The introduction of a central counterparty (CCP) and a single-platform Central Securities Depositary (CSD) are just two of the changes in infrastructure affecting Nordic custodians’ business. In the face of these developments, service providers in the region are buckling down and making sure they are ready to handle the new reality.
The introduction of a CCP benefits market participants as it drives liquidity and lowers costs, but this has a direct effect on the business of custodians.
In the Nordics, where a CCP was introduced in the second half of last year, it has led to custody banks losing business, and challenged them to strengthen their offering in other parts of the value chain to remain competitive.
The Nordic custody business is in flux. It’s not the nature of the business itself that is changing, but rather the infrastructure and the way things are done. The introduction of the CCP was just one part of the new reality custodians in this region have had to face.
EMCF and Nasdaq OMX Nordic agreed to implement CCP clearing for cash equities in 2009. In a statement EMCF said: “The introduction of a CCP, in contrast to fragmented bilateral settlements, will benefit market participants by driving liquidity and lowering costs. Most European markets today are centrally cleared, and this move ensures that the Nordics keep pace with international standards. Most crucially in the current climate, a CCP acting as counterparty to both the buyer and seller will significantly reduce counterparty risk.”
But although this is good news for market participants, custodians could be said to be less than thrilled about the new development because they carry out functions that are in competition with the CCP.
Luciana Pacor Hygrell, head of Nordic custody services at Svenska Handelsbanken, says: “The custody business lost income here because we introduce an extra layer in the whole chain, which is now negated by the CCP. It’s tough for the custodians here.
Before the CCP was introduced, we cleared and settled each transaction for our clients on an individual basis. In a CCP environment, we just settle the netted amount and this means less revenue for the custodians.”
Niklas Nyberg, global head of GTS financial institutions at SEB, says: “The introduction of the CCP has had a major impact on our business and volumes.”
In its 2009 year-end report Nordea also said that the introduction of the CCP led to lower custody transaction volumes. One industry player says, on average, the CCP led to more than 50% loss of business.
So, the introduction of the CCP means the players in the market need to fight harder for their piece of the pie.
In an article, Nyberg’s colleague, Göran Fors, global head of custody at SEB, says: “With the increased competition follows a need for all parts of the value chain to take part in a greater share of the same value chain.
“In order to stay competitive in all segments, and also to defend position among local broker dealers and banks, it is necessary to become a general clearing participant on all CCPs that clear Nordic securities.”
Pacor Hygrell, of Handelsbanken, says: “As a result of the increased competition, we need to focus and develop new products. There are services we’re building and strengthening to make sure we remain competitive. One is the GCM [general clearing member] facility to the CCPs in the region.
Nyberg says: “We’ve done some hard work to cope with the introduction of the CCP. We have to continue to have a strong position in this new environment and continue to invest to maintain this position. One way of doing this is through a strong GCP [general clearing participant] offering to various members of the stock exchange.”
And Nordic custodians have yet more infrastructural changes to make as another major development looms on the horizon.
In 2008, Euroclear acquired the Nordic Central Securities Depository (NCSD), from Nordea, SEB, Svenska Handelsbanken and Swedbank, that held more than 99% of the NCSD. The sale included the Finnish and Swedish CSDs.
As a result, the Swedish and Finnish transaction-processing activities will be transferred to Euroclear’s multicurrency, multi-jurisdictional single platform where all Euroclear group clients will settle trades and process corporate actions and related transactions.
Through this platform, NCSD’s clients will be able to settle cross-border transactions as if they were domestic transactions with counterparties in seven, rather than only two European markets, and at domestic market settlement prices.
Once again, this development means increased competition for Nordic custodians and yet more changes and adaptations to be made.
Annika Larsson, head of relationship management and sales, Nordic custody services for Handelsbanken, says: “The migration to the single platform will take place in a couple of years and we are presently modelling our products around that event because we know there will be changes around settlement and asset servicing in Europe.”
Euroclear had said the transfer was planned for 2011, but Larsson says they have not yet been given an official date.
She says: “This is another area where we will face competition but of a different nature because part of the Nordics will be included with all the other countries on Euroclear’s single platform.
“Conversely, this is also an opportunity for us to go directly to the single platform for settlement and custodian services.”
In an effort to prepare for this move, Handelsbanken is looking to streamline its operations. Pacor Hygrell says: “We are looking at how we can carry out certain processes in a more efficient manner and we’re being proactive in seeing how we can create more cost efficiency in the way we handle our business.”
Nyberg, of SEB, says: “The Euroclear migration is an infrastructure change we will just have to comply with.”
But the Euroclear acquisition of the NCSD only includes Sweden and Finland. Although this is one step forward towards consolidation, Norway and Denmark still operate separate CSDs.
This, together with the increased number of multilateral trading facilities (MTFs) means the Nordic post-trade market is still somewhat fragmented due to a lack of interoperability.
Larsson, of Handelsbanken, says: “At the moment activity is still siloed. Investment banks will be the driving force behind increasing the interoperability between all of these platforms, in the name of cost and efficiency. Furthermore, there is no standardisation between any of these platforms and therefore the infrastructure is becoming more complicated.”
Target 2 Securities
The introduction of the Target 2 Securities (T2S) regulation is another factor with which Nordic custodians have to grapple.
Its main objective is the centralisation of the settlement of euro-denominated securities for participating institutions on a single pan-European platform by 2013.
Once again, this will mean that custodians will face new competition from CSDs. Fors at SEB says: “T2S will give the CSDs a possible mandate to move up the value chain… this will in the end mean competition between CSDs and custody banks.”
But although T2S will give CSDs the potential to compete directly with custodians, Fors notes that “large investments may be needed and there are well-established competitors in this market”.
Larrson says: “On a longer-term perspective, we envision that the T2S effort will drive the CSDs to go up the value chain and provide more asset services competing with the local sub-custodians.”
According to the European Central Bank, the introduction of T2S and the increased competition this will bring with it will lead to lower costs for market participants.
But Fors warns: “In the longer term, it may also lead to a situation with higher concentration to a few large participants and CSDs, which does not necessarily guarantee high competition and low costs.”
Time for change
All this transformation will indeed change the face of the custody industry, including that in the Nordics.
Pacor Hygrell, at Handelsbanken, says: “Everybody has to ‘remodel’ their business. Asset servicing in the future will change but there are certain services that will always be needed.”
Nyberg, at SEB, says: “The custody model will change, it will become more continental and we will have to find a strong position in this new world. The Euroclear acquisition and the introduction of the CCP are two of the first steps towards this new reality.”
All these infrastructural changes will result in the need for heavy investment by these institutions. But some wonder whether that will be enough.
Madeleine Senior, head of Northern Trust's Nordic asset servicing client service team, says: “If you’re a local bank with many parts to your business your level of reinvestment into custody will be very thin. This is because the capital needs to be spread among all those different services.”
©2010 funds europe