The financial crisis is vexing asset servicers in Central and Eastern Europe, finds Fiona Rintoul. But there are other causes of change too...
Europe is not homogeneous and nowhere is this more true than in Central and Eastern Europe (CEE). Some countries are in the European Union (EU) and some are not. Some – Russia, for example – will probably never be in the EU, and some will.
This means it’s important for asset servicing providers to have a presence on the ground in each market as far as possible. There may be some generalities across the region, but you can never know everything you need to know about a market unless you are there.
“You have to have a regional presence and the same level of service in every market,” says Ramy Bourgi, head of emerging markets at Société Générale Securities Services (SGSS).
In many markets in the region SGSS is present through the wider Société Générale banking network. Where it is not, Bourgi looks for a local bank with whom to partner. “If we don’t have a presence in a market we go with an existing local player because you cannot acquire local knowledge and market expertise overnight,” he says.
That’s the case whatever the size of the market. In the Adriatic region, for example, SGSS has capability in Slovenia and Serbia to match its Croatian capability, although Croatia at the moment is a considerably larger market.
“Small is important,” says Bourgi. “To be able to provide a pan-regional solution it’s important to have a strong regional presence and the same level of service in every market.”
In the post-financial crisis environment, this brings new challenges. Clients are asking more questions about sub-custody networks than they were before the crisis.
“Agent risk has become quite a topic with all CEE institutions over the past half year,” says Chris Porter, a regional executive of BNY Mellon Asset Servicing, which operates from a regional hub in Frankfurt. “Even before the crisis it was a topic, but the emphasis has shifted from achieving more global access to putting more emphasis on the risk profile of the agent.”
CEE clients still need global network solutions post-crisis, says Porter, but the emphasis is now not on how quickly a service provider can get them to market, but on understanding that market. Clients want to understand a provider’s risk profile and the risk profile of its agents.
“It has brought network management to the forefront,” Porter says.
Clients are looking more deeply into sub-custodians, looking at their balance sheet as well as their operational capabilities.
“People realise that banks can fall down,” says Bourgi. “It makes it more interesting and more difficult for global custodians.”
One tangible consequence of this is that custodians are increasingly looking at alternative providers. “They are looking for a secondary custodian in a market where they already have an agreement just in case they get the jitters about the institution they are using,” says Bourgi. “This never happened before the crisis.”
Another consequence is that the credit rating of the underlying institution has become more important. When clients choose a custodian there is always a question about credit ratings and credit services, but until now it was largely a box-ticking exercise, says Theofilos Mitsakos, head of BNP Paribas Securities Services in Hungary.
Internally, there is also a stronger focus on compliance. “The procedures we have in place are stricter,” says Mitsakos. “Every potential issue is transmitted further up the hierarchy of the bank.”
While dealing with this heightened focus on network management in the CEE region (although it should be noted this trend is by no means confined to CEE), asset servicers in the region also face an increasingly complex set of demands from local clients. The service that asset servicers in the CEE region provide to in-bound international clients may be all about consistency across a global platform supported by local knowledge, but for outbound local clients and indeed for domestic clients service requirements are evolving rapidly.
BNY Mellon’s Porter explains that the rapid internationalisation of CEE investments that followed the collapse of local stock markets after a period of ebullient performance put a lot of pressure on local asset servicers. They then turned to international providers such as BNY Mellon for a solution, he says.
“Previously, CEE portfolios were heavily weighted to euro bonds and just a few equity markets and were relatively easy to service. Then portfolios became extremely global requiring access to Asia and exotic markets. This created a tremendous amount of pressure for local asset servicers who hadn’t been doing this in the past.”
The present crisis has actually created a kind of reprieve for these local asset servicers because portfolios have been retrenching, says Porter. “Many are using the period of decreased pressure to realign how they deal with global investments.”
Another factor that has put pressure on asset servicers in the region – and will continue to do so – is the changing profile of CEE pension funds. “As pension regulations develop, products that are bread and butter for pension funds in Western Europe will become very important for pension funds in Eastern Europe,” says Bourgi.
Already the pension regulations in CEE have evolved considerably from initial days when international investment was forbidden or limited to, say, 5%. In the future, we may expect CEE pension funds to move into alternatives just as Western European pension funds have done, aping their American cousins.
Local asset servicers will have to cope with this and are likely to turn even more to international providers as they have done already during the internationalisation of local CEE portfolios. This makes building up a strong CEE presence look like a canny move for global providers – although not one that all that many firms have taken.
“There are actually very few global players in this region,” says Bourgi. “If you look at the list of top global custodians that have focused on CEE, it’s extraordinarily short.”
The list does not include the big US players State Street and JP Morgan, though fellow American Citi is in the game.
“This brings up the classical mistake that tends to be made by global providers who simply view the region in a snapshot of where it is today and compare it with developed markets,” says Porter. “CEE needs to be viewed from a more dynamic perspective. It’s not where it is today, but where it will be tomorrow or three years down the line.”
Perhaps companies need to have a reason to be in CEE. For BNP Paribas it is the fact that securities services is a core part of its business and so it should be present everywhere that assets are serviced. SGSS’s presence in the region stems from – and is supported by – the wider Société Générale group’s commitment to building a business in the region. BNY Mellon, meanwhile, has a long-term engagement with the region.
“We’ve worked through the evolutionary steps with them,” says Porter. “We were there before the capital markets evolved. We worked through the evolutionary states with them, including the post-communist privatisation. It was a very natural progression for us to facilitate the growth of portfolios into international markets.”
A tricky business
You need a reason because however great the region’s potential, doing business there can be complicated. Many markets have developed an excellent infrastructure learning from the mistakes made in developed Europe and drawing on their neighbours’ experiences. But not all. Some point to Russia as an example of a country where the infrastructure is not all it could be.
There are also many local considerations to take into account. In Hungary, for example, BNP Paribas has just introduced a new product designed to facilitate the liquidity needs of clients and is in the process of developing another product specifically for the Hungarian market. Obviously, this only makes sense if you expect to get a reasonable amount of business out of the Hungarian market.
At the same time, the service level demanded by clients in these markets is as exacting as elsewhere.
“Most of the differences in terms of service arise because of specific market practices,” says Mitsakos, who notes that value-added services are increasingly in demand.
As for the future, it’s tempting to say that the CEE markets will converge with developed European markets in terms of portfolio sophistication and attendant asset servicing needs. But CEE in fact has a different profile from developed Europe and, once the crisis is behind us, may plough its own more adventurous furrow.
“CEE portfolios had become extremely global,” says Porter. “That’s been underestimated. Proportionally there was a much higher allocation to foreign emerging markets than you’d generally find among German or UK investment managers. They came themselves from emerging markets, and so there’s a different context and a different expectation of returns.”
©2009 funds europe