The subjects of much debate in recent years used to be the following: how the asset servicing industry was to cope with the then predicted avalanche of money that was to move into European mutual funds? How were asset gatherers going to cope with the subsequent boon in cross border investing? And how the movement from DB to DC pensions provision was going to add impetus to these trends? .
Today, those predictions are slightly tempered. The focus across Europe is now very much on how to cope in a world of decreasing asset values and trading volumes. One issue that hasn’t changed however is the complex servicing environment that exists. If anything this is more so today than it ever was.
Consultant Oliver Wyman in a report last year defined the industry as in Chart 1. The shading on this illustration tends to obscure that the boundary between institutional and retail service is becoming less distinct. The major service providers are engaged in meeting complex needs for both sectors and building service models accordingly.
To illustrate this point it is worth discussing the UCITS III fund legislation. On the one hand, this defines a regulatory framework for passportable funds and on the other prescribes levels of reporting for the investment company ‘owning’ the fund. The expansion in the range of instruments available as UCITS opens up new investment opportunities for fund managers and the end investor. This enhances choice and flexibility but poses significant challenges to administrators and other service providers. In particular, many providers are likely to find that they need to upgrade to more sophisticated systems and processes if they are to be in a position to deal with funds of funds and derivative instruments. The very structure of fund of funds makes expansive and efficient linkages with other administrators a prerequisite for an administrator to be able to keep track of underlying fund assets.
There is also an extra layer of complexity in terms of compliance to take into account. Administrators will be required by legislation to provide evidence supporting the independent nature of valuations.
On the other side of the fence, the investment companies themselves will require more sophisticated management reports. Services such as compliance, accounting, performance measurement and attribution will be necessary for investment company use. In effect the same breadth and depth of reporting and monitoring more often demanded by plan sponsors. Chart 2 graphically illustrates how the UCITS III legislation increases the administrative complexity for the fund and the investment company and from this it should be clear how a single source service model should lead to greater economic benefits.
Before we move on to discuss pensions directly, it is worthwhile considering the role of transfer agency on a pan-European basis and first take a considered view of the potential developments in the European fund servicing business.
Generally, the present consensus is that as the European funds market matures it is probable that that European banks without fund management expertise will want to provide access to funds while large branded fund managers want to reach the end-investor directly. Consequently, there is, within the industry, movement towards an open architecture model whereby promoters are offering competitive products through their own distribution channels - third party distribution. But this distribution route increases pressure on margins and increases the need to drive down costs whilst once again increasingly the level of complexity required to service these needs.
The majority of European funds are still administered in-house by fund managers and these bespoke transfer agency systems will require huge short-term investment to provide all the capabilities needed for cross-border distribution through third parties. Systems must be able to cope with the multiple tax codes and regulatory regimes that make up the marketplace. The major initial and continuing investment needed places further pressure on already thinning margins. The continuing provision of in-house transfer agency is increasingly a distraction and an unsustainable cost for a fund manager who needs to concentrate on development of distribution channels and the core activity of investment management. Furthermore the process of trading in funds, especially to direct retail investors is extremely sensitive to volume swings so the obvious solution is to outsource to a specialist transfer agency provider. Third party capable transfer agency systems need to be multi-lingual, multi-currency and multi-product – just to keep such systems current is very expensive and significant volumes are needed to justify the continual investment required.
Unlike the US, with NSCC/Fundserv, there is no common order processing, settlement and information distribution system for funds within Europe. In Vestima from Clearstream and Fundsettle from Euroclear there are the beginnings of common standards, but they remain distinct and separate, and their universal adoption is still a long way off. In short, to be successful across the whole of Europe the fund manager is continually challenged by competitive pressure, multiple market complexity, lack of standards and pressure on costs. The role of the transfer agent will be crucial to the fund manager in achieving cost effective cross border distribution.
It would be disingenuous to say that that is what providers are able to offer today. Most provision is in local markets. Pan-European solutions tend to be supporting offshore distribution in Luxembourg and Dublin together with one or two local onshore markets. Fidelity probably possesses the closest to a pan-European system with MFT. The Bank of New York is currently engaged a major initiative in partnership with Microsoft to ensure that RUFUS becomes a true Euro TA platform and no doubt other providers like State Street have designs in this area also.
What clients say they want and need are the following key attributes: pan-European expertise, pan-European technology, pan-European coverage and that is what providers are aiming to deliver. Without those three key factors, cross border administration becomes costly and inefficient.
Thus far we have has concentrated on the change in the fund servicing and fund management industry. The question is whether any of this has relevance to the pensions sector? Traditional custody service providers long ago moved up the value chain in the pensions, fund management and fund servicing sectors. Specifically in pensions funds have been busily outsourcing various accounting and administrative functions for many year. In the UK, much has been made of the Myners report and the associated investment principles that has led to much attention on how best to provide information and reports to pension fund trustees. Master custody, whereby a servicer provides consolidated reporting and accounting for multiple fund managers to one fund is now pretty much standard.
A recent NAPF report illustrated that the range of services provided to funds today is both broad and complex. Typically a fund in the UK today will look to its custodian for compliance, performance monitoring and measurement services and this trend is increasing in other markets, typically with the Netherlands at the forefront.
Developments in one sector are tending to mirror another. Single source servicing is increasingly within the pensions sector at the same time as much more rapid developments are taking place in the fund servicing arena. And with the effects of legislation such as UCITs III is potentially creating demand of both types of services by single organisations thus reinforcing this single source service model.
An interesting question is whether there is even more cross over as prescribed by this legislation and whether and where this may have relevance to either the pensions sector at large or pensions administration in particular.
We move to the UK to witness the seeds of a potential trend. The brief of the Sandler review in the UK was to ‘identify competitive forces that drive the industry, in particular in relation to investment, and suggest policy responses to ensure consumers are well served are well served.’ The recommendation that a range of simple, price capped mutual and pension fund products has been a widely reported and contentious recommendation.
Price capping is not yet an accepted reality but already product providers are seriously looking hard at how and if they can make money out these types of products in a price capped environment. Capped pricing structure makes the administrative task that more critical. If these products were to be developed this would create even more pressure on cost effectiveness of pension fund administration. Putting more pressure on the administration at a time when the movement from DB to DC schemes has created a debate on how best to service all the levels of needs of a pension scheme: how to provide cost effective servicing and meet the requirements for administrative and accounting services at the corporate, fund and individual levels. There are many layers of need and multiple layers of cost. What is the potential for single source servicing?
This article has illustrated how the introduction of regulated products has a tendency to make servicing requirements more complex. We tend to believe that the benefits of the single source service model in these situations leads to more cost effective service.
Pan-European pensions servicing is already complex. The development of multinational schemes together with the replication of the UK’s movement from pay as you go to funded schemes creates significant servicing issues. The pan-European servicing picture is already complex. Pan-European DC fund administration poses similar issues. It was highlighted earlier how in the fund servicing marketplace providers like ourselves are creating single source service models and pan euro TA systems are being developed to meet the future needs.
Could these systems provide the necessary tools to provide cost effective pan European DC administration? Will a single source service model encompass DC administration in addition to fund accounting, master custody, compliance?
The current level of single source service that providers like ourselves is clear. We have developed this service model in both the pensions and funds sectors. There are many similarities but many differences also. The potential demand for pan-European administration for DC type pensions is a grey area. It is difficult to make any predictions about how a single source administration model for corporate, fund and individual needs will be developed at the pan-European level. There is legislation and trends already at work but it remains to be seen how demand and supply will develop.
To conclude we refer to BW Deloitte. They argue that there are three ‘design issues’ required for an efficient market: the creation of sufficient volume, attractiveness and margins to encourage consumers, providers and distributors. To encourage providers, say Deloitte, one requires both sufficient margin and cost effective administrative solutions. Given this only one thing can be stated with certainty. The provider response will be predicated on that of the distributor and consumer. In short, the demand created by pension funds and their members.
Benjie Fraser and Nick Parkes are with the Bank of New York in London