The investment and alternative fund industries in Europe have long been considered the last virgin territory for processing transactions digitally, straight through from order to settlement.
Now thanks to the efforts of the Society for Worldwide Interbank Financial Telecommunications (SWIFT) and other market infrastructures, automation and standardization of the message format that make straight-through processing happen are slowly being embraced. And in the nick of time.
As the number of investment and alternative funds-and distributors-grow in Europe so too does the potential for error and additional costs related to paper-based communications and proprietary message types. There are no official figures on how much it costs the investment fund and alterntive fund industries annually to process and correct transactions manually in Europe alone but Depository Trust & Clearing Corp. once estimated it was over 6 million euros for investment funds alone.
That was in 2002. Fast forward six years and fund managers still complain about the slow pace of change in the 8 billion euro European investment fund market. By contrast, they say the far larger U.S. mutual fund industry relies heavily on proprietary message formats created by DTCC.
"It's a good sign that the SWIFT message formats are now being more widely embraced by investment funds, distributors and transfer agents" one operations executive at a New York investment fund said. His estimate: investment fund managers and distributors easily spend over $5,000 a month each to handle paper-based communications in Europe.
The price tag is even worse-more than double he believes-for custodian banks representing hedge funds-of-funds. That is because they have to send several hundred orders and redemptions to multiple fund administrators representing underlying hedge funds entirely electronically. Add the rest of the work-reconciling net asset valuations, positions and cash forecasts with underlying hedge fund managers and their fund administrators-and the paper morass can become unmanageable.
Officials attending the annual SWIFT conference in Amsterdam last week say that investment funds industry is on target to migrate to messages that adhere to the new 20022 format from the International Organization for Standardization, from older ISO 15022 messages by the end of 2012.
That's when SWIFT will eliminate the ISO 15022 messages from its network for trading and processing of investment funds which have been in place since SWIFT launched its SWIFTNet Funds initiative in 2004.
"About 20% of our message traffic for investment funds came from the new ISO 20022 messages in July 2010. Overall funds traffic for both ISO 15022 and 20022 combined grew by 50% over the previous year," said Michele De Boe, director of investment funds messaging for SWIFT in La Hulpe, Belgium. "The reason for the discrepancy in usage from the older SWIFT message formats is because of the earlier timing of the legacy 15022 messages."
SWIFT, which promotes both ISO-message types and operates the network on which they can be transported, processed about 27 million messages related to investment funds processing in 2009 for 800 firms in total; about 130 are already using the ISO 20022 -based service.
While there are only three ISO 15022 messages for orders, redemptions and exchanges for traditional investment funds, a total of 68 messages will encompass orders (subscriptions, redemptions, exchanges), transfers, position reconciliation, net asset valuations, account openings, and cash forecasts.
So far, the most popular use of the ISO 20022 messages have been for orders.
SWIFT will also next year test six new ISO 2022 message types for the fund-of-hedge funds market for custodian banks, administrators and transfer agents to place and receive orders electronically, via the SWIFT network. This work will be done in a group coined the SWIFT Hedge Fund Harmonization Pilot or Sharp.
The messages will confirm hedge fund orders and include information on performance fees and equalization methods.
"There is a substantial amount of work related to the current paper-based communications and we have dedicated staff in Dublin and Guernsey just to process orders and redemptions," said Ian Headon, director of alternative investments for Northern Trust in Dublin, which receives several hundred orders from fund of hedge fund managers each month to process. In addition to Northern Trust, HSBC, JP Morgan Chase, GlobeOp, Morgan Stanley and BNY Mellon are members of the Sharp group.
Independent service providers are quickly adapting to the new ISO message formats, although uptick is not uniform. Euroclear SA, the parent of securities depository Euroclear Bank in Brussels, says that the vast majority of the orders and redemptions for investment funds and hedge funds it processes annually through its FundSettle platform through either ISO 15022 or ISO 20022 messages.
"A negligible level of communication take place via a browser-based interface and proprietary messages with smaller transfer agents," said Lieven Libbrecht, director of investment fund product management for Euroclear, which doesn't disclose the volume of its traffic.
EMX, a service owned by Euroclear SA specializing in UK investment funds, still uses proprietary message formats adapted from the Financial Information Exchange protocol for orders and redemptions; but it can reformat those messages into ISO 20022 formats.
EMX's rival Calastone estimates that over the past 12 months about 32% of its five million trade and settlement messages for UK investment funds use the ISO 20022 format while 11% remains in ISO 15022. That still leaves 57% of messages being sent from promoters to distributors and transfer agents in multipl file formats.
"Many European fund distributors and managers are still content to use the ISO 15022 messages while some European distributors don't want to make the capital investment to adopt to any ISO standard," said Kevin Lee, chief executive of Calastone.
"SWIFT will have to find a way to reduce the costs of membership for some of the smaller fund distributors, which in turn, prompt fund managers to go along," Lee said.
Calastone offers a free hosted SWIFT service for fund managers and distributors which want to use the ISO formats but don't want to pay for a SWIFT infrastructure.