Transfer agents are worrying about the wrong thing. AIFMD is eating resources, but the real threat is T2S for funds.
The fund administrators and transfer agents of Luxembourg are not as ready for the coming of the Alternative Investment Fund Managers Directive (AIFMD) as they like to pretend. It took them a while to grasp that AIFMD does not concern hedge fund managers only—which would have made it more of a problem for Dublin than Luxembourg—but captures all managers running non-UCITS funds. Since a third of the €2.6 trillion of assets under management in Luxembourg funds are invested through non-UCITS vehicles, dozens of Luxembourg administrators are now scrambling to get ready for the July 22 deadline.
They are worried that AIFMD will drive business away from Luxembourg, as fund managers from beyond Europe balk at the costs of compliance, including higher levels of disclosure. AIFMD also regulates Part II funds, the flexible Luxembourg vehicles that have enabled managers to bypass the investment and leverage restrictions of UCITS funds while still distributing widely. Authorized by the Commission de Surveillance du Secteur Financier (CSSF) on a case-by-case basis, Part II funds have proved the ideal vehicle for attracting wealthier investors via a minimum subscription price of €125,000.
Now even Part II funds will be forced to cut leverage, report more to regulators and appoint a depositary bank. A depositary bank has to be paid of course. If it is not part of the same group as the administrator, that price cannot be subsidized by earnings elsewhere, putting relationships at risk of being lost to third parties. Because it is liable for any losses and is charged with monitoring service providers and movements of cash between investors and fund managers, the depositary will also take a close interest in where assets are held. Managers will be encouraged to move business from fund accountants and transfer agents of lesser quality.
Luxembourg transfer agents are right to be worried about their operations being scrutinized by a depositary bank answerable to investors, because they are inefficient. But they ought to be much more anxious about the ambition of the European Central Bank (ECB) to extend the scope of TARGET2-Securities (T2S) to encompass the settlement of mutual fund transactions as well as securities trades. For large fund distributors, the invitation to settle transactions finally and irrevocably in central bank money on a delivery versus payment (DvP) basis will be hard to refuse. At present, trades are processed by fax instruction to thinly capitalized transfer agents who pay in commercial bank money three days after the units are delivered.
The €0.15 cent price of settling via T2S will also be nugatory by comparison with the €25-30 it costs to settle a transaction in commercial bank money. So it was surprising to find, in a poll taken at the International Transfer Agency Summit (ITAS) in Luxembourg at the end of February, that only one respondent in 15 thought the impact of T2S on transfer agency revenues would be catastrophic. Transfer agents are clinging to the belief that they offer fund managers more than T2S ever can, such as maintaining a register of investors and their holdings, running Know Your Customer (KYC) and anti-money laundering (AML) checks on investors, calculating and paying commissions to distributors, settling trades in multiple currencies and furnishing them with information on who is distributing and buying their funds. Unfortunately, they are not much good at these tasks either, which is why pressure is growing for the creation of a KYC and AML data utility, and new entrants (such as Calastone) are developing tools to offer managers access to distribution data in real-time.
But the truly existential threat to transfer agents is the excessive degree of intermediation in the European funds industry. The long-term prognosis is for central securities depositories (CSDs) to maintain mutual fund investor registers as well as settle mutual fund trades. The dematerialization law adopted in Luxembourg in April last year will encourage the issue of funds into CSDs such as Lux CSD and VP Lux. Mutual fund DvP in a CSD is far from outlandish. It happens already in France and Germany, which means the two largest domestic fund markets in the eurozone are already destined to settle in T2S. In Denmark, also a T2S currency, the CSD already controls the register of fund holders. Once mutual fund settlement moves to CSDs, it will inevitably shift to T2S. Transfer agents, which have somehow escaped the logic of disintermediation by fund platforms, may not be so lucky this time.