In today's complex distribution environment, mutual funds have fee arrangements with hundreds of third-parties that vary by product, platform and services provided. Complicating matters further is the continued adoption of omnibus accounts at brokerages, obscuring the underlying client and sales data.

Today, mutual fund companies' back offices, as well as their distribution partners, largely process intermediary payments manually using numerous spreadsheets and documents, which is both time consuming and error-prone.

However, forward-thinking fund companies and distributors are beginning to embrace more sophisticated and automated processes for generating, receiving and processing invoices. They are also using advanced database management and analysis to improve expense and income forecasting.

Going even a step further, compensation management solutions are uncovering the value/cost ratio of each distributor-and helping fund complexes more successfully pursue their most profitable distribution partners.

Money Management Executive recently hosted a live webinar to explore the challenges fund companies face with current intermediary payment processes, what can be done to streamline invoice reconciliations and payments, and how they are overcoming the transparency obstacles of omnibus accounts.

Apperaing at the live webinar, "Bye-Bye Spreadsheet: Addressing the Challenges of Financial Intermediary Payment Processes", at SourceMedia's New York headquarters were:

* Carol Denny, Director, Legg Mason Global Fiduciary Platform, Legg Mason

* Michael Interrante, Director, Finance Asset Management, Deutsche Bank AG

* Chip Miller, Executive Vice President, Access Data, a Broadridge company

* Robert Rokose, Managing Director, Head of Financial Strategy, Allianz Global Investors

Access Data, a Broadridge company, sponsored the Oct. 20 event, which was moderated by Money Management Executive Editorial Director Tom Steinert-Threlkeld.

 

Tom Steinert-Threlkeld: Payments to distributors constitute the largest single expense to mutual funds and often account for 25% of the total management fee. Why don't fund companies have a better handle on this critical area?

Bob Rokose: The overall process is very complicated-for all of the fund groups. It's pretty safe to say that each fund group has determined their own unique way of coming up with invoice reconcilement and payment, which are very complex and very time consuming.

Each month, we have to accrue our intermediaries' expenses, reconcile the invoices, get them approved and generate the payment.

It's all very manual and time intensive-and it takes a lot of money to run those processes.

 

Steinert-Threlkeld: So, are there as many reconciliation systems as there are investment advisors?

Rokose: There are reconciliation systems that are starting to come out now, but I would say for the last several years, it's been elaborate Excel spreadsheets.

Carol Denny: Part of the issues that we've seen is getting proper invoicing from different intermediaries, being able to validate their data, and being able to ensure that the funds are paying the proper amount.

As Bob mentioned, right now, the industry is currently using very elaborate Excel spreadsheets.

Anytime you're doing anything manually, there are errors. It's also difficult to report from spreadsheets when you have multiple tables and to carve out the type of reporting that needs to be done.

 

Steinert-Threlkeld: What's the worst spreadsheet-based error you've ever seen?

Denny: I've seen invoices come with a different company's funds on them.

 

Steinert-Threlkeld: I have heard about invoices that have gone out with a zero total. I don't expect that goes over well. But when it's done properly, there's $25 billion worth of these invoices being paid every year, right, Chip?

Chip Miller: The invoices funds receive result from contracts negotiated with distributors, each outlining different terms of payment.

With so much of the process still handled manually, the boards and the management company now want to have the confidence that these invoices correctly represent the sales agreements.

There are some automated systems now available, and Broadridge's is certainly one of them. We offer comprehensive, operational oversight for fund companies to help them better understand their relationships, as well as opportunities, with intermediaries-including compliance and risk issues.

So, technology is now starting to play more and more of a role.

But the technology requirements must ensure that the system contains the rules of all the agreements, so that the program can audit the accuracy of each transaction.

 

Steinert-Threlkeld: How do spreadsheets figure into the payment process, and what kind of data manipulation does that allow?

Denny: We typically receive our invoices either in hard copy or electronically. Many of the invoices that come electronically will be set up on an Excel spreadsheet, which does make it easier for us to check the calculations and apply the proper amount to the funds.

However, when it comes in hard copy, we have to manually enter everything into a spreadsheet.

The next step is to manipulate the data, which means applying parameters and caps to the funds.

Furthermore, analysis of expenses can be applied.

So, it's a matter of being able to extract the relevant information from the invoice, and then being able to validate the calculation. You have to check each fund's CUSIP and make sure that the expenses are being applied to the correct funds.

These are the types of data manipulations that are being done in Excel.

Miller: Our industry has changed quite a bit over the last number of years. Before we had omnibus-level accounting, which has made payments far more complex today, a lot of the core data was available in the recordkeeping system.

Now, a lot of that information has been taken off of the recordkeeping system and traded in an omnibus account-creating additional problems and exacerbating the payment process itself in terms of how much you pay one entity versus another.

We have seen companies with thousands and thousands of spreadsheets, with very different payment plays associated with each different CUSIP.

Rokose: There are so many distributors, so many funds and so many different approaches to processing payments that it's obvious we need standardization, both in industry paradigms and in technology.

Take servicing fee agreements. There are many different terminologies that people use. It makes it very difficult for our legal groups to work on the agreements.

We also need a standardization of data feeds. Each distributor is sending separate data feeds, and fund groups are probably all asking for different types of data. This creates a lot of hours that our IT groups have to spend on getting the data into our systems.

We need a technology solution that's going to eliminate the spreadsheets and create some free time for the finance and operations groups that are building these spreadsheets.

 

Steinert-Threlkeld: One of our audience members asks: In this spreadsheet era, how then does the reconciliation take place and how do you make sure you get all the information? For example, how do you account for advisory wrap and ERISA assets, if the firm does not break it out?

Rokose: Each firm has their own data warehouse to capture the data. You have to work with your own sales groups to go back to the distributors and ask them to break out their different programs.

We try to receive our data feeds in a format that will help us reconcile the invoice.

 

Steinert-Threlkeld: How can you improve this process?

Miller: It's really a relationship management issue. You have to continually ask questions and try to gain comfort with the all of the data-be it sales data, redemptions, total assets, a particular account type or channel, et cetera. You have to be able to examine all of the embedded calculations in the invoices you receive to ensure your agreements are being calculated as they have been designed.

Michael Interrante: While accuracy is certainly the goal, companies create tolerances around their payment systems. For instance, a company might process a payment if it is within 5% to 10% of its contract agreement. Or, it might decide to go back over its payments over some period of time to recapture some of that money.

Those are some of the complexitites. The calculation is no longer multiplying assets times basis points. There are actually multiple calculations that may be based on a percentage of sales, on a percentage of assets, on a tiered relationship, or even some other factor.

So, the more dimensions obviously that you add to it, the more granularity you need in order to support and verify that calculation.

Making this even more complicated, payments to an intermediary oftentimes can include a certain percentage that's reimbursed from the funds and a certain percentage that's reimbursed from corporate.

Denny: And different constituents at a fund complex want different information. Boards are looking for full disclosure on payments. Management wants to know which channels are selling. Salespeople are very interested in the relationships that they have and the assets that are coming in so that they can know whether they should develop a relationship further or establish a new contract.

So, in addition to the complexity of the information itself and the challenges of obtaining it-there's been an increase in this type of ad hoc reporting.

With the information changing so frequently, especially in today's volatile market-where your assets, your number of accounts and your sales can fluctuate-you need real-time data to run the business and deal with accruals or redemptions on both the fund side and the firm side. We are accruing off of the most recent data we have, which can sometimes be stale for many months.

Moreover, in addition to obtaining the data and being able to analyze and create business reports from it, having the most recent data is also key.

 

Steinert-Threlkeld: Mike, where do you see the weaknesses?

Interrante: We've talked a lot about the calculation. We've talked a lot about confirming accuracy in granularity. I think the next key is really the database, a place to store the information, because that's really the feeder for all downstream processes-whether it be accruals to ensure you've not missed a payment, or an internal P&L report for management or a sales report.

Miller: That is why the rules guiding your payment program and the database have to be an end-to-end solution. So when the auditors come back and look at how you came to a payment conclusion, you can show who made the decision, and that information is all there and memorialized appropriately.

Denny: I agree. A consolidated, centralized approach that automatically pulls in data feeds and has the rules to reconcile them, is the way to go.

 

Steinert-Threlkeld: What is the DTCC's role in this movement towards omnibus accounting? Will its OmniSERV project, where it aggregates trades and the communication of the aggregated information between brokers and their partners, make a big difference?

Interrante: Having a common database, having the granularity, having a centralized source that you can go to, to confirm data, a spreadsheet and a method to ensure the calculation is not going to be manipulated will help.

Miller: I think OmniSERV is going to be helpful from the standpoint of transmission of information. It will be a way to basically acquire more information from more parties. The question is that you have to maintain and store that information on an ongoing basis.

But the other thing is, much of this is only really designed around payments that are really due from the fund organizations, not necessarily the other types of payments that management companies have to make outside of what the fund arrangements were.

And when we see the complexity of this business, it's not as much a 12b-1 fee arrangement that's based upon the assets of the fund. It's all those other arrangements that go beyond what the fund is paying and what the management company is now responsible for, which I'm not sure that they're intending to address.

I think that there's clearly an opportunity here for an information hub within the industry. And there's a need for the standardization of this for both the intermediaries as well as for the fund companies.

In the same way that Broadridge has been a utility for the way in which proxy information is distributed, there's the same opportunity for us to consolidate payment information because of our relationship with those distributors already.

 

Steinert-Threlkeld: If the industry were to do this, Carol, how long do you think it would take to say bye-bye to spreadsheets and have this industry-wide solution take root?

Denny: I think it is still a few years out. One of the main challenges is really to get participation from all of the intermediaries out there. It's very easy to get the large broker-dealers to participate, of course. But it is difficult to get small retirement plans on board. They may not have the personnel, or perhaps they cannot report all of their data because their recordkeeping system is not transparent.

So, I do think there are going to be some challenges with this.

Rokrose: But clearing firms can serve as catalysts to help broker-dealers and plan sponsors standardize their approaches.

The key is standardization of the process, rather than who actually manages and controls it.

At Allianz Global Investors we're looking at this as direct expenses and indirect expenses. The direct expenses are clear. When you have a manual process, it takes a lot of people to do that manual process, and those resources could be better utilized.

And the indirect expenses mean less errors, less resources within the organization being redirected, such as your legal departments or your sales departments, to resolve issues with invoices.

The systems that do it automatically still require people to input information about agreements and probably still need an audit of the output.

Miller: Agreed. You also want to confirm with the front office that the various agreements you have in place are operating correctly, and that the assets in a particular channel are accurate.

Automated, payment processing still involves other groups in your organization. It doesn't just sit with operations or finance. You still need to involve the back office and the front office.

 

Steinert-Threlkeld: Besides simplicity, what is the other key benefit of automating intermediary payments?

Denny: The resulting improved accuracy of payments benefits relationships with intermediaries.

And then, of course, management and the Board appreciate the accuracy and reduced risk.

Rokose: Don't forget the issue of value. Such a system enables a firm to see who are the best sales intermediaries and clients that they have.

They may have a client that has a lot of assets but discover they are in assets with low management fees.

When you start querying the system and asking questions about where your most profitable customers are, and where your wholesaling staff should be spending their time based upon the relationship you have, your business improves.

This is very difficult, if not impossible, to do with thousands of spreadsheets.

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