Guide to Sub-custody 2007
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Sub-custody service levels are now broadly equivalent across the regions - but SWIFT messaging (particularly for corporate actions) is a pertinent sticking point.
INTRODUCTION
Over time, sub-custody services have distinctly improved. Last year's survey noted an upturn in Asian service levels. This year, there is nothing quite so notable as service levels roughly evening out across the regions covered.
What is clear from some of the responses received by Global Investor is that good relationship management - that is, actual client contact – reflects positively on a bank. Clients like it when sub-custodians reach out to them with solutions, such as showing flexibility in dividend SWIFT notifications, which one client said had increased its operational efficiency and had been "greatly appreciated".
The most common complaint by clients is the failure of sub-custodians to comply with SWIFT messaging requirements for corporate actions. So prevalent is this comment that it seems that, if the sub-custody world could eliminate this issue, the service would be almost perfect.
The survey extends to countries across Western Europe, Southern Europe, Eastern Europe, Scandinavia, Asia and the Middle East and Africa. For the rankings and scores of the providers serving each country, together with extensive analysis and comment, see the full survey write-up.
METHODOLOGY
Click here to view methodology
RESULTS
Western Europe: Less value to add
The major piece of legislation on the horizon for much of the region will be the Markets in Financial Instruments Directive (MiFID), which heralds a transformation in the structure of Europe’s capital markets of Big Bang proportions. How significant it will be for sub-custody providers in the affected markets, though, remains to be seen, says Gerald Noltsch, head of location for BNP Paribas Securities Services (BPSS) in Frankfurt.
"I do not foresee any major direct impact resulting from MiFID. It is more indirect, that banks are now seeking alternatives to trading on the stock exchanges, and those alternatives might also trigger changes in the clearing and settlement of those transactions."
Certainly changes are already afoot in Europe’s trading environment, as evidenced by the various merger discussions taking place between stock exchanges, and the recent announcement by seven leading investment banks that they intend to set up a rival pan-European equity trading platform. What kind of post-trade links the banks’ trading facility will put in place remains to be seen, but "I doubt those clearing and settlement volumes will go along the same chain as of today, although you never know," says Noltsch.
And according to Garrick Smith, BPSS’ head of location for Switzerland, such market consolidation efforts are sure to have a big impact on the sub-custody arena, "because if there are less markets to serve there is less value to add". However, it is important to be on the ground in the respective capital markets in this situation, argues Smith. "If two exchanges consolidate and we’re serving clients in both locations, we can create solutions and bridge everything for them." In addition, even if the trading moves somewhere else, market differences in areas such as tax and corporate actions mean "you are always going to have value to add by offering a local market expertise."
As for the situation with the London Stock Exchange, a successful bid by NASDAQ – or indeed any US organisation – raises fears that the Sarbanes-Oxley regime could end up being imported into the UK market, which would have a considerable impact on new listings, says Eric Dickinson, head of sales and product development, investor services UK with Société Générale Securities Services (SGSS). "Compliance, and therefore UK sub-custody, would become more expensive for both new and existing listings."
Then there is the introduction next November of the Eurozone’s TARGET2 payments system. How that will affect sub-custodians and their clients in terms of their funding costs and trading activities won’t be clear until all the key markets are migrated in 2008, but BPSS is looking into the potential for new products around cross-collateralisation and cross-margining, says Connie Raif, head of financial intermediaries coverage with the firm in Frankfurt.
Allied to TARGET2, and another source of great uncertainty, is the European Central Bank’s (ECB) idea for a TARGET-2 Securities (T2S) platform. Details are still sketchy, but in essence all Eurozone securities transactions would settle through this centralised platform, with the central depositories holding on to their existing custody functions. The ECB’s decision on whether to proceed with the project is expected some time in the first half of the year.
Southern Europe: More competition
While market idiosyncrasies mean the coming year will inevitably bring its share of country-specific changes and challenges, the evolving EU regulatory landscape – in the shape of initiatives such as the Markets in Financial Instruments Directive (MiFID), the EU Code of Conduct, TARGET2-Securities, and Basel II – will be a central and unifying theme.
The driving force behind these initiatives is the push for increased harmonisation of markets across the EU, and reducing the barriers to efficient and safe securities clearing and settlement systems, notes Clive Triance, EMEA head of direct custody and clearing, and chief operating officer for securities and fund services EMEA with Citigroup Global Transaction Services.
As such, the upcoming regulatory requirements will stimulate the creation of new business models by dominant industry players, with the shifting landscape leading towards increased competition from regional players, including the further development of central securities depositories (CSDs) and international CSDs as competitors, argues Triance.
As for the local level, one of the central issues facing the Italian market in the coming year will be a revision of Monte Titoli’s operating practices, to enhance the efficiency of the domestic settlement system, says Triance. Some operating difficulties experienced at the beginning of 2006 led local regulators to scrutinise the existing practices in order to minimise the risk of tight liquidity situations and of a significant deterioration in settlement efficiency.
One area of improvement scheduled for 2007, then, will be the elimination of telephone pre-matching between settlement counterparties. Plans are also afoot to establish a ‘fair’ penalisation scheme for late settlements that result from counterparties having insufficient quantities of stocks to cover all pending deliveries, as well as a revision of practices for market buy-ins during corporate events, adds Triance.
Another area of focus for sub-custodians will be growth in the asset management industry, including in the pension fund and hedge fund sectors, says Triance. For example, the "introduction of pension scheme revisions will lead to new business opportunities in the custody and post-trading services industry," he believes.
The big news in Spain, according to Triance, will be the final consolidation/standardisation of both the equities and fixed income operating platforms, which the CSD (Iberclear) started two years ago. There were further system changes in 2007, including the matching system for fixed income known as SUC3. Rules and regulations for equities and fixed income will be harmonised too.
A key trend in the market is the strong and growing competition between sub-custody service providers, says Celeste Costa, senior vice president, custody at Banco Espírito Santo. Such challenges may contribute to an "increase in the quality of services provided, and also to additional enhancements in the sub-custodian systems, expanding the degree of automation with the objective of reducing costs."
Meanwhile, in Greece the main issue will be remote trading, reckons Citigroup’s Triance: "There has been increasing interest from overseas clients in trading equities remotely from abroad. This will build upon the implementation of the Athens Exchange and Cyprus Stock Exchange common trading and clearing platform, which was launched on October 30," as a result of which Citigroup extended its direct custody and clearing network to Cyprus, with remote access through Citibank’s Greek branch, a move announced in November.
And in Turkey, a key development will be derivatives clearing by custodians, says Triance. The private derivatives exchange, Turkdex, started operations in 2005, but the market has lacked foreign investors, and therefore significant liquidity, he explains. This initiative therefore will enable foreign investors to participate in derivatives trading by allowing the clearing and settlement of the derivatives contracts and the collateral management of the open positions to be carried out by their custodians. "We fully expect Turkey to open up as a derivatives market in the near future, and when it does we plan to offer our clients on-exchange clearing services," he says.
Another important initiative in the Turkish market will be the dematerialisation of government bonds and treasury bills by the Central Registry Agency, which is scheduled for the end of 2006, adds Triance. The move is seen as an important step for further transparency and efficiency in the market, Triance says.
Eastern Europe: Driving changes
The long-term economic outlook for the Central and Eastern European (CEE) region remains impressive, especially by comparison to the more established major markets, and this success continues to fuel buoyant stock exchange performances and trade volumes from Warsaw to Moscow, says Bettina Janoschek, relationship manager in the custody department at Raiffeisen Zentralbank Austria (RZB).
Such growth has drawn the attention of the global investment community, with international investments expected to continue to grow in the forthcoming years, argues Janoschek. However, interest from international investors is increasing pressure on sub-custodians active in the region to improve market conditions and service levels in the respective markets, she adds. "Hence, we see it as one of our core tasks to drive market changes in the interest of our international custody clients."
Of course, the heterogeneity of the region means market conditions vary widely. Poland, Hungary, the Czech Republic, Slovakia, Slovenia and the Baltic states were among the most recent batch of entrants to the European Union in 2004 – with Slovenia set to be the first of them to join the eurozone this coming January – and as such they offer a relatively developed market environment. Romania and Bulgaria will also become EU members as of January 1. However, other younger markets still have a long way to go to reach international standards, says Janoschek.
Scandinavia: Norway resists merger
Consolidation remains a key theme across the Nordic region for the year ahead. At the market infrastructure level, OMX, the regional stock exchange, has continued its drive towards a single integrated trading model for the Nordic and Baltic markets, with its recent acquisition of the Icelandic stock exchange and its securities depository. Yet efforts to forge a parallel unified clearing and settlement environment have proved less fruitful, with Norway’s VPS in particular resolutely opposed to integration with its regional peers, leaving a corporate merger in 2004 between Sweden’s VPC and the Finnish APK – to form Nordic CSD (NCSD) – the sole integration to date. Now, though, comes the tricky task of actually consolidating the platforms at a functional level.
Having one system for Sweden and Finland should bring cost savings for the whole market and is therefore to be welcomed, but the problem is it takes a long time, says Peter Dahlgren, head of securities services at Nordea Bank. Nordea is therefore watching the development of NCSD, and how it will bring APK and VPC together system-wise, with great interest, and "we can expect to know more about it during the next year," he says.
There are concerns however that the European Central Bank’s proposed TARGET-2 Securities (T2S) platform could stymie the NCSD initiative. Although still at a nascent stage, the scheme would see T2S assume responsibility for the settlement of securities transactions carried out in the Eurozone countries. But since Finland is a member of the euro and Sweden is not, T2S could threaten the whole NCSD integration, says Dahlgren. Again, more will become clear in the first half of next year, once the ECB’s Governing Council makes its final decision on whether to proceed with T2S or not.
Then there is the question of rationalisation among the current range of agent banks. "I’m convinced there will be consolidation in the market," says Dahlgren. "The local providers that are around now won’t be in a number of years. I don’t know when but that will happen, because the price pressure we have seen in this market must be offset by higher volumes. So size matters."
For its part, Nordea is the result of a merger of Sweden’s Nordbanken, Merita Bank of Finland, the Danish Unibank, and Norway’s Christiania Bank, making it the largest financial services group in the region. "The price pressures are hard for us, but it’s even worse if you don’t have the critical mass," says Dahlgren. "Now we are seeing a heyday in the custody market, because the transaction volumes are fantastic. But a rainy day will come, when transaction volumes go down, and then it will be crunch time."
Asia: Stiff competition in Japan
This crowded market has led to stiff competition and low profits for the players. Custody the world over is a low-margin business, but downward pricing pressure in the Japanese sub-custody markets is particularly notable and is due to intense competition between the domestic players and foreign banks. Japanese banks have been accused of slashing their prices and forgoing profitability to keep business from drifting to their foreign rivals. But there is more history to this pricing pressure than an influx of foreign competition. In 2002 after a decade of negative economic performance, and as Japan’s main foreign market – the US – began to slow down, Japanese banks were viewed as basically insolvent and rating agencies downgraded them.
Mizuho tops the sub-custody tables for Japan, with HSBC coming second. Comments from clients included the remark that HSBC is a "reliable, quality provider" and that Mizuho is "highly efficient and competent".
Middle East and Africa: Gulf overspill
Surplus liquidity from the Gulf is finding its way into the Middle East and Africa. Meanwhile, foreign inflows into Egypt are expected to continue.
Survey Rankings - Japan: Unweighted
OVERALL RANKING OF CLIENT SATISFACTION
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2007
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Score
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1
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11.57
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2
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11.02
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3
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10.37
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4
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10.29
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5
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10.22
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6
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10.18
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Survey Rankings - Japan: Weighted
OVERALL RANKING OF CLIENT SATISFACTION
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2007
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Score
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1
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19.82
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2
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18.44
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3
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17.57
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4
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15.09
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5
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13.61
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6
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10.18
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CONCLUSIONS
The full survey write-up shows the rankings and scores of the providers serving each country, together with extensive analysis and comment. Request the full survey write-up by clicking on the button below.
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