Securities settlement in Europe is known to be more costly and inefficient than in the US. These pale into insignificance when compared with the financial assault on investors in European investment funds, again in contrast with their counter parts on the other side of the Atlantic.
In the US, the Peter Marshall of the Depositary Trust & Clearing Corporation (DTCC) in New York, which is the trade organisation responsible for mutual fund clearance and settlement, reckons it is time some spotlights were turned on this area. The messaging firm SWIFT has put the finger on the tremendous burden passed onto investors because of the lack of an infrastructure.
There is a E1bn annual cost of re-keying in the 50m fund units orders that are processed manually every year in Europe. That’s what appears above the water, according to SWIFT director Francis Remacle, while below the surface, lie the costs of rectifying errors, reputational and other risks – he put the total costs at a minimum of E5bn.
This works out at around E20 direct costs per trade and perhaps as much as E100 in direct costs. “Such figures are anecdotal, and by no means scientific,” Marshall acknowledges. But even if they are half that level, they are still very far away from the 35 cents per trade in the US, of which DTCC charges 17.5 cents.
The European figures quoted are from a study, published last year by European research group PROMETHEE, which examined the what needed to happen to the funds industry so that it could reap the rewards of the integration of European markets. DTCC sponsored this report ‘Bridging the funds divide’, in hopes of opening up discussion, particularly on this largely ignored aspect of funds’ costs. “But the report and PROMETHEE’s conclusions are their own,” Marshall stresses.
While he says that DTCC does not have any mandate or mission to try to solve what is fundamentally a European problem, he reckons Europeans are basically barking up the wrong tree. “In continental Europe, the view has been that the right way of handling units or fund shares has been through the custodial function.
“We do not operate that way. We fundamentally provide an information service on funds side, as our mutual fund business was part of the clearing operations before we merged in with custodial side.”
The US system was purpose-built, looking at how a fund as a type of security operates. “We built from first principles, working from the attributes of the industry rather than taking an existing equities model and imposing that on funds.”
An open end fund is a continuous primary offering with no secondary market, but the whole custodial model is built around the secondary market, Marshall points out. “There is no place for an exchange as there is no price discovery, just NAV once a day.”
DTCC does not keep a registry which is provided by the fund group. “We do provide the information interconnectivity between the distributor and the funds. This is a highly standardised mechanism. We do not think that there is a role for a central registry since funds are not transferred, as they are created and eliminated. There is not true delivery versus payment.” In the US if you place an order for funds, it goes to the registrar who creates new units then and then there is a cash movement a few days later.
In his view, “Europe is trying to retro-fit a delivery versus payment model, which involves double reconciliation. The custodian in the middle is reconciling with the distributor, and with the fund, but the fund and the distributor do not have a common set of information”.
What the DTCC provides is a conduit of information in a very formatted way. The distributor and the fund have identical information so if there is a problem they can work it out. “You want the parties with the relationship with the facts to have the relationship.”
In Europe, Marshall cannot think of one market that has straight-through processing as there is on the funds side in the US. “We are not saying that what we have in the US is perfect for any other market,” he says. What has been achieved through the DTCC’s Fund/Serv system was possible due to the common infrastructure that was broadly accepted in the US market. But thanks to the efforts of the DTCC, which is a market-owned operation tremendous functionality has been put in place. “When a market organisation with the right focus, puts its mind to it and with the right support, there is a tremendous amount of cost ultimately borne by the investor that can be removed.”
Where Europe is also missing another trick is when it comes to defined contribution, which many countries have already embraced in some form as the core of their second pillar pension provision. “There has not yet been a recognition that the same infrastructure could be used in the funds market and in a DC pension market.” The two markets are seen as separate silos, whether you are talking about Germany, the UK or Australia.
Marshall points to the DTCC Clearing and Settlement product for the DC arena. “This recognises that you often have a tri-party arrangement in DC, with, for example the same administrator and trustee, both with differing authorities.” There frequently is a bigger set of investment options than just mutual funds, with for example insurance contracts, but have the same business characteristics, in having a net asset value and trade in units. They may need some system modification to accommodate them, but this can be done, he says. “What this means is that a record keeper pensions administrator, can funnel their trading activity through us, and the post trade reporting from the fund going back to the administrator will go through us.”
But Europeans need to sit up and take notice of a development last November. Then the DTCC announced it was turning its attention to bringing cross border investment funds more within the system. The aim is by leveraging its Fund/SERV platform to provide “seamless end-to-end processing, reporting and reconciliation of cross-border trades, including the ability to handle euro-denominated transactions”. In addition to serving the traditional offshore funds, this also is attracting business from outside the US. “Pure institutional business served by banks and brokerage firms, such as pension funds in Chile or bank in other parts of Latin America are placing trades on behalf of these clients.”
He also points to the trend to consolidation of clearing platforms in order to control costs. Some US groups are consolidating support for their Luxembourg and Dublin into the US. “In the past year, there has been strong interest from European fund organisations to get access to our services. We are now seeing the west-bound traffic of European fund managers seeing this as a portal to distribution for their funds.”
In 2001, there were some 220,000 offshore funds transactions with a cash value of $18bn handled through the existing system, with Luxembourg funds accounting for 50% of this, Dublin for 20% and the rest of the world for the balance. In 2002, the $18bn figure had been reached by end September. So even in these depressed times for fund investing, this part of the DTCC is now working with industry players, both US and European to sort out “the kinks” in the system that cause inefficiencies. “We have formed an advisory group with 34 firms. Task forces have been set up for the different topics. We are working on the documentation, as we think this is the only way you can clarify where the glitches and kinks are and work them through.” For example, they have found there are different patterns in terms of funds’ processing cycle, their trade date and when they report this, whereas in the US there is one – so that has to be worked out, he says.
“I am not aware of any other organisation that is taking this approach saying that ‘exception processing’ is the enemy and we are trying to attack it.” The immediate objective is to become fully multi-currency by the end of 2003 and to have full STP and straight through reporting.
There is one glimmer of hope that might make Europeans realise the imperative of working together in the funds area. The DTCC approach is to work in partnership with those in the market place.
The US mutual funds system was born out of a paper crisis hitting the funds industry. “If the fund market revives in Europe there will be a paper crisis.” He points to the predicament of third party transfer agents in Europe, with one of the largest having to support over 70 different proprietary connections. “Euroclear and Clearstream believe in their hearts that they should own this business and have had products in the markets for three years.” But Marshall says DTCC calculations reckon that the volumes of European funds business already being handled through it are higher than the European ICDS, and that is before the US group has developed any products.
“If you look at the growth of the US market, it is inconceivable that it can have grown without a service such as ours, providing the efficiencies.” His greatest fear for Europe is one of inaction. “The worst scenario is one of paralysis – with no one making up their minds and no one investing.”

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