Throw Out The Fax

How SWIFT and Financial Tradeware are trying to help hedge funds get connected

Stuart Fieldhouse
Originally published in the February/March 2006 issue

It is a small issue for a bank, with big consequences for a customer. A cheque goes astray in a clearing bank. Nobody notifies the client. He has to find out it is missing from his own statement. Needless to say, when he follows this up with the bank concerned (in my case the UK's very own NatWest), nobody has a clue what has happened to it. The complaint is duly logged, no doubt in a lengthy queue, and the client is expected to go back to sleep and await some form of resolution. Days pass. Compounded with the human error that caused the failure in the first place, is the lack of speedy and accurate communication between the client and the bank.

In this case, the problem required several phone calls, a physical visit to the bank, and even the sending of a fax. It finally emerged that the transaction had failed because two pieces of paper were detached at some point in the clearing process, but it also served to illustrate how reliance on paper-based processes within financial transactions remains fraught with difficulties.

Obviously, this is a small retail banking error, but the client comes away with very negative thoughts regarding his bank, and wonders why he will continue to be charged the same fees regardless. This is just as true of the fund management business, which continues to rely, despite efforts to the contrary, on paper-based trading and client reporting functionality.

Back in 2000, I worked for a technology platform designed to address just such issues. The solution was intended to introduce paperless investing in offshore funds, including hedge funds, as well as efficient electronic reporting and trade tracking. It was one of a number of platforms being marketed at the time, some of which have since been acquired and are now being supported by large providers of technology services to this sector. Amongst them are Clearstream with its Vestima offering, and JPMorgan with FundsHub. Such solutions are taking root amongst the large and mid-sized fund management groups in Europe, but the technological revolution is a slow one. Many firms remain wedded to legacy systems which they were advised to build, expensively, in the late 1990s at a time when many COOs were still worried about the phantom Millennium Bug. From a liability perspective, there are still obvious concerns that too much reliance on an outside technology partner could create unforeseen problems, and for bigger groups this does translate itself into an understandable reluctance to outsource technology in such mission-critical areas.

A recent seminar in Geneva tackled this issue headlong, with many senior figures from the Swiss asset management world in attendance. Turnout was reflective of the fact that there are still concerns over straight through processing (STP) on the Rue du Rhone. Amongst those presenting was one of the most established names in financial communications, SWIFT, which has been active recently in making the case for the advantages of its networkfor the asset management industry. Its biggest problem at the moment, according to Swiss regional manager Klaus Schritt, is one of visibility.

"Some people still think SWIFT is just about payments," Schritt explains. "But 34-35% of our traffic volume is just securities traffic."

SWIFT can see that it has a more crucial role to play in the investment industry than it currently performs. Schritt himself reckons that close to half the volume on his network is being triggered by the securities industry. It is not just payments traffic: SWIFT is capable of handling a range of different messages. It sees itself as a low-risk, high resilience solution that has the potential to be the foremost messaging infrastructure for the investment industry. It is also a cooperative enterprise: last year it paid back 7% to its members. "Our ambition is to become the messaging platform of choice for the investment funds industry," Schritt claims.

SWIFT was originally founded to replace the use of Telex in the banking industry in the 1970s. It has evolved into a communications network that is capable of maintaining strict ISO standards, with 2600 members who all own shares in the network. Right now, it is seeking to augment its success story by moving from a set-up that has seen it connecting to other clearing systems, to making direct connections with smaller investment firms, private banks and hedge funds included. The scope for operational failures remains high within fund management firms, despite a move towards paperless trading. The estimated cost of the failure of manually processed orders, per year, is €5-€10bn "There is still a massive reliance on the fax machine," says Schritt.

SWIFT aims to help address these failures. Like a cheque going astray in the UK retail banking system, it is widely recognised that reliance on paper is leaving the investment industry at the mercy of human error, and is costing it billions of euros in wasted man hours, not to mention delayed trades and consequent client anxiety.

The UNIFI standard

The rise of the Internet as a communication medium for financial transactions has, of course, brought with it revolutionary changes within the asset management industry. It was not around when SWIFT was planning its succession to Telex, but now it represents a major opportunity to streamline and harmonise financial communication. If a problem still exists, it is one of a lack of common language.

With the widespread growth of Internet Protocol (IP) networking earlier in the decade, the emergence of XML as the de facto open technical standard for electronic communications created the unwelcome possibility of a range of competing and uncoordinated XML standards. The International Standardisation Organisation (ISO), working alongside other agencies like the DTCC, SWIFT, and various banks and fund managers, developed the UNIFI standard for XML-based financial messaging in an effort to avoid this scenario. It shields investments from further syntax changes by proposing a common 61business modelling methodology to capture, analyse, and describe syntax independently of the business processes of potential users and their information needs.

The ISO 20022 UNIversal Financial Industry Message scheme was published in 2004, and defines the ISO platform to be used for the development of financial messaging standards. According to the ISO, its business modelling approach allows users and developers to represent financial business processes and underlying transactions in a formal but syntax-independent notation. These business transaction models are what the ISO describes as the real business standards. They can be converted into physical messages in the desired syntax.

The first point of focus in the application of UNIFI standards was cross-border communication between financial institutions. If this particularly tough nut could be cracked, it was reasoned, domestic markets wouldbe easier to convert. "The challenge was to make sure everyone uses it," says Schritt. "It has taken several years to change practices, and this has partly been achieved via regulatory pressure, like the MiFID directive. SWIFT aims to harmonise the different markets."

Various national working groups have been set up, as well as the involvement of extra-national bodies like FIX Protocol, ISITC, and the United Nations. Banks and clearers that played a role include BBH in the US, BBL in Belgium, BVIK and Deutsche Bank in Germany, Credit Suisse and Julius Baer in Switzerland, and JPMorgan FundsHub in the UK amongst many others. Participating investment managers included Fidelity and Skandia. It is a major international effort to harmonise market practices dramatically. Schritt himself believes that open market globalfunds standards will be a reality by 2008. "We want to avoid proprietary messaging standards," he explains. "We want a single window for all counterparties."

At the end of 2005, orders and confirmations including switches, order status, price reporting, and cash forecast reporting were all available via SWIFTNet Funds. Holdings statements, statements of executed investments in funds, and transfers of units were still in the pilot stage, but were expected to become functional soon. Account opening and maintenance, and annual standards maintenance are currently being trialed, and SWIFT expects to be tackling areaslike commission reporting, static data reporting, and requests for statements in the near future.

SWIFTNet FIX and Corporate Actions

The FIX standardised messaging format is used by many players in the market, particularly in the US and UK, but is not as widely recognised in continental Europe. SWIFT has, however, recently responded to demands from industry players that the network be used to transfer FIX messages. "We can now transport every kind of data format," Schritt says. "We have also built an FIX hub over the SWIFT network. Noone in this business guarantees delivery, but at SWIFT we can guarantee delivery within two seconds."

Why promote the FIX format for SWIFT users? Previously, SWIFT had not been able to deliver a message type to the trading desks of its members, leading to a lack of functionality in the front office. With the introduction of Light Order Entry Tools (LOEs), traders have been given the capability to make FIX-format entries into the SWIFT system. It enables them to benefit from the established SWIFT infrastructure, already trusted by the world's major banking organisations, as well as the intelligent FIX Hub, which will ensure message continuity. It represents the first global network and FIX Hub combination.

SWIFT has also been working to tackle corporate actions. "It is very often underestimated, and considered to be boring, but many clients need to automate this," Schritt says. SWIFT is alreadyoffering a number of corporate actions messaging types on its network, namely: MT 564 for event notification, MT 567 for corporate actions instruction status, and MT 566 for confirmation of account activity. Based on analysis of message types used on SWIFT in 2005 against 2004, it was found that MT 564 (event notification) grew by 30% in terms of numbers of messages sent, while use of MT 568 remained almost static.

"Clients were having problems getting electronic trade confirmations," Schritt says. "There was a lack of standard market practice: only two or three broker-dealers could do that a couple of years ago."

He says there are significant cost savings involved in the implementation of standardised messaging formats throughout the trade cycle, although they remain hard to quantify accurately.

Market data distribution remains a large problem for SWIFT members, due to the different formats that are still in circulation. SWIFT has introduced a new category on SWIFTNet, namely 'Market Data Provider' in an effort to address this. It now includes data providers like Interactive Data, Telekurs, WM, the London and Tokyo stock exchanges, and the DTCC GCA service. "There are more to come," Schritt assures us.

SWIFT is continuing to research new messaging types in an effort to extend the reach of its clients, reduce database costs, and improve automation. It is acutely aware of international progress being made to adopt ISO 15022 as the global standard for straight-through securities messaging, as urged by the G30 in its Global Clearing and Settlement Report. This will all take time, but given progress made already in 2005, it is to be hoped that communication across global networks will improve remarkably in the very near future.

Focusing on the smaller business

Perhaps of most interest to the hedge fund management and hedge fund investing community, however, is the fact that SWIFT has been focusing more recently on smaller players. It no longer sees itself as the preserve of the large banks and other financial entities with massive scale. It has been working with intermediaries like Financial Tradeware to develop services that smaller managers and investors can use to benefit from SWIFT's efforts. Financial Tradeware, for example, is an established SWIFT solutions provider for the fund management industry already, and has been working with Microsoft.NET to achieve this better integration between SWIFT and fund management businesses. Significantly, in October 2005, Financial Tradeware appointed Graham Bright, a 20-year veteran of SWIFT, as its new head of international sales. One of his roles at SWIFT was as manager of the SWIFTNet FIN migration team, with responsibility for IP communications and interfaces in the financial community.

"Our whole philosophy is working closely with SWIFT," Bright explains. "It is hard to ensure that all counterparties are automated. Fund managers and banks are using different terminals for different counterparties, with different password schemes."

He knows of one major bank that is using 140 different systems under one roof: "If you're a profit centre [with this bank], you're allowed to buy a system," Bright says. Even those banks that are SWIFT members, like Citibank and Deutsche, can maintain slightly different internal data requirements for SWIFT processes. It becomes very difficult for a small firm to manage multiple counterparties on a limited budget and with a small number of operational personnel. It all makes for a technological patchwork that it is very hard to make sense of.

Bright says that increased compliance demands on smaller fund managers, particularly hedge funds, is making the use of SWIFT more attractive for them. "There is a need for a hedge fund code of conduct, and there is a need to set standards for valuing hedge funds," he says. This is particularly so if some firms are considering using hedge funds as underlyings in sophisticated retail products, where there might be a requirement for an accurate assessment of risk within the portfolio before it could be authorised for sale. However, it also has validity for funds of funds acting as a conduit for assets entering the sector from the institutional market. They are known to be focusing heavily on the infrastructure in place at individual hedge fund businesses, acutely aware as they are that many failures can be attributed to operational and business risks rather than market risks.

Bright reckons that nearly 80% of the investment industry has yet to achieve full intregration: "The front office may believe that a trade has been executed, but it may not have been." To this end, Financial Tradeware has rolled out its H-FUND product, intended to fully automate pre- and post-trading activities for hedge funds. This includes portfolio modelling, NAV calculation, real-time accounting, and SWIFT/FIX communications capability.

H-FUND is designed to integrate front, middle, and back-end hedge fund operations using a modular structure that allows additional components to be added according to the specific requirements of an individual firm. It supports a wide range of instruments, including multi-currency cross-border trading for equities, fixed income, and derivatives. It automates pre- and post-trading activities using FIX protocols for real-time trading, the calculation of NAVs, back office connectivity using SWIFT for clearing and settlement, portfolio modelling, and direct links to the major data providers like Bloomberg. It is the result of over two years of development work between Financial Tradeware and Microsoft, focusing on the deployment of a fully integrated .NET platform. The idea has been to provide hedge fund managers with a cost-effective, modular, single source for their operations, which is as effective managing their front-end market data flows as it is covering the settlement of their trades.

H-FUND is broken down into four main functional silos, representing different areas of hedge fund operations, namely Front Office, Middle Office, Back Office, and Compliance. Each silo is subdivided into different function areas: for example, Compliance includes a range of sub-packages, amongst them Internal

Auditor, Database Reader, Dealing Supervisor, and Online Accounting. Managers only really need to think about those elements they need to automate within their business, but H-FUNDhas obviously been written from the perspective of smaller operations which do not already have separate departments dealing with these functions.

Financial Tradeware is no technology start-up that is just getting to grips with this market: it has also launched, a suite of portfolio and fund management modules that helps mainstream fund managers automate their front, middle, and back office functions, and it has worked on developing risk assessment tools for the fund management market. It has been operating in the fund technology space since 1997, and counts hedge fund EIM and French fund manager Européene de Gestion Privée amongst its clients.


Systems like H-FUND are about stream-lined, cost-effective solutions for small and medium-sized investment management firms. The modularity of H-FUND's approach is likely to appeal to COOs looking to fill holes in their operational set up. The connectivity with SWIFT, and the participation of Microsoft in the development of these tools are a major bonus when it comes to putting the system under the spotlight of institutional due diligence.

Given the amazing amount of money still being squandered via the use of paper-based processes within the fund management industry, and the high proportion of hedge fund failures attributed to lack of investment in operational infrastructure, there should be a ready market for cost-effective solutions like this one. The degree to which SWIFT, with its proven messaging network, seems prepared to go out to the smaller firms is also encouraging, as they will doubtless benefit from the levels of FIX connectivity it offers. Indeed, anything that can be done to stop pieces of paper going astray and making life unnecessarily complicated can only be for the good. Just ask my bank.