International custodians have targeted the Mena market in anticipation of increased capital inflows and regulatory changes to the domestic market, all of which are yet to happen. Nicholas Pratt talks to some of the key players to determine whether the expectation and optimism still prevails.
The custody landscape in the Gulf Co-operation Council (GCC) has changed from the early days when HSBC was the sole provider of direct custody and every other international asset servicing firm employed a sub-custodian. In the past twelve months, the council has become an attractive market for these international firms. Many have withdrawn their sub-custody mandates to either launch their own stand-alone services or manage their mandates in-house.
In the past two years, international financial conglomerate Citi has launched sub-custody operations in Abu Dhabi, Dubai, Bahrain and Kuwait. It also plans to launch in Qatar as soon as the regulatory environment allows. And in June this year it ramped up its presence in the region with the launch of its Middle East Global Window service, a global custody offering based on local market working hours, using local operations based in the United Arab Emirates (UAE) and Bahrain offices and treasury teams with cash accounts, cut-off times and currency pairs specific to the local markets.
Meanwhile, Deutsche Bank (DB) Security Services has been a custody participant in the UAE since 2006 and was a founding member of the Dubai Stock Exchange. More recently, it has looked to expand its presence in neighbouring markets in an effort to create a GCC franchise. DB Security Services has been in Saudi Arabia for a year and is in the process of setting up an office in Qatar.
In addition to the likes of Deutsche Bank and Citi launching Middle East operations to rival HSBC’s long-held dominance, local custodians are also looking to break into the global custody market by linking up with international firms. In July, the National Bank of Abu Dhabi (NBAD) signed a commercial agreement with Société Générale Securities Services (SGSS), making it the first local bank to provide direct custody services in the United Arab Emirates.
The NBAD and SGSS alliance may be the first of its kind in the United Arab Emirates but Hany Samir, head of securities and fund services at NBAD, expects more to follow, especially once various market issues are addressed that will create more activity in the domestic market and also bring more international capital into the region thus creating the two-way flow of capital (inward and outward) that asset servicing firms are hoping for.
The increased liquidity that asset servicing firms were anticipating is yet to appear in the GCC markets. But, says Samir, the reasons for this are easy to explain and should be overcome in time. There are macroeconomic factors to consider, he says. “There has not been much growth in the United Arab Emirates in the last year, but there has not been any growth anywhere, so we are not in isolation.”
And there are microeconomic factors, such as the efforts made to bring local markets in the GCC up to international standards, he says. For example, delivery-versus-payment has been introduced in the United Arab Emirates and Qatar, thus addressing one of the two main issues in the GCC market – the risk in the post-trade process.
The second issue is to address the lack of diversity in the market. “There is a disproportionate relationship between the liquidity in the market and the diversity of products available, but work is being done to create more diversification and consequently bring more liquidity into the market,” says Samir.
The market is introducing short-selling and security lending, subject to regulatory approval. The next step, he says, is to introduce some kind of sales coverage into the market.
In addition to reducing risk in the post-trade process and introducing more diversity into the capital markets, custody itself needs to become a more prominent and independent function, says Samir. “Currently, custody is optional within the GCC market. Also, 60% to 70% of the market is retail-driven so they are more used to having local brokers handle both the custody process and the management of their positions so there is no segregation of duty. There are plans to make it compulsory but there is, as yet, no definite date as to when that will be.”
The lack of a definite date is not helpful, especially given the number of asset servicing firms that have set up in the market in anticipation of greater volumes. Such situations can often create concerns that there will not be enough asset servicing business to sustain all the current competitors.
“It all depends on what you are looking for from the market,” says Samir. “If you are only focusing on the inflows then the amount of business does not allow for having five custodians over a long period of time. But if you expand your offering to include different services in the market, and once custody becomes compulsory, then the amount of business will be able to support a wider number of custodians.”
Loss of momentum
“The momentum was massive two to three years ago and perhaps the current attitude is more realistic,” says Mike Cowley, head of product and client management, Mena, DB Security Services. “The GCC market is only 15 years old and the level of development that has been achieved is more advanced than we have seen anywhere else.”
Nevertheless, the continuing fall-out from the financial crisis has led to a deceleration in the council’s market development and some reservations about the adoption of Western standards and operating models.
For example, says Cowley, the adoption of an omnibus approach to asset servicing may not be as attractive as it was three years ago. “There is a realisation that the GCC has its own characteristics and these must be respected in the way the market develops.”
These characteristics can be seen in the way the different exchanges of the Gulf Co-operation Council have developed, says Cowley. “The exchanges in Dubai have adopted all the latest global standards in terms of the platforms and the market models but they have very few listings and very little liquidity. Whereas the Saudi exchange does not have all the latest standards but has almost all the listings and the liquidity.”
To completely change the local model is not going to work. Instead, there has to be a combination of existing practices and international standards, says Cowley. “I think the GCC market supervisors have been good at achieving this. Unfortunately, liquidity has dropped in the GCC market as it has everywhere else. But I believe things will get better in the next twelve to 18 months.”
Cowley sees December as being a crucial period for the Mena market, not least because the much-anticipated MSCI Index upgrade may finally be approved. “I think the delay could be quite positive. I don’t think the models were ready in June, but by December they will be. So I think the MSCI’s decision to delay until December rather than wait a whole year is in recognition of this.”
Cowley also expects there to be more initial public offerings in the next twelve months and points to the recent issuance of the first tranche of an AED5 billion (€0.986 billion) structured bond from Dubai-based developer Nakheel as an example of market activity.
Cowley is not alone in his optimism. Samir agrees that the upgrade for the United Arab Emirates should be a formality. “The MSCI report was clear; the UAE has satisfied all the required measures but they happened too late to be included in its June report. So we are confident that the upgrade will go ahead.”
It is certainly hard for any asset servicing firm not already in the Mena market to put forward a persuasive business case for doing so now, especially given that capital inflows are considerably higher in other markets, such as Asia and Latin America. But for those firms that did make the decision to grow their Mena businesses, none of them looks likely to give up and are here for the long term.
Standard Chartered has been operating in the Mena market for more than 90 years but it is only in the last three that it has launched an asset servicing business in the region. As with other firms that have launched such a business there in the last two years, it does not intend to reduce its operations. “This is a significant market to which Standard Chartered will remain committed to developing deeper client relationships and enhanced service offerings,” says Stewart Adams, managing director and regional head of investors and intermediaries at Transaction Banking, Mena.
“The markets have not attracted the inflow from the international community that was hoped for, though intra-regional investing continues to be active,” says Richard Street, managing director and head of securities and fund service for Middle East and Pakistan at Citi.
But he also states that the provision of a custody infrastructure to service international and regional investors and intermediaries is a long-term investment with a long-term commitment. “Citi considers this to be a strategic build out of its global securities franchise and remains committed to this initiative.”
©2011 funds global