Luxembourg is Europe’s capital for funds. In fact, some 12,685 funds with a total volume of €2,019 billion were being managed in Luxembourg in July 2010, according to ALFI, the Association of the Luxembourg Fund Industry.
The Grand Duchy is also the prime centre for investment funds conforming to the EU’s UCITS Directive which regulates funds and asset management companies allowing fund units to be offered across Europe.
Indeed, Luxembourg’s speed in implementing EU fund regulations has been a major factor in ensuring it maintains its top position in Europe in cross-border transactions.
Today, Luxembourg is reaping the benefits from many years of experience in the area of funds and its accumulated expertise now reaches across the whole of the financial sector from product developers to lawyers, auditors to specialised service providers.
This exceptional depth of understanding of funds has led to Luxembourg being particularly strong in innovation: a decisive factor if Luxembourg is to lay permanent claim to its status as the leading international centre for funds.
A complex world
In the post-trade area – matching and settlement of trades and cash – the investment funds industry across Europe lags behind other forms of investment such as equities, bonds and certificates.
The processes are very complex due to the involvement of numerous participants: investors turn to a fund distributor/distribution bank which acquires fund units.
In order to do this, the fund distributor/distribution bank turns to so-called transfer agents or custodian banks which administer the fund units.
These in turn form the interface with fund management companies which issue the new units.
Multiplying this structure across the world creates a vast network so that banks and brokers must establish hundreds of connections if they are to sell or purchase fund units.
Automation and standardisation should raise the efficiency of settlement procedures and operating risk but, at the moment, the market is still dominated to a large extent by fragmentation and manual processes.
Sending transfer orders by fax is the norm – a process which carries a great deal of risk – while the lack of standardisation also raises operating costs which are ultimately borne by the investor.
Much-need streamlining
Efforts are being made to address the need for greater efficiency.
As early as March 2007, Clearstream launched a solution on the market in the form of the CFF, a new system to automate and synchronise the exchange of cash and fund units between the fund distributors placing the orders and the transfer agents/custodian banks.
Central Facility for Funds (CFF) works together with Vestima+, Clearstream’s central order routing system for all market participants.
The integrated system enables direct handling of the entire process chain from order capture to settlement and custody streamlining settlement processes for investment funds considerably, lowering operating and administrative costs and reducing risk.
As funds are increasingly used in cross-border transactions, the industry is adapting its processes and services accordingly.
Clearstream, for example, will now enable its international clients to access secondary trading of funds units via Vestima+.
From the start of 2011, investors will be able to buy and sell ETFs and fund units on the German stock exchange as easily as equities using Vestima+ as the access point.
This innovation looks set to boost the attractiveness of funds, allowing them to catch up with competing investment instruments such as equities, bonds or certificates.
In future fund distributors have a choice:
they can acquire funds from the corresponding fund management company at the net asset value or they can place their order on a stock exchange at the current price if there is a direct connection to an exchange or their order can be routed through Vestima+.
In addition to the 80,000 fund share classes (individual ISINs) on Vestima+ – including almost all European cross-border funds – Clearstream will also add exchange-traded index funds, ETFs, to its platform.
Fund issuers will benefit from easier access to investors who prefer stock exchange transactions. Fund trading via the stock exchange does not threaten the transaction work of transfer agents; rather, these will be freed from the time-consuming and cost-intensive private client business.
In the distribution model of the future, transfer agents will, among other things, be able to widen their distribution base through a stock exchange.
New distribution channels
Fund trading on stock exchanges has been possible since 2000 in the form of ETFs on Xetra of German stock exchange, which has expanded and defended its market leadership in Europe in this sector.
Currently around 3,200 funds are listed on Xetra – approximately 2,500 mutual funds and about 700 ETFs – which comprise 95 percent of stock exchange fund trading in Germany.
This on-exchange trading does not compete with established distribution channels but adds to it by including investor groups that can no longer be reached by traditional fund distribution.
Active investors, in particular, frequently use professional applications from online banks and rely upon having their stock exchange orders processed in seconds.
The bulk of funds trading on stock exchanges is currently carried out by those institutions which rely on exchanges as trading platforms for a variety of investment classes such as equities.
In mutual fund trading, however, purchases and sales mainly take place on the primary market, i.e. via traditional fund distribution channels.
International expansion through the cooperation between Xetra and Clearstream is something new: in the future, around 1000 customers of Clearstream’s Investment Funds Services division in Europe, America and Asia will be able to trade fund units on platforms like Xetra.
Half of all orders which are routed through Vestima+ concern funds which can be traded via the stock exchange.
Investors benefit from a number of advantages through trading funds via a stock exchange, especially in price transparency and immediate order execution.
This contrasts with the more “traditional” method using transfer agents or custodian banks when investors could not know the price of fund units when placing their orders as the price is calculated just once a day.
The execution report often only reaches the client at the end of the day while, for clients in Asia, it only arrives on the following day.
On the stock exchange, however, investors immediately receive an execution price, i.e. a transaction value for their fund units.
This represents a considerable advantage for investors who make reinvestment decisions as the traditional allotment procedure for mutual fund units often takes until the following day.
From the investor’s point of view, fund trading via the stock exchange means reduced costs, since front-end loads are avoided.
The successful establishment of standardised stock exchange trading with ETFs and the use of the associated settlement processes show that mutual fund trading could follow a similar course.
The industry must keep pace with this development and adapt to the fact that the secondary market in fund trading will increase in significance considerably during the coming years.
Luxembourg should not miss this trend and its industry must enable investors to access the stock exchange in order to further maintain its position as Europe’s number 1 financial centre for fund business.
