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ASSET SERVICING: Mila’s crossing

BridgeAs Brazil continues to attract increasing competition, global custodians are turning their attention to some of the secondary markets in Latin America. Nicholas Pratt investigates.

In 2011, the global custody world paid serious attention to the blossoming investment market in Latin America but few really looked much beyond Brazil.

As at the end of 2011, Brazil was the world’s sixth-largest investment market with assets under management exceeding $900 billion for the first time. Unsurprisingly, this has been the principle area of focus.

While the domestic custody market remains dominated by domestic players – Itaú Unibanco, Bradesco and Banco do Brasil control more than 70% of the market – the likes of Citi and HSBC have made significant inroads in the growing cross-border custody market. This has in turn inspired other global custodians to grow their Brazilian presence. For example, JP Morgan expanded its headcount in Brazil, to set up a headquarters in São Paulo and to launch a direct custody and clearing service.

However, there is also increasing attention being paid to other markets in the region – such as Chile, Colombia, Peru and Mexico. “If you look at these markets, they are much smaller than Brazil but they have growing pension and mutual funds markets,” says Cedrick Reynolds, executive director at JPMorgan Worldwide Securities Services. For example, retirement funds in Mexico (Afores), Chile, Colombia and Peru (AFPs) have a compulsory contribution system. “Historically, these pension funds tended to be asset gatherers and invested locally, but they are increasingly investing overseas,” he says.

In Chile, these pension funds can invest up to 80% of their portfolios offshore, in Mexico the figure is 20% and, in Colombia and Peru, the figure is 40% and 30%, respectively. From a global perspective, growth is expected given current offshore investment allocations are largely below legally allowed limits.

In addition to the offshore investments of the pension fund sector, Reynolds believes that the traditional mutual funds industries in these regions are becoming increasingly attractive to international investors as they mature and grow in size, meaning that there will eventually be the foreign inflows to provide additional volumes and growth to the local markets.

BNP Paribas Securities Services established a presence in Brazil in the last quarter of 2011 and is now turning its attention to other opportunities in Latin America. In March 2012, it opened offices in Chile and Colombia, appointing Emiliano Martinez and Claudia Calderón as the respective regional heads. The Chile office will serve Ecuador, Bolivia and Peru, while the Colombian office will serve the Caribbean, Venezuela and Mexico.

“We are targeting the domestic institutional market that have investments overseas,” says Álvaro Camuñas, BNP Paribas Securities Services’s regional manager for Spain, Portugal and Latin America.

These investors include sovereign wealth funds, pension funds and insurance companies. In terms of services, BNPP SS is offering global custody and fund distribution services (the subscription and redemption of international funds).

While the US-based global custodians such as JP Morgan and BBH can offer access to the neighbouring US funds market, BNPP SS will be hoping to stress its European heritage and presence in Luxembourg.

“It is not just US funds that these investors are looking at. Ucits is already a well-recognised brand in Latin America and if a Chilean pension fund wanted to invest in a Brazilian fund, it would be easiest to do it through a Luxembourg-based Ucits fund. We also feel we have a competitive advantage in Asia and we will be including US mutual funds so that we can offer the full range,” says Camuñas.

Chile was the forerunner of the cross-border investment market in Latin America, investing in Peru and Colombia and then Brazil. Chile has traditionally had larger pension fund assets but relatively smaller capital markets, hence the need to look outside the national borders for more attractive investment opportunities.

A key development in the Colombian, Chilean and Peruvian markets was the decision to consolidate their respective stock exchanges and, in May 2011, the Mercado Integrado Latinoamericano (Mila) exchange was launched. It allows brokers and investors in any of three countries to invest directly in any listed equities. It was motivated by the respective exchanges and brokers as a reaction to the rise of neighbouring exchanges rather than the demand of asset managers.

Nevertheless, if the project is successful it could be key in attracting overseas investors to the region.

“We see Mila as a Euronext for Latin America and an opportunity for those markets to gain the significant size, but they need to attract overseas investors,” says Matinez.

“The first step will be the order routing, then the dual listing and then the execution integration and harmonised clearing and settlement. It will take a few years to reach that final stage but it is a serious first step. I think the volume will grow significantly between the next five and ten years, especially if Mexico also joins. In ten years’ time, I expect there to be two major markets in Latin America – Brazil and Mila (including Mexico).”

To create this scenario, the Mila markets will have to be far less heterogeneous than they currently are, says Martinez. “They are all very different with their own rules and specialities but if you speak to the authorities and the stock exchange, there is a clear desire to create a homogenous market. However, it won’t be easy.

“The first step is to address clearing and settlement and then look to develop harmonised asset services but it will be complex. Just look how challenging it has been in Europe where there is at least a single currency, for the large part.”

The exchange will also have to increase its volume significantly if it is to fulfil its potential.

“The Mila exchange should ensure seamless transactions across the three markets, thus generating more liquidity and making them more attractive to international investors in the long-term,” says Reynolds. “But the jury is still out. It has been going for a year now and the volumes are still very low.”

In the exchange’s first six months, total trading amounted to just $15 million with Colombian securities accounting for 50% of that total and Chilean securities accounting for 49%, leaving Peruvian securities to take up just a 1% share.

The investors in the Mila exchange are predominantly high-net-worth rather than institutional but the growing demand for exchange-traded funds may prove important. The institutional investors have most recently invested in ETFs administered in Luxembourg and Dublin but this is starting to change, says Alejandro Berney, Citi Transaction Services’s Securities and Fund services head for Latin America.

“We are now seeing local ETFs being launched. In September last year, Colombia launched a local ETF and in Chile local rights for ETFs have been sold. There are also Mila ETFs being developed as an alternative to the global ETFs that tend to be more generic and not necessarily reflective of the needs and expertise of local institutional investors.”

Consequently, Citi, one of the few global custodians to offer both local and global custody services in Latin America, is providing ETF services for Brazil, Chile and Colombia. However, the ETF market is still in a state of early evolution, says Berney. “It is a very new market and ETFs are all about scale so there has to be a level of volume for these products to be successful.”

Berney is also hopeful that fund accounting will become a more demanded service among the asset managers of Chile, Colombia and Peru. “The fund accounting service is developed in Brazil,” he says.

“But in the rest of the region, we don’t find managers are interested in these services and accounting tends to be done in-house. However, these markets are increasingly looking at international standards and regulators are becoming aware of the benefit of independent pricing and valuations.”

So what of the competition between the global custodians operating in Latin America? Brazil has probably reached saturation point in terms of asset servicing providers and could probably benefit from a reduction in the number of players.

But that is not the case in the secondary markets where a select number of providers tend to be prevalent. Consequently, the regulators in each region are keen to encourage more competition and welcome new entrants.

Political stability is a necessity if the Mila markets are to develop in line with the global custodian’s most optimistic expectations. All of these markets are currently stable, especially Colombia which has recovered from the drug cartel-fuelled instability of the 1980s and 1990s to become an oil-fuelled investment market worth more than $40 million. “The more the stability continues, the more the market will continue to rise,” says Martinez.

“There is always some concern if a new government is elected but, if that happens, it is important that any ruling party recognises the value of the international investment market and avoids the nationalistic and protectionist policies of Argentina, Bolivia and Venezuela.”

©2012 funds global