CITI TRANSACTION SERVICES

Spotlight on Fund Distribution

April 2010

Welcome

Richard Ernesti
Managing Director, Global Head of Client & Sales Management for Investors
Global Transaction Services, Citi

A frequently repeated cliché is that 'we live in a global marketplace'. When it comes to the investment funds business, however, the reality is somewhat different: the 'global' market looks more like a jigsaw of fragmented pieces, each with its own tax and regulatory framework, distribution characteristics and order routing processes. This is particularly so in the high-growth markets of Asia, on which this issue of Spotlight is focused.

In a world of increasing complexity, effective distribution and the ability to read changes are important elements of any global strategy. On the one hand, that means dealing with big operational challenges. On the other, it requires a detailed understanding of the way each market is developing and the openings it presents.

In the emerging markets, particularly the high growth economies of Asia, the key is to tailor the distribution strategy to the particular requirements of each country while still managing the operational challenges in a cost-effective manner. And that requires the involvement of a service provider who understands the cultural issues that set each market apart and the importance of sophisticated distribution support.

Managing an Asia Strategy

Steve Bernat
Client & Sales Management for Investors
Global Transaction Services, Citi

Matthew Newnham
Asia Product Manager for Transfer Agency and Fund Distribution
Global Transaction Services, Citi

Today, any investment manager with global ambitions must learn not only to manage a multiplicity of distribution channels but to anticipate the way each market is moving. Little is static. Even in the more mature markets such as the US, UK and Australia, the rise of open architecture, the growing importance of third-party distribution platforms and the trend towards more transparent fee structures for distributors are all major proponents of change.

In Asia, local distribution channels are highly fragmented. In Singapore, investment products are mainly distributed through banks. In Hong Kong and Taiwan, there is a mix of different channels. In Korea, securities firms and independent financial advisers dominate the market. This makes it difficult to put standardised processes in place across the region.

Competition is clearly growing at a furious pace, making distribution links ever more valuable. In the cross-border market, the UCITS 'brand' is now firmly established in most Asian markets. A survey by the European Fund and Asset Management Association (EFAMA) showed that, for the 28 survey participants, 90% of all net sales of internationally distributed UCITS come from Asia. The long waiting list for registration in Taiwan (see Taiwan update below) testifies to the number of foreign fund promoters still looking to up their presence in these markets.

Korea Update: All Change

Hee Jin Kim
Korea Securities and Fund Services Manager
Global Transaction Services, Citi

Of all the Asian markets, Korea looks to be one of the most exciting right now for international investment managers. At the end of last year, a capital gains tax exemption for investors in locally domiciled mutual funds investing in overseas equities was removed. Imposed in 1997, the exemption was designed to promote outward investment at a time of mounting dollar reserves, but its effect was to make offshore funds less attractive than local ones. Now offshore fund promoters can compete on equal terms.

At the last count there were more than 400 foreign funds, mainly Luxembourg UCITS, registered for sale in Korea, but that number is now forecast to rise sharply. Finding local distribution is key. The market is dominated by securities firms and independent financial advisers, though the share of banks and online platforms is increasing.

Foreign firms with a local presence can make life easier for distributors by registering their funds themselves – rather than leaving the process to the distributor. And while registration is extra effort for a distributor anybody can do it on their behalf.

To date, domestic funds have survived the tax change without suffering major redemptions. Now the trend for foreign firms located in Korea is to use a master-feeder structure for new funds investing overseas.

While the subscriptions and redemptions process for domestic funds is all automated through the Korea Securities Depository (KSD), offshore fund transactions are still processed manually in Korea. This is set to change within the next 18 months. The KSD is putting a new fund distribution platform in place using Euroclear's FundSettle system which will transform the subscription and reconciliation process for offshore funds. We will be working closely with them.

More Move to UCITS

A new trend has been apparent in recent months. New fund promoters, based in China, Korea, Brazil and India, have started to jump on the UCITS bandwagon. Having seen the success of offshore funds in their own backyard, a number are looking to set up their own Luxembourg or Dublin funds to compete in the international markets.

The competition is likely to intensify if plans for passporting Australian funds bear fruit. The Johnson Report, commissioned by the Australian government and published at the end of January, envisages cross-border recognition of Australian funds based on bilateral agreements across Asia, using UCITS as its template.

In such a competitive marketplace, third-party distribution support is vital. Many investment managers struggle to manage and service their distributors. Access to data is paramount.

Citi's service model, in which transfer agency capabilities are part of a fully integrated operation, delivers local transaction support with the option of taking on some or all of the local distributor's back office processes.

Local Know-How

In Hong Kong, for instance, Citi's service centre can support the distributors and act as an extension of the offshore transfer agent in Asia, allowing all transfer agent services to be supported locally while acting as the Hong Kong Representative and provider of paying agent services, transaction processing and reporting.

We also support local feeder funds across 12 markets in Asia through our extensive custody and fund administration services and work closely with Citi's consumer bank fund distribution platform to provide a truly enhanced level of service, capabilities and, importantly, automation. All combine to reduce the cost of distribution for the investment manager.

Citi has been mandated to provide an end-to-end package of services to a number of leading Asian investment managers. In some instances we administer Cayman-domiciled funds onshore while undertaking more specialist services one of our leading European service centres and drawing on the regulatory knowledge of our local teams to allow us to service each fund to the required specification.

Overcoming Manual Process Issues

Low levels of automation are a major challenge in most Asian markets, though initiatives undertaken by key players, such as the Asia Fund Automation Consortium or SWIFT, aim to change that. Citi has been working with clients in a number of markets to help them automate what are currently paper-based systems, drive down costs and further differentiate themselves. Recently, we delivered a 40% improvement in automation to the Luxembourg SICAV of one of our key clients.

The manual nature of trade processing in most Asian markets makes it doubly important to have an effective strategy for trade cut-off times and valuation points for cross-border funds. For most flagship funds listed on exchanges around the globe, valuation points fall in the second half of the European working day, when most markets are either open or have recently closed. Those using a 'forward forward' pricing model, where the valuation point is either T+1 or US market close, fall much later. Clearly, the latter will be unpopular with Asian distributors if trade confirmations are not available until late on T+1.

One solution adopted by some investment managers is to offer regional share classes with separate valuation and cut-off points. This places added demands on the fund administrator. In order to ensure Asian investors receive up-to-date information on orders placed 24 hours before, an administrator must be able to execute processes in multiple regions, calculate net asset valuations overnight to have them available before the European day starts. Multiple servicing hubs, delivering 24-hour processing capabilities, are vital.

The ability to draw on a strong combination of local servicing and global processing is vital for any investment manager marketing offshore products into the Asian markets. Local personnel, in the same time zone and with the industry knowledge and understanding of local cultural issues, play a key role in servicing local distributors and investors. But to meet the most demanding of processing deadlines there must be service teams in multiple locations around the world capable of accessing the information flows through the same system. Depending on the global clock, they will be setting up new client accounts, processing trades or handling client queries.

Taiwan Update: Overseas Investment Incentive is Removed

Datong Chang
Taiwan Head of Securities and Fund Services
Global Transaction Services, Citi

Taiwan has one of the most vibrant funds markets in the Asia-Pacific region and more than half of all funds registered for sale are domiciled offshore. Now, however, fund promoters are waiting to see what impact a recent tax change will have on investing patterns.

From this year, the tax exemption that domestic individual investors enjoyed on foreign income has ended – effectively removing an incentive to invest abroad. Previously, individuals were only taxed on their Taiwan-sourced income, but effective 1st January 2010 Alternative Minimum Tax (AMT) for individuals will include offshore income as the tax basis at the rate of 20% with an exemption threshold of TWD 6 million (approx. USD186 million equivalent). The move puts all international investment funds on an equal footing, whether they are offshore domiciled funds distributed in Taiwan or the overseas funds managed by Taiwanese Securities Investment Trust Enterprises (SITE). However, it does result in an unequal tax treatment between the income from onshore funds investing in the Taiwan market and offshore funds.

Many international firms have established local operations by either setting up or acquiring a local securities investment trust enterprise (SITE). Of the 39 SITEs operating in Taiwan, 14 are at least partly foreign-owned. The alternative for a foreign investment manager is to appoint a master agent to register its offshore funds for local sale and appoint sub-distributors. There are 40 master agents, made up of SITEs and securities investment consulting enterprises (SICEs).

Around 72 fund houses are either marketing, or applying to market, their offshore funds locally. Banks account for around 40 per cent of the market, with securities firms the second most important channel. With 65 branches in Taiwan, Citi is recognised as a strong player in fund distribution.

There is however a mounting backlog of applications for registration. Around 985 offshore funds are currently registered, but there are as many as 760 waiting, which indicates continued interest of tapping the Taiwan investors.

In late 2008, the Luxembourg regulator left Taiwan off a list of countries considered to offer equivalent standards of anti-money laundering (AML) and anti-terrorist financing (ATF) provisions. Later in October 2009 FATF commented that Taiwan had made significant improvement in these regards showing commitment to the Financial Action Task Force (FATF) recommendations and removed Taiwan from the FATF blacklist. In November 2009, the Luxembourg government tore up its official list of AML/ATF equivalent countries. In the meantime, Luxembourg funds are still being registered and distributed in Taiwan.

Conclusion

It is precisely this combination of local presence and global service capabilities that Citi delivers to its investment manager clients in Asia – helping them maximise the opportunities in a market beset by fragmented distribution, low levels of automation and time zone issues for offshore funds. In every case, we tailor the nature of the distribution support we deliver to the requirements of each client to make their strategy as effective as possible.