Mutual fund settlement for subscriptions and redemptions is typically carried out by a centralising agent, which sends orders to fund registers, operated by fund managers or their transfer agents (TAs). Settlement of subscriptions and redemptions into units of a fund must be finalised in a fixed time as laid out in the fund offering prospectus. On a cross-border basis, settlement is effected via fund distribution market infrastructure operators, some but not all of which are international central securities depositories (ICSDs). </p> “The mutual fund settlement landscape was traditionally the preserve of the ICSDs, although national central securities depositories (CSDs) have begun to encroach on the space as well, particularly in domestic transactions,” says Sandor Szalai, head of strategy and client relations at Keler, the Hungarian CSD, which operates a mutual fund order-routing platform in its domestic market. CSDs in France, Germany and Denmark, to name but a few, have been engaged in the practice for several years, in response to local fund manager demands for domestic fund settlement, but CSDs overall have refrained from cross-border business. </p> As such, while French and German domestic funds settle in local CSDs, mutual funds domiciled in Luxembourg, which are distributed around the world, must be delivered not only to national CSDs and ICSDs (such as Clearstream Banking Luxembourg and Euroclear Bank in Brussels) but also into the registers of fund managers or transfer agents.</p> Catalysts for change?</strong></p> Further change to mutual fund settlement processes are anticipated once TARGET2-Securities (T2S), the European Central Bank’s (ECB) project to harmonise securities settlement in Europe, becomes fully operational across European markets by the end of 2017. On the other hand, the biggest game changer could be the known unknown that is the distributed ledger technology (DLT), aka the blockchain, which many believe could have a massive influence on the future of fund settlement.</p> Just seven CSDs have connected to T2S to date but in total more than 20 will have done so once the next three waves have been completed. T2S is not aimed specifically at mutual funds, although transactions in European securities instigated by mutual funds can settle on the platform once they are accepted by one of its participant CSDs. Some have acknowledged that T2S could extend beyond settlement in central bank money for equities and bonds into mutual fund settlement, a move that could reap cost-savings for cross-border transactions. </p> Fund distributors and transfer agents, which exchange cash and fund shares frequently, are likely to achieve greater process efficiencies in the event of a migration of fund settlement to T2S, but will first need to convince their fund manager clients of the advantages. According to Paul Bodart, a former member of the T2S Board, quoted in a recent paper by fund order routing platform FundSquare and the Association for the Luxembourg Fund Industry (ALFI), there may be cash benefits too. “As a distributor, you can pool all your shares and bonds activity with your funds activity, so the cash flows to one central bank account, as opposed to multiple accounts with multiple commercial banks. The benefits of pooling, and the liquidity related to that pooling, should not be forgotten or discounted,” Bodart explained. </p> At present, fund settlement remains highly manual, in part because of the number of intermediaries involved across the transaction cycle. As an international, if not global, business, mutual fund distribution requires the support of CSDs, ICSDs and TAs with cross-border processing capabilities. Very few national CSDs settle transactions in domestic funds that occur in a foreign market, although VP Lux, the Luxembourg-based CSD and fund platform operated by Denmark’s VP Securities, is an example of the potential for internationalisation. Overall, however, the systems on which these fund settlement processes are run are somewhat antiquated and the scope for error – e.g. administrative failures resulting from process breaks in manual intervention – is high. </p> Once CSDs and ICSDs sign up to T2S, thereby migrating cross-border securities settlement flows to a single platform, fund managers and their TAs could face pressure from clients and distributors to settle mutual fund subscriptions and redemptions in T2S too, thereby gaining harmonisation benefits and cost savings across multiple EU markets. Such savings could be welcome, given the increasing scope and complexity of regulation with which asset managers, and the ongoing squeeze on fees.</p> Nonetheless, some believe that much other remedial work must be done by existing fund providers, intermediaries and market infrastructure operators, before migration to T2S can become a realistic source of process efficiency. “Automation in mutual fund settlement is something that needs to continue. Many distributors and TAs still continue to rely on paper-driven processes and faxes. I do not, however, see T2S disintermediating the traditional mutual fund settlement processes. Many of the traditional settlement participants are moving away from antiquated technology towards forms of automation, such as use of SWIFT messages for fund distribution processes,” says Tom Casteleyn, head of product management for custody, cash and FX at BNY Mellon. </p> Direct access to T2S is predominantly the preserve of market infrastructure operators and major banks. Fund managers or TAs backed by banks may gain access to T2S through their parent companies, but the success of T2S in the fund space may depend on the willingness of counterparts to use the platform and agree to settle in central bank money, which is unlikely to happen overnight. </p> The FundSquare/ALFI paper acknowledged dual settlement systems might have to co-exist before fund settlement gradually migrates to T2S. This could require fund managers to maintain the supporting infrastructure and ensure they collect data on whom their distributors are selling to as part of their KYC and AML obligations.</p> Benefits of disruption</strong></p> Separately, disruptive technologies are being assessed by a number of financial institutions and infrastructure operators as a way to scale down costs and obtain business efficiencies. Many middle- and back-office processes around settlement or settlement repairs are manual. To reduce the need for manual intervention, many are looking to the blockchain, a distributed ledger containing data supplied on an on-going basis by multiple parties which is resistant to tampering (in theory) due to its rigorous cryptography. </p> As the blockchain is a single-source database which cannot be manipulated, advocates of the technology feel it can be deployed to speed up and improve a multitude of back-office processes, including mutual fund settlement. In theory, blockchain would allow for accurate T+0 or realtime settlement for mutual funds, but is currently facing scrutiny across the finance sector over its lack of standardisation, interoperability, scalability and cyber-security. </p> However, BNY Mellon’s Casteleyn says market practice issues must be addressed before blockchain can benefit mutual fund settlement. “Blockchain can be a catalyst for change, but it cannot force change. Blockchain could have a major impact on fund settlement but its impact will not be immediate. Standardising rules around fund subscriptions and redemptions is complex. Look at how long it took to achieve uniform rules for settling European securities under T2S,” says Casteleyn.</p> </p> Find out more from industry experts at ‘The future of funds hubs</a>’ session, which takes place on Tuesday 27 September during Sibos 2016 Geneva.</p>