AST: Can you tell me a little about Calastone - why it was formed, what it offers and who your clients are?
Despite years of investments in trying to automate fund orders, the levels of automation in the fund space remain extremely low compared to what we see in the equities space. We were convinced that existing solutions to automate fund processing did not completely meet the needs of the industry.
What Calastone is doing can be compared to what a travel adaptor does for the international traveller - it provides a simple, reliable and cost-effective way of electronically connecting fund distributors and fund managers irrespective of the chosen standard used by other parties.
Calastone was set up as a private company in 2007, and we started to operate the first transactions in 2008. Our clients are fund managers who operate across multiple jurisdictions as well as fund distributors. Our services were initially focused solely on the UK fund market, but by 2009 clients were pushing us into the cross-border market. So we started offering the same model for cross-border funds domiciled in Luxembourg and Ireland. We opened our Luxembourg office in 2010 to cater for the European market, and in 2011 we started to expand in Asia.
AST: How automated is communications in the mutual fund industry?
There has been 10 years of intensive effort and millions have been spent to automate the space. ISO standards have been created, and ICSDs have moved into the market by using the systems created for bonds and equity to go into the fund space. There are a number of industry groups who have recommended the use of the ISO standards.
But the latest EFAMA-SWIFT survey on the level of automation of third party cross-border fund orders shows that in the first half of 2011, the rate of transactions that use the ISO standards is still quite disappointing, at 37.8 per cent. The rest of the transactions are bilateral flat files and there are still over six million faxes processed by transfer agents in Luxembourg and Dublin. The scary thing is that this number is increasing each year, mainly because cross-border distribution continues to expand into new regions and to new types of distributors.
AST: What is holding back the move towards automation?
There has been a myth from the beginning of 2000 that all the players in the fund industry would all invest in their IT infrastructure in an attempt to move to a single standard. Many fund managers believed the SWIFT ISO standard would solve the problem and all their clients would move to it. But this didn’t happen. Fund distributors have not been willing to invest in their infrastructure to automate fund orders by developing new communication standards solely used by the European fund industry.
It’s worth remembering that fund distributors come from diverse types of organisation - they could be banks, brokerage firms, insurance companies, pension firms or even specialised fund platforms. They all have different business models, different levels of sophistication and different IT infrastructures - they do not necessarily think of themselves as being part of the fund industry.
Going back to the analogy of the electric adaptor, you can see that countries or regions have different voltages and frequencies around the world. But there’s very little debate about whether or not to harmonise electrical supplies, which is what the fund industry is trying to do. Even if the electrical suppliers were able to agree on one global standard, which is unlikely, just try and imagine the level of investment to change supplies in the countries that need to adapt. But the main reason why there isn’t a debate is because there is a simple solution - plug adaptors.
In the fund industry, we think we can solve the problem and accelerate the automation take-up by creating this interoperability. Everyone can keep their own communication standards and we can put the technology in the middle to translate messages from various messaging protocols. The ability to communicate orders between counterparties is not new, but the translation capability is where we add the value.
AST: What is driving the move towards automation in this sector - is it simply down to cost?
If we look at the UCITS industry we can see there is a strong trend of growth coming from cross-border funds rather than domestic funds. Luxembourg and Dublin have been very successful in promoting UCITS funds across the world – fund managers with UCITS products that were initially set-up for distribution in a selected number of European countries can very easily expand their distribution market across the globe as more Asian and Latin American countries adopt UCITS.
The impact of this is that distributors in new markets often have different operating models and different IT infrastructures, so each time you increase distribution, transaction numbers increase but the level of automation falls.
Cost is one of the main drivers. Some clients are reporting savings of up to 60 per cent when they move to automated messaging. So it’s a big driver, but it’s not the only one - scalability is vital. As firms expand into new markets they would need to increase their staff if they kept everything manual, but having automated processes make the whole expansion much simpler.
Another very important factor is service levels to distributors and this is particularly vital in Asia, which has a culture of zero defects, there’s no tolerance of errors. And when you’re expanding into other markets, particularly those where the time difference is significant, doing everything by fax can mean up to two days before the end investor gets its trade confirmation.
AST: Are there particular types of funds that are seeing the benefits sooner than others?
In terms of cost reductions, retail funds with high dealing volumes from multiple distributors tend to see the cost savings sooner. But the risk reduction aspect is the key driver for institutional or alternative funds - they have the high value tickets, where the financial risk of missing a dealing deadline is much higher. And if you look at service levels, everyone benefits in the same way.
AST: Is there a difference when you implement the solution in new markets, compared to those that are more established?
They have the ability to start building automation more quickly, so in one sense it’s easier. But often they don’t have the ability to go onto the SWIFT network. Across Asia, there are fewer than 10 distributors with SWIFT fund messaging capabilities.
AST: Who needs this automation?
Fund managers are the ones that need the automation - it’s their industry. Fund distributors, be they banks or brokers, distribute funds as well as other financial products, so they don’t think of it as their industry, they just want to have a cost efficient and secured way of processing fund orders. The main costs of manual processing lies at the transfer agent level, they need to charge fund managers more for manual transactions. There’s one fund distributor we speak to who says that Asian distribution represents 20 per cent of its total fund holdings but these distributors account for 50 per cent of its total transfer agency costs, simply because the levels of automation are not yet there.
AST: What is driving the growth in cross-border markets?
The growth is coming from emerging markets. At the moment, Asia is the biggest region for fund managers, but there is an increasing focus on Latin America.
Fund managers who set up a global distribution platform in Luxembourg or Ireland, for example, benefit from the economies of scale of having one fund range distributed globally. Initially UCITS were created for distribution in the European market, and that remains about 60 per cent of where the assets are sourced from. But the rest of the world now often accounts for up to 40 per cent of the assets, and that’s growing.
Most of the cross-border fund expansion comes from European funds looking outward – UCITS is currently the only true global fund product We don’t see many US, Asian or Latin American domestic funds sold on a global basis, it’s a one-way traffic.
AST: How much is changing regulation altering the way fund managers operate?
I don’t believe that regulation is a direct driver for the automation of the business. However, all the regulations imposed on fund managers have a big impact on costs and as a result fund managers have become much more cost-conscious. Automating is an easy way to reduce the cost burden, thereby reducing funds TERs.
AST: Asia is a growth area for both the industry as a whole and for Calastone. How do you see the market in this region?
What we have seen over the past three to five years is a growing number of global fund managers either setting up operations in the region or expanding their presence there. But we now also see large Asian asset management companies creating a UCITS product to exclusively distribute back into Asia.
The way we have been operating is by helping fund managers to accelerate the automation of their European distributor base. As Asian flows have rapidly grown, we have received an increasing number of requests to provide a solution in Asia. So this year we have put people on the ground in Hong Kong to cover this region - essentially following the needs of our clients.
When you look at the opportunities in the global markets, for our clients Asia is the most important region in terms of manual transaction volumes - at the moment there is very little adoption of automation and several of our clients have seen transaction levels double year on year for the past few years.
We tend to work within the more mature markets in Asia, and there are two reasons for this. Firstly, the likes of Vietnam, Thailand and Malaysia are still relying mostly on domestic funds and there is still very little cross-border distribution. There’s also the issue of labour costs. The increasing need for automation in Europe is generally down to the cost of labour. In Hong Kong, Singapore and Korea, labour costs are still cheaper, but rapidly growing and also becoming a significant expense for fund managers. In countries like Vietnam, labour costs remain very low, which means the cost of manual processing is not yet a major issue.
AST: You already have a successful base in Australia - does this translate well for the rest of the Asian market, or are the requirements very different?
The Australian funds landscape is very similar to that of the UK, with domestic funds mainly distributed through financial advisers. We set up a base in Australia in 2011 and in less than nine months we’ve created a pilot group that includes one of the largest wrap platforms and several large domestic funds. We are now successfully expanding our network to other major players in this market.
Although the regulations and dynamics are different in every country, we have demonstrated that our model is exportable in different markets. So we have already replicated the Australian experience in Singapore, where people have been talking about automation for more than five years with very little achieved. In April we will have four of the largest local distributors running a pilot with several large domestic and offshore funds distributed in Singapore, and we will then roll out our network to all the major players in the second part of the year.
We’re currently setting up similar pilots in Taiwan and Hong Kong which we expect to start in June. I think this proves our model is exportable - of course every market is different but because we are interoperable, none of our clients needs to make significant IT investment to take advantage of the benefits, which is a big difference from the past and makes the whole process to move to automation much quicker.
AST: How do you see the market developing in the future? What is Calastone doing to prepare for this?
One trend of particular interest in our space is the changing behaviour of investors over the next 10-20 years. Current investors come from the pre-internet days and still rely on traditional advice channels - banks, financial advisers and so on. What we see happening over the coming decade is the Facebook/Twitter generation becoming the new clients of asset managers. This will mean a big change in behaviour of clients in relation to professional advice - they are expected to be less reliant on financial intermediaries, to get information directly online from product providers and to deal into funds online.
This would not be short of a revolution for the fund industry. Transaction volumes could increase significantly, payment mechanisms and investor servicing models would need to be re-engineered. Needless to say that if the major players do not get the automation levels up today, this could be a big missed opportunity for the industry.