The Depository Trust & Clearing Corp. (DTCC) and the Society for Worldwide Interbank Financial Telecommunication (Swift) are working together to introduce 12 interoperable XML-based message formats to the alternative investment community.
The initiative is designed to allow market participants to connect to DTCC's Alternative Investment Products (AIP) platform, slated to begin testing in the third quarter, via the Swift network using International Organization for Standardization (ISO) 20022-compliant XML messages. Firms will also be able to use proprietary formats through DTCCs Smart network.
"While DTCC's and Swift's efforts at servicing the alternative market space began separately, both organizations quickly realized the need to work together for the benefit of common customers who wanted to reduce the potential for errors from fax-based communications and post-trade reconciliation," said William Gourlay, director of Swift's investment funds business.
Swift members will be able to send orders and redemptions on behalf of their fund of hedge funds clients to single-manager funds. The message types will also include status order confirmations and statements of account holdings. Eight of the new ISO 20022 messages have no predecessors, while four were adapted from some of the 68 messages Swift introduced for the investment funds industry in 2005.
The Swift Hedge Funds Harmonization Pilot group, which was founded in Dublin over a year ago and has since expanded into Luxembourg, Switzerland and the Channel Islands, helped design the new formats. Twenty-five of the world's largest fund administrators and custodian banks, which serve as outsourcing agents for fund of funds managers, are represented in the group.
AIP will be offered by DTCC's National Securities Clearing Corp. (NSCC) subsidiary and parallels the Fund-Serv platform for mutual funds. The service, which received Securities and Exchange Commission approval in May, will process subscriptions and redemptions, commission payments, position reporting, valuation reporting and account maintenance details for funds-of-funds, single-strategy funds, real-estate investment trusts (REITs), private equity funds and commodity pools. Users will include fund administrators, custodians and broker/dealersa growing distribution channel for retail customers.
The market for alternative investment products, which are typically offered through private placements to high-net-worth individuals and institutional investors such as pension funds, has grown rapidly since 2000. However, the processing environment for the products remains largely manual, and DTCC says the impact of automation will be more significant than has been anticipated.
"If the industry had estimated the future mutual fund volumes that would be processed over Fund-Serv by taking volume levels from 1984 and projecting annual growth, it would have significantly misjudged the transformation that the automation has had on fund distribution," said Ann Bergin, managing director of DTCC's wealth management services unit. "The same potential for exponential transaction and messaging growth now exists in the alternative investment products industry." Fund-Serv began operating in 1986.
Keisha Bell, director of wealth management services at DTCC, said that when the New York-based utility and Swift did their initial analysis, they saw there were few differences between their message formats, so they decided to make them interoperable. "We didn't want an AIP user to be limited in who it could communicate with and to need to use two separate networks," she said.
NSCC will receive the data in a fund's security profile and issue an identification number that the fund and broker/dealer will use when communicating about a specific instrument. Some alternative investment products don't have standard identification codes.
While Swift's hedge fund messages will cover only secondary transactions, AIP will include initial orders by scanning paperwork and signatures. The DTCC service will also allow for broker-controlled positions, letting broker/dealers buy and sell the products for their retail customers and include the related information in their consolidated reports.
The collaborative messaging effort could face one major obstacle: Most offshore-domiciled hedge funds do not currently accept electronic communications. Gourlay, who doesn't expect regulatory changes will be needed, said that Swift is working with local regulators and trade groups such as the Irish Funds Industry Association to encourage the funds to permit subscription and redemption orders to be conveyed electronically.
DTCC has completed testing the new messages with brokers and REIT administrators, and a second phase will incorporate communications between brokers and fund-of-funds administrators. Pilot testing of custodian and fund manager messaging, slated for November, will overlap with Swift's pilot testing of the message types with 15 hedge fund and custodian bank members.
According to Gourlay, Swift plans to release the messages to its broader membership by the first quarter next year.