CITI TRANSACTION SERVICES

Cash Management
May 2008

Welcome

Jervis Smith
Managing Director, Global Head of Managed Funds & the Middle East, Financial Institutions Group, Citi

I am pleased to introduce this edition of Spotlight, which considers how fund managers can achieve efficiencies across their entire operations through effective cash management solutions. This is particularly relevant in the current climate of increasing competition and regulation.

As investment performance becomes harder to predict, investors are increasingly looking to differentiate by other means, and funds are coming under pressure to justify, or reduce, management fees. At the same time, Europe's financial infrastructure is being harmonised on a number of fronts.

While the Single Euro Payments Area (SEPA) has eliminated differences between the payment instruments used to move money across borders, the Markets in Financial Instruments Directive (MiFID) is promoting competition between Europe's equities markets and Target2 for Securities (T2S) - the ECB's proposed single infrastructure for securities settlement - heralds further change for securities depositories, custodian banks and their customers. In particular, SEPA and T2S provide scope for fund managers to cut operating costs by rationalizing their clearing, settlement and cash management processes, thereby potentially reducing operational risk capital requirements (ORCR) under the European Capital Requirements Directive (CRD).

Achieving Efficiencies

Roger Brookes
Director, Financial Institutions Cash Sales EMEA, Global Transaction Services, Citi

The need to minimise operational risk is encouraging European mutual funds to adopt streamlined, centralised and preferably automated processes. Add to this the opportunities already being afforded to cross-border providers by SEPA, MiFID and UCITS III, and the fund management industry has an unprecedented opportunity to streamline processes across all its operations - front and back-office - to increase efficiency and build for growth.

With this in mind, the investment industry is rethinking business models and redesigning processes to drive down costs. A good place to start the quest for administrative efficiency is by analyzing the value chain for securities services.

Meeting business and regulatory requirement for mutual funds involves a complex set of transactional reporting tasks, right down to the details of fund units within individual accounts. But, good technical integration and strong relationships between the transfer agent (information services and retail record-keeping), the cash manager (subscriptions and redemptions) and securities services (custodial services and fund accounting) will boost efficiency by accelerating data flows and minimising operational delays and errors.

Many mutual fund providers manage their securities services' relationships strategically, while cash management is seen as a must-have utility. But well structured cash management will deliver efficiency dividends in two areas:

  • Actively managing banking relationships can significantly reduce the costs of collection and payment (transaction charges and banking fees), by exploiting scale benefits and better ways of working.
  • Best-practice cash management will ensure that incoming cash is received, reconciled and applied to accounts at the lowest cost and as quickly as possible, thus significantly reducing working-capital needs.

Rationalising banking relationships

For funds with international distribution and cash management arrangements based on historical relationships with fund distributors and correspondent banks leave transfer agencies having to interface with multiple banks to receive subscriptions from retail or institutional investors and pay out redemptions for each fund under management.

This approach leads to inefficiencies and costs at every level. Each relationship will be subject to: a separate price and service negotiation; transaction fees (e.g. cross-border, extended clearing delays, lifting charges); unforeseen charges; lack of standardisation; and visibility and control of balances across multiple bank relationships. Most issues can be avoided by establishing a strategic cash management relationship with one bank that can deliver local services in each country of operation, usually with minimal disruption.

Use of a single bank provider also presents an opportunity for mutual funds to reduce regulatory capital. Caution has often led to large amounts of capital being held in-country for regulatory purposes with local banking providers. Fund managers that take advantage of SEPA to consolidate Euro accounts with a single bank, and in the longer term reduce this down to a single account, will find it easier to monitor and potentially reduce capital held for regulatory purposes.

Particularly as new information tools now provide an in-depth view of cash flows. A best-practice cash management solution should provide technical integration both within the country of domicile and at distribution level to enable the mutual fund provider to benefit fully from standardised interfaces and processes. In addition, fund managers should look for the four fundamental capabilities:

  • Extensive branch network. The mutual fund provider can leverage this to receive incoming subscriptions and payout redemptions across borders at minimum cost and loss of float.
  • Segregated accounts in the name of each individual fund allow items to be associated with the correct fund at every stage, simplifying reconciliation and making cleared funds available for investment earlier.
  • A single-window electronic delivery platform for transactions and reporting should span a fund manager's entire account structure, be integrated with the transfer agency's back-office systems and be accessible from all locations.
  • Access to Continuous Linked Settlement (CLS) services for risk free settlement of foreign-exchange transactions leads to lower operational processing costs, optimisation of daylight overdraft lines and enhanced liquidity management.

Refining cash management processes with a single bank

Having selected a single provider, the fund manager must streamline relationships, interfaces and processes to country-of-distribution level to achieve full efficiency benefits. When data and funds are passed between different banks in different countries, costs are hard to control due to banking practices such as hidden value dating and float. Instead, fund managers should look to achieve the best of centralised and local cash management: initiating and controlling subscriptions and redemptions centrally from the country of domicile of the fund, but collecting into local accounts and using local payment via mechanisms familiar to investors, with charges at domestic transaction pricing levels.

The first step is to set up subscription accounts with the selected cash management bank in each country of distribution. These accounts will be segregated to keep subscription to each fund separate. Balances on the subscription accounts can be swept to a concentration centre of choice (such as Luxembourg, Dublin or London) on a daily basis, or as required, for rapid investment.

Investors pay their subscription to these local accounts by electronic wire transfer, domestic transfer, cheque or direct debit. Particularly suitable for retail investors, international direct debits enable the transfer agent to send the bank one file containing instructions to debit investors' accounts in any of eleven countries in Europe.

Notification of the rejected direct debits will also be retuned in one file to the transfer agent for reconciliation and follow up. Processing of subscriptions paid by cheque can also be centralised via lockbox services to minimise in-country overheads. Cheques sent by investors to a local PO Box (the lockbox) are collected daily and couriered to a central processing unit; a single file is then sent to the transfer agent for reconciliation, while the cheques are delivered back into the local clearing in the country of origin.

Redemptions and other payments can also be cost-effectively centralised. The transfer agent can prepare a single file of redemption instructions and send it to the bank for sorting into payment types (electronic wire transfers, domestic credits or cheques) and destinations. The bank will then execute the redemptions and the transaction data will be reported back electronically for reconciliation.

By replacing today's patchwork of national payment instruments and standards with a new set of consistent pan-European products, SEPA may offer fund managers further opportunities to streamline subscriptions and redemptions from retail investors denominated in euros.

The introduction of the new SEPA Direct Debit product during 2009 will not only promote process efficiency and automation by eliminating existing differences between national direct debits schemes, it also reduces barriers to entry to new markets and allows collection activities to be managed out of a single account. Whereas a fund manager might previously have needed to set up a new banking relationship and account structure to facilitate payments from retail investors in, say, Finland, subscriptions can simply be collected via this new pan-European tool.

Equally, on the redemptions side, non-urgent euro payments can be made across Europe from a single account using the new SEPA Credit Transfer service. A redemption that today would require a high-cost same-day cross-border transfer, or the continued cost and effort of managing a domestic account structure, can be expedited from a single euro account located anywhere in Europe.

Such opportunities to reduce costs and grow business should be seized quickly as the reduction of barriers to entry applies to all European markets, allowing nimble new entrants to steal a march on existing players.

Net gains

As Europe's new financial infrastructure takes shape, mutual funds must reassess their competencies, their competitive advantages and their value to customers. Opportunities for process efficiencies will differ: fund managers that need to maintain local accounts for regulatory reasons will still be able to rationalise internal processes by using standardised euro payment instruments. Streamlining cash management will pay an efficiency dividend in reduced banking fees, lower costs of capital, improved internal processes and reduced operational costs. Although savings will vary on the specifics of the particular business, the elements that make up those savings are the same.