Firms operating across Europe are prevented from achieving the same

economies of scale as those in the US because of the multiple

jurisdictions in which they have to operate. However, the market is

gradually moving towards “domicile indifference” through pooling funds.

Frances Maguire reports.

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.

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