Solutions for Europe’s hottest fund centre

With assets worth over ?1500bn, Luxembourg is the world’s largest investment fund centre behind the United States and boasts a 77 per cent market share of cross-border Ucits distribution in Europe. Indeed, the increase in third-party fund distribution and the wider adoption of Ucits III have certainly played a key role in making the Grand Duchy rise to its current dominant position. It is estimated that over 55 per cent of all European net inflows are into Luxembourg-domiciled funds. Statistics show that each working day in 2005, over ?1bn of investment fund assets found its way to Luxembourg. The question now is whether the infrastructure is in place to support such continued growth. Although the industry is developing fast (80 per cent growth over three years), its post trade area is characterised by high fragmentation and little standardisation, which lead to high operational risk. Philippe Seyll, director of Clearstream’s fund business, explains how the firm’s new central facility for funds (CFF) will address these issues, by providing more efficiency in the settlement process of Luxembourg-domiciled funds. “Distributors of Luxembourg funds are facing two major challenges” he says. “The first one, which is related to the order routing side, has to do with the many relationships that distributors have to maintain with the transfer agents.” Each relationship is technically different and therefore expensive to manage and maintain. “The second challenge”, continues Mr Seyll, “is related to the inherent settlement risk, deriving from the fact that the cash leg of the transaction is decoupled from the security leg of the transaction.” Clearstream estimates that approximately 80 per cent of investment fund transactions carry this risk, which means that both parties run a risk on the deal not being completed during the period between trade date and settlement date. “CFF, a market-led initiative financed by Clearstream, will provide a solution to these issues” says Mr Seyll. He explains that the new CFF operating model would combine the best of the two models currently in use in Europe: the CSD (central securities depositary) operating in France and Germany, and the Transfer Agent (TA) model used elsewhere. This means CFF will provide a hub for settlement and delivery versus payment (DVP) as the CSD model does, solving the problem of the high fragmentation, or of the “many to many relationships” typical of the TA model. More importantly, CFF would eliminate the settlement risk proper of the TA model, by providing simultaneous exchange of cash and securities. But it would also provide that transparency proper of the TA model, which the CSD lacks, explains Mr Seyll. Not surprisingly, the announcement of this new hub, which is supposed to be the first of its type to offer delivery versus payment for Luxembourg domiciled funds, has sparked immediate reactions from Euroclear, which offers an integrated solution covering order routing, settlement and asset servicing through its platform Fundsettle. The main criticism of Clearstream from Euroclear is that SVP is applicable only to a secondary market security, where there is no creation of new shares but just movement back and forth of shares between different counter-parties. That’s when a delivery versus payment is needed, to make sure that securities and cash are released at exactly the same time. In a primary market, to which funds belong, there is no release of securities, but a creation of new shares. So DVP would not apply to funds. The concept of settlement is the same, but it is the mechanics themselves that are different. Sébastien Chaker, director of investment fund product management at Euroclear, says: “It’s difficult to understand the added value of Clearstream’s latest initiative. It again seems to propose a solution that treats funds as secondary market securities, like bonds and equities, when the primary market features of funds require a different approach. FundSettle already offers a tailored settlement infrastructure for more than 17,000 Luxembourg-domiciled fund classes.” CFF is an open model and enables the multiple-order routing mechanisms that exist today such as Swift or Vestima+ or even those who still use a fax, to connect to the CFF, promises Mr Seyll. CFF will be launched in 2007, although a pilot will begin towards the end of this year. At the moment the focus is on the Luxembourg market, but this does not rule out a potential geographical expansion to the Dublin funds market, according to Mr Seyll. He expects that all distributors distributing international funds will benefit from CFF, regardless of the volume they handle.

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