Standardising Dematerialised Mutual Fund Sales Agreements
Presently, mutual fund sales agreements between the fund promoters and the fund distributors in the European Union lack standardisation and automation. The problem becomes more acute when it comes to using distribution channels outside the fund’s home country. Also, in the case of amendments, a manual agreement does not help the already busy back office in commissions processing as it increases the complexities of tasks at hand. The end result is a stretched operations servicing cycle.
Figure 1 demonstrates the current practice of inking manual agreements between the fund promoter and fund distributor and the inherent problems faced with this practice.
In 2006, a working group led by Schroder Investment Management started to discuss how to improve the existing inefficient negotiation process between mutual funds and their distributors and make the commissions calculation and payments more accurate and streamlined. Thus was born the idea of dematerialised mutual fund sales agreements (DMFSA) with twin objectives of standardisation of the agreement terms and conditions and of weeding out inefficiencies of the downstream commission-calculation and payment process.
DMFSA seeks to build, store and maintain the sales agreement between the mutual funds and the distributors in a dematerialised format. It is akin to the International Swap Dealer’s Association (ISDA) master agreement.
DMFSA eliminates the need for physical storage of agreements and also paves the path for writing programs that would automate and enable the straight-through processing (STP) of the downstream commission calculation, notification and payment process. With DMFSA in place, the financial, operational and legal risk will be reduced. This will help free up resources.
Figure 2 provides a high-level overview of the proposed automated agreement process between the fund promoter and fund distributor and the advantages thereof.
Figure 2: Proposed Agreement Process 
Source: Infosys
DMFSA envisages a legal framework within which fund sales agreements may be made and a technical framework in which their commercial terms may be defined.
The legal framework comprises the master agreement, which describes the general terms and conditions applying to the promotion of investment funds and the contractual rights and obligations of the parties. It contains the terms and conditions, common to all territories and employed in every agreement (global terms) and terms and conditions, specific only to certain jurisdictions and employed only in those agreements that need them (domestic terms). Until now, the DMFSA working group has drafted only the global terms and the consultation to shape the domestic terms and conditions is underway.
The technical framework defines the term sheet using pre-defined syntax for mutual fund sales terms. A syntax-centered term sheet promotes the industry standard for defining commercial terms, while at the same time giving flexibility to counterparties to do business on proprietary terms. Such a term sheet provides the much-needed link for STP in back-office processing without compromising on cost, accuracy, legal and operational risk. It can also be exchanged using electronic messages over a trusted messaging protocol or network such as SWIFT. At the same time, it becomes possible for fund promoters to reconcile holdings, report and pay commission, maintain distribution networks and apply changes in commercial terms much more easily.
The master agreement and term sheet, collectively and read in conjunction with each other, will form a binding fund sales agreement between the contracting parties.
Syntax is a set of rules which describe mutual fund sales terms and forms the basis for the term sheet. Syntax ensures development and usage of common messaging language among the participants and thus promotes standardisation of commercial terms.
Every clause in the term sheet has a corresponding syntax rule defined. These rules are a simple, yet powerful, way to describe the information that parties exchange when they contract a mutual fund sales agreement. For example, the syntax on a CounterpartyCapacity appears as below:
CounterpartyCapacity = ((‘Distributor’, [‘SubNetworksAllowed’]) | ‘Dealer’ |’FinalBeneficialOwner’ | ‘FundofFunds’ | ‘PlacementAgent’), [CounterpartyCapacity];
The details emerging from the above rule will be presented in the term sheet in this manner:
‘CounterpartyCapacity’: Indicate in which one or more of the following roles the Counterparty will act:
“Distributor”, “Dealer”, “FinalBeneficialOwner”, “FundofFunds”, “PlacementAgent”
‘SubnetworksAllowed’:
Only if CounterpartyCapacity contains “Distributor”
Insert “Yes” or “No”
This means that the counterparty will act in any one of the capacities enumerated above. If the counterparty is acting as a distributor, then an option for allowing sub-networks is also given.
The idea of DMFSA is such that there is no need for a centralised message repository or single market infrastructure for the industry as a whole. The participants can build their own technology infrastructure or, alternatively, they can avail themselves of the services of an external technology service provider. In order to achieve true standardisation and market acceptance, it is important to promote and adopt open standards. At the same time, necessary messaging protocols should be developed, or existing messaging protocol like SWIFT can be used.
It is likely to be some time before the industry will adopt fully dematerialised agreements, given that it will take time to develop the technology and communication infrastructure.
With Europe controlling almost a third of worldwide investment fund assets, the cost of transactions is still high. The fragmented and inefficient distribution infrastructure is one of the main reasons for the high cost of transactions and continues to present an operational challenge to the growth of the mutual fund industry in Europe. The DMFSA concept is a step in the right direction as it is cost-effective, makes the process simpler and faster, and paves the way for STP. The proposed model is flexible and if successful has the potential of being used internationally as a standard practice.
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