Back office cost cutting

The vast changes that the German funds industry has encountered in 2004 have affected the back office as much as the front office. A handful of leading custodians and administrators have been positioning themselves to get a fair crack at what they see as a once in a lifetime opportunity.

“We have seem dramatic changes in German mutual funds in the last 12 months,” says Dietmar Roessler, head of BNP Paribas Securities Services in Frankfurt.

The main change described by Mr Roessler is that distributors are becoming much more powerful than manufacturers. They have the buying power and are able to attract the leading domestic and foreign players onto their platforms. Their sales forces have the selling power to guide customers into products made by preferred providers – Deutsche Bank alone has 13,000 branch sales staff.

One key development has been that of specialist companies constructing administrative vehicles for distributors offering “private label”, sub-advised retail funds.

“Private label funds are retail funds that are launched in co-operation with external partners, frequently independent asset managers, but also banks and insurance companies,” says Michael Wolf, head of sales and distribution at Universal-Investment-Gesellschaft in Frankfurt, which is currently responsible for administering funds worth E48bn.

“There is a continuing high level of interest being shown, for instance by independent asset managers in these joint fund products,” says Mr Wolf.

The move by distributors towards a more open menu of products will have a significant effect on how the back office players do business.

“Open architecture was the buzz-word of the day and this fitted well with retail demand in early 2000, but the high-cost environment, operational cost and risk were going through the roof,” says Mr Roessler at BNP Paribas.

Up to 50 per cent of German mutual fund subscriptions are still sent by fax from a German bank’s back office to the transfer agent. “We’re relying on a paper-based process,” says Mr Roessler. “This was not a big issue in 2001, but a very big issue in 2003, when the market collapsed and people started looking at the cost.”

When it comes to funds marketed by non-German firms, 60 per cent of products are ordered by fax. But the foreign funds pay much higher trailer fees to distributors, which helps them recoup the transaction costs.

“People are conscious to recoup costs, especially as trailer fees are coming down,” says Mr Roessler. “We’re now starting to get a better balance between open architecture and in-house funds distributed in the German market.”

Distribution solution

This market has found a solution, which is suitable for the distribution houses, namely guided architecture, believes Mr Roessler. He also has another name for it, “restricted distribution,” referring to the limited number of investment groups chosen as partners by Commerzbank and Deutsche Bank.

While he expects this trend to spread to other major German retail banking institutions, Mr Roessler is conscious that an efficient settlement and subscription mechanism must be perfected to service this guided infrastructure.

BNP Paribas has traditionally worked with manufacturers to help their distribution plans. But the new shift in market dynamics means that distributors will increasingly need to work with third-party securities services providers.

“Before, there were questions about trailer fees and performance, now the power is shifting from manufacturers to distributors, who must enforce on manufacturers a proper subscription mechanisms,” says Mr Roessler.

The thinking behind the nature of these mechanisms has changed, however. Last year, BrainTrade, a subsidiary of Germany’s stock exchanges, unveiled Investro as the key subscription and settlement solution for mutual fund trading. Both manufacturers and distributors were offered significant cost-reductions through a low-cost straight-through processing environment. BNP Paribas had strong input, having entered into a strategic partnership with BrainTrade.

But there were unforeseen problems – namely a lack of commitment from shareholders to use the platform – which led to lower than expected trading volumes, and BNP Paribas clients have since been migrated to an internal transfer agency system.

Mr Roessler remains undaunted by the hiccup. “The matter is not as complex as we feared it would become,” he says, adding that the users of Investro, were only starting to build up their book, so trading volumes were still very low.

His preferred solution is now based on transfer agency, supported by SWIFT messaging. A central hub in Luxembourg communicates through local spokes with distributors in each jurisdiction, crucially keeping tabs on volumes of funds sold by each outlet.

“The typical global custodian is only interested in safe-keeping assets,” says Mr Roessler. “But our aim in Europe is also to provide support to the distributor as well as the manufacturer. This brings us much closer to the heart of asset management.”

Roessler: ‘paper-based reliance’