CUSTODY REVIEW: The clients who matter

Signing contractSovereign wealth funds are still the top customers for Mena custodians, but public sector pension funds and endowments may be significant in future. George Mitton gives a run-down of the main types.

Custodian banks, like asset managers, have tended to see sovereign wealth funds as the most important clients in the Middle East and North Africa (Mena) region, and no wonder. The custody business is about volume, and the likes of the Abu Dhabi Investment Authority control hundreds of billions of dollars.

Yet these are not the only client types. Local and global asset managers, public sector pension funds, and endowments, both private and public, could become increasingly important clients in future.
We surveyed custodians in the region to see which client types are likely to be the biggest drivers of growth in the coming years.

Sovereign wealth funds
It is estimated that the Gulf countries are home to about a third of the world’s sovereign wealth assets. The funds typically have huge and diverse investment portfolios, providing a lot of business for custodians that serve them.

The main benefits of having sovereign wealth funds as clients are: they are supremely long-term investors and can form long relationships with their custodians, lasting perhaps 20 years or more; they continue to make money from oil and gas exports, meaning their assets are rising; they are sophisticated investors that will pay for a wide range of services from their custodians.

The funds are particularly important to custodians because they can generate significant follow-on business, says Thomas Sams, head of investor services, Middle East and Africa at Citi.

“As sovereign wealth funds’ investment mandates mature, the segment demands more value from providers’ services resulting in strategic product development and, where possible, firm-wide cross sell opportunities,” he says.

One negative factor is that although the likes of Abu Dhabi, Kuwait and Saudi Arabia will not be short of cash any time soon, increased domestic development demands and the cost of finding jobs for a young population will put pressure on public finances and perhaps draw some money away from the sovereign funds.

Another point is that because large sovereign wealth funds are well established and have most of their relationships already in place, it may be difficult for custodians to win new clients.

However, the past few years have seen a number of smaller sovereign funds either set up or carved out of the main funds, and these could be interesting prospects for custodians. Meanwhile, there is the chance that existing funds will re-emerge after periods of isolation.

Many custodians have their eyes on the Libyan Investment Authority as that country edges back into the global market.

Public sector pension fundsIn most of the world’s markets, the pensions industry provides the bedrock for asset management. This is not the case in the Gulf, where oil has provided an alternative source of investable wealth. However, public sector pension funds are on the rise.

A recent survey commissioned by Invesco found that industry professionals believe public pension fund assets in the Middle East will grow by 19% this year, up from a forecast of 9% in the same survey in 2011. The growth will come from a population bulge of young people entering the workforce.

Public pension funds are “an extremely interesting client type simply owing to the fact that it is one of the sectors that has not utilised its full potential,” says Shikkoh Malik, regional head of products, investors and intermediaries, Mena region at Standard Chartered.

Public pension schemes are small compared with sister structures like the sovereign wealth funds, meaning there is scope for expansion. However, there needs to be a change in mindset before these funds become the ideal clients for custodians.

The investment approach of Middle East public pension funds today is extremely defensive, says Malik, because “shortfalls in revenue generation are expected to be filled either directly by the government or through other government investment vehicles [such as the sovereign wealth funds]”.

Another factor that is lacking are pension schemes for expatriate workers, who make up nearly 90% of the workforce in some Gulf countries. There has been talk of creating expat pension schemes, but little action yet.

“If that happens it is going to initiate a complete new line of activity whereby these flows would invoke enhanced opportunities in all aspects of the economy including capital markets,” says Malik.

In the meantime, most expat savings flow into pension schemes outside the region. Malik says the pensions segment in the Middle East is interesting, but “needs structural changes for it to live its full potential and play a part in the local economies”.

The desire to give money to do good is ingrained in Muslim culture, both at the state level and among individuals. The increasingly well funded Qatar Foundation is one example of a government-sponsored initiative with money to invest in worthy activities such as education, community development and scientific research. There are a number of private foundations too, such as the Al Rajhi Foundation, established by the founder of Saudi Arabia’s largest bank, as well as scores of smaller endowments known as awqaf (see pages 14-16).

As more state resources are funnelled into domestic development projects in the wake of the Arab revolutions of 2011, state endowments may find they have more money to play with.

Sams says endowments are at an early stage of development, and “many are just beginning to put formal service provider structures in place”. That means there are opportunities for custodians who establish relationships now.

Outside of sovereign wealth fund mandates, the figure for assets under management in the Mena region is low compared with the rest of the world. However, there has been an increase in activity in the past year or two, helping to reverse the trend seen after the financial crisis, when growth came to a halt.

“There has been some encouraging improvement in terms of activity but, traditionally, asset managers in the region have not been as big as their peers out of Asia, Europe and the US,” says Malik.

Nevertheless, local asset managers can form the foundation of a custodian’s business and help build up scale. Gaining global asset managers as clients is useful too, but this may be a job for head office rather than the Middle East division, since these managers tend to rely on service structures implemented in their home markets or regions.

©2013 funds global MENA

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