CUSTODY: Changing role of the custodian

GatesThe custody market in the Mena region is seen to be dominated by four firms: HSBC, Deutsche Bank, Citi and Standard Chartered. Barney Hatt talks to the key players about recent changes in the custody landscape.

For decades, HSBC has been the dominant direct custody presence in the Middle East, but its supremacy has been recently challenged by other players launching operations in the region.

In the past 12 months, though, the most significant changes affecting custodians have been in the area of regulations. The UAE introduced fund rules that say managers of local funds will have to use a third-party administrator and custodian.

The regulation became law on September 28, but is backdated to August 27, with companies having 12 months from the earlier date to put in place the relevant infrastructure to provide the services needed on the fund side.

Mike Cowley, Deutsche Bank’s head of direct securities services, Middle East and North Africa, says that “on the custody side, it is fair to say it has been an involving process”.

“The exchanges and regulators have always been fairly open to speak to participants regarding developments, take on board comments and try to build a model which suits all,” he says.

Meanwhile, Qatar has recently implemented new regulations that will see greater co-ordination between its three regulators, the Central Bank, the Financial Markets Authority and the regulator of the Qatar Financial Centre. Under the regulations, the chief executive of the Financial Markets Authority now reports to the governor of the Central Bank and the chief executive of each regulator sits on the board of the other regulators.

Glyn Gibbs, HSBC Securities Services’ Middle East head of development, says: “The consequence is that at a very top level when proposals come through they are looked at in the round, and there is less likelihood of a decision being taken in isolation that may have wider impact which is not realised at the time.”

Custody is currently optional in the Gulf Cooperation Council but markets are evolving with the delivery-versus-payment mechanism recently introduced in both the UAE and Qatar. Many in the custody industry have welcomed this move as a significant step towards tackling the issue of risk in the post-trade process, but Gibbs believes more work needs to be done.

“We think risk can be reduced further by providing a custodian with full control of the assets throughout the settlement process, which has been largely achieved though investors still feel there are a few small gaps in the way fail trades are handled,” he says.

Gibbs says HSBC has been working closely with the UAE regulator to introduce a buyer compensation scheme, which he believes would effectively give the custodian full control of client assets, thereby further reducing risk. He points out that in the case of Qatar there is already a buyer compensation model in place.

Gibbs says that as a custodian in the market, HSBC has been able to give client feedback to the relevant exchanges to help improve that mechanism further.

“However, like all risk mitigating measures, these have introduced new costs in the form of penalties for failed trades in the markets.”

The closure of many local brokerage businesses in the Mena region in recent months has meant less custody is available. It can also be very expensive for custodians to connect to exchanges and to process trades, while the broker will do their version of custody for free.

Richard Street, Citi’s Europe, Middle East and Africa head of investor client sales management, says: “Having a custodian and a broker will result in increased cost for the investors, as there are also charges which go to the regulator and the market itself. This may prove prohibitive to some investors.”

He adds: “With the current market volumes there is not room for a hundred-plus brokers in the UAE. Even at the peak period of 2006 to 2007 this number of brokers was unsustainable. Not all investors will sign up to mandatory custody: if the total cost to access the market is too much, they will take their money and invest it elsewhere.”

BNY Mellon is the world’s largest custodian bank with $27.9 trillion in assets under custody and administration.

Tarek Elrefai, BNY Mellon’s senior executive officer and head of development for the Middle East and Africa, points out that the continued high oil price has allowed Gulf countries to maintain ambitious plans for domestic spending.

“These spending programmes act as a catalyst for market and investment growth and, as a consequence, we are witnessing growth in assets under management and assets under custody,” says Elrefai.

“As long as the oil price remains above $100 per barrel, governments in the Gulf region will be able to keep spending levels strong and continue investment in market infrastructure.

“Infrastructural investment, domestic spending and continuing stability are combining to create a virtuous circle, where market values increase, new investment comes into the market and overall assets grow. Clearly, global and local custodians are benefiting from this asset growth.”

For Hany Samir, head of securities and fund services at the National Bank of Abu Dhabi, though, there are demand and supply issues which need to be addressed if the market is to develop further. “From a demand perspective, the market is dry and has been for the past couple of years,” he says.

“Most of the jewels provided by the companies are not available for public trading. When we look at the particular segments, whether it is healthcare or petrochemicals, for example, these are companies where the majority stakes are government-owned.”

Samir adds: “In terms of the supply which has to be available to create a demand there has to be an injection of fresh blood on the jewels in this part of the world.

“This would automatically create demand, not only injection of fresh flows from the current investor base, but will also attract new segments which currently have very minimal exposure to the region, if any.”

Samir points out that “our markets are young, generally speaking between ten to 12 years old”.

He says, however, that more needs to be done to “bridge the gap between the international best practices and our operating environment and risks associated with the post-trading side of the business”.

For Rod Ringrow, senior executive officer at State Street Mena, best practices are always attractive when trying to attract foreign capital.

“The region has been very lucky to be able to sustain its development via bank financing. However, the additional investment in infrastructure as well as privatisation opportunities may create additional openings for foreign capital,” he says.

“There is a growing interest in the region from institutional international investors, whether it is Asian or Western looking to the Middle East. It would be good if they were to tap into this trend, and create the right environment for increased foreign direct investment.”

©2012 funds global mena

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