Ted Stanley, president and chief operating officer of Evare LLC in the US. Evare is the second largest provider of STP in the US after Brown Brother Harriman.
Another issue affecting the introduction of STP until now was that any software reconciling the trades had to be able to handle incredible volumes on the scale of several million a month. Each broker, fund, administrator and custodian uses a standard which is slightly different from its competitors. This meant that companies either had to standardise their way of handling paperwork with any of their counter- parties or, what is more usual, have a third-party do it for them. The challenge for the third-party, or the STP provider, has been to present the final product to all sides in a format that they find acceptable, says Mr Stanley.
“What investment managers want is to do a trade and then throw the paper work over their shoulder in the hope that somebody else will catch it. We can do this for them.” He explains that Evare handles about five million transactions a week and trades worth up to $3000bn (€2495bn) a month.
At such a scale starting an STP operation is a costly process and effectively eliminates smaller players. It will increasingly be a game reserved for the biggest institutions.
