The concept of “pooling” for funds is a simple one. It isn’t new –
Citigroup has been pooling funds, domiciled in Luxembourg, since 1995.
The premise is that instead of managing each fund as a separate entity,
greater efficiency and economies of scale are achieved if funds can be
grouped – or pooled – and managed as one. This dramatically eliminates
repetitive administration and frees up the fund manager to manage the
funds.
Cutting time and costs
Apart from the economies of scale achieved for multiple segregated
accounts, there is also the reduced cost and, more importantly, the
reduced time needed, to have to only buy and sell for one pool instead
of up to five or six similar, but separate, portfolios. Pooling enables
two or more funds to co-mingle their assets in investment pools to
reduce investment management, administration and custody costs. A pool
is not a fund but a notional entity with no legal substance. The funds
participating in the pool retain their legal and fiscal integrity as if
they had invested directly in the assets in the pool. Pooling is not
like a fund of funds – a fund that invests in other mutual funds –
since with pooling the fund has a direct beneficial interest in the
assets of the pool.
Seán Páircéir, managing director of Brown Brothers Harriman (BBH) in
Dublin who overseas its fund administration services, says that the
demonstration of ownership is central to pooling. “Custodial systems
have evolved to reflect traditional safekeeping principles; assets held
for a client are segregated and clearly belong to that client.
“Pooling is a sophisticated next step in the evolution of this
principle. The now almost uniform electronic holding of assets allows
for possibilities to re-interpret ownership. Pooling seeks to make
asset managers’ life simpler by enabling their employers’ distribution
side to add incremental pieces of similar mandates to a single pool of
assets and benefit from significant economies of scale. The
administrative technology provides the allocation of ownership to the
separate and individual legal entities.”
Intra-fund pool
BBH currently supports intra-fund pooling in Luxembourg and is aware of
an asset manager seeking approval for a similar process in Dublin. The
custodian has a customer in London, Frank Russell, that is currently in
the process of approving an intra-fund pool that will be run in both
Luxembourg and Dublin.
The mutual funds industry has been searching for some time for a way in
which redundant portfolio management can be eliminated in the delivery
of investment products, and ultimately enable them to be managed as a
single portfolio of assets. In a perfect world, this integrated
investment strategy would include products from multiple domiciles.
But due to the perceived complexity in meeting the legal and regulatory
requirements of all the relevant parties, the debate has subsided over
the years, with limited pooling of funds occurring in Luxembourg and
Dublin, where the authorities were the first to be approached in Europe
with regard to pooling strategies, and which have been the most open to
considering alternative asset management arrangements.
Market heats up
But recently things have heated up. The pioneers and providers of
pooling services, usually the custodian banks, have quietly forged
ahead, and continued an active dialogue with regulators. To this end,
the first cross-jurisdictional pooling products are close to coming to
market. To date, the closest that any firm has come to
cross-jurisdiction pooling has been Crédit Agricole, which tackled the
issue from an entirely different approach than pure pooling, and came
up with a proprietary model, known as “cloning”. Citigroup has
approached the regulators regarding pure cross-jurisdictional pooling
and the bank is fairly confident of going live next year. Meanwhile, it
continues to fine-tune the model and build the technology.
Bernard Hanratty, vice-president at Citigroup with responsibility for
global transaction services in Dublin, says: “Inevitable delays are
incurred as regulators contemplate the revolutionary proposals being
presented. Often, the approval given by a regulator will be ‘in
principle’ – waiting for a real live case to be presented to them. It
may only be when such a case is presented that their true concerns will
surface.”
Unfortunately, there is a cloak and dagger mentality among the service
providers with regard to cross-jurisdiction pooling. There is fierce
competition among providers and the prevailing feeling is that those
that get there first will have a true competitive edge. The upside of
this is that custodial banks are investing a lot in bringing pooling to
market; the downside is that they are not working together as an
industry but going it alone – which may lead to unnecessary duplication
of efforts.
Mr Hanratty says: “There is a very strong argument for players in this
field to combine their resources in pursuit of the ultimate goal of
cross-jurisdictional pooling. The participants could comprise asset
management and service provider representatives. Regrettably, tangible
steps towards this goal can only be deemed to have been completed when
two (not one) regulators approve the concept in principle and there is
a live case in operation.”
Different structures
Pooling applications are best described by their examples, as there are
many different types of structures. The most basic is where groups of
multi-currency share classes are brought together to allow the
management of a single pool of assets, while investors are given the
option of purchasing shares in sub-funds that have the same investment
objective but are denominated in two or more currencies (see figure 1).
Another, perhaps more complex, example is the asset diversification
model (see figure 2). In this very specialised multi-manager
application, a fund promoter is able to engage the services of many
specialist fund managers without the requirement of a sub-fund
allocated to each manager. This allows a particular “investment style”
to be incorporated into an overall sub-fund investment objective where
that style might not be permitted, for regulatory reasons, in its own
right as a dedicated fund. This is achieved because the proportion of
assets allocated to the investment style is low, relative to the
overall size of the sub-fund and therefore the concentration of that
style is diluted.
Commitment needed
In order to achieve the ideal of domicile-indifference pooling,
significant investment and long-term commitment is needed to overcome
the many hurdles and stages of implementation – each to be taken by all
the service providers. A domestic depository bank function needs to be
created in each of the countries that are expected to participate in
the cross-jurisdiction pool.
The basic intra-fund pooling structure, which most of the serious
players already have in place for Luxembourg and Dublin, needs to be
presented to the regulator of each country for approval. Then a more
developed extra-fund pooling structure (involving two or more legal
vehicles in the country) must be presented. Only when these two stages
have been agreed in principle can the issue of cross-jurisdictional
pooling be broached with the regulator. It may be a significant
advantage if the depository banks established in each country are each
part of the same legal vehicle.
But it is clear the rewards are worth it, since the asset management
industry in Europe will be transformed as a result of these efforts.
Not only will it help bring Europe in line with the US mutual funds
industry, which has thrived on being built on a single jurisdiction, it
will also help with new product development.
Mr Hanratty says: “Once a pool is in place it will enable new products
to be added faster and the past performance of the pool can be used as
an indication of future performance of the new product.”
For both Citigroup and BBH, while there are savings to be made in terms
of the number of transactions needed through pooling, these cost
savings are far outweighed by the other infrastructure benefits – such
as the efficiencies in time and administration, and the ease of adding
new products and tranches of investment. Further developments are also
afoot. A working group of the Investment Managers Association in the UK
is in talks with the regulators with regard the treatment of unit
trusts and OIECS.
Reaching wider audience
Additionally, as Mr Hanratty points out, while to date pooling has been
used for the bank’s regulated mutual funds, the practice is also
“deeply applicable” to pension funds and other segregated funds.
Hopefully, in a year’s time, once regulators have been reassured,
cross-jurisdictional pooling will be rolled out to a wider audience and
this practice will be more readily available to other kinds of funds.