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Magazine Issues » April 2013

NORDICS ROUNDTABLE: The right interpretation

Depositary banks in the Nordics are waiting with bated breath for their local regulators to interpret the AIFMD. What will it mean for depositary liability, lost securities and cost? George Mitton asked participants at our Stockholm panel.

Nordics roundtable april13

Johan Ålenius, head of fiduciary services Sweden, Citi
Belinda Burgess, managing director, Nordics, Northern Trust
Tiina Norberg, head of Swedbank Securities Services, Swedbank
Jopi Sairio, head of GTS Banks & FI, Finland, SEB

Funds Europe: How have you helped your clients prepare for the Alternative Investment Fund Managers Directive (AIFMD)? Are fund managers and investors ready or are there challenges that must still be overcome?

Belinda Burgess, Northern Trust: We held a poll at a recent event for our fund manager clients and only 6% said their AIFMD project was at an advanced stage and ready to implement.
It’s still a very complex process. There’s still a lot of uncertainty. The interesting debate at the end of the session was about the whole idea of the AIFMD. It is about investor protection, but how many investors really understand it and see it as a benefit to them?

Johan Ålenius, Citi: It’s a worry that some people are not yet ready for the AIFMD, but I’m not surprised. Level 2 was finalised just before Christmas. Fund managers still need to understand the full implications of the directive. Citi has representations in all important associations in the larger financial centres and we update our clients with any news as soon as it is available.

Jopi Sairio, SEB: It’s going to be a tight race. Where I am based, in Finland, it has now been opened for comments. After that, we still have the interpretations to be made by the local financial services authorities (FSAs), and that’s the key thing, because you can look at the directive in many different ways. It all boils down to the interpretations.

We have our fingers crossed that the local FSA in Finland will take a liberal approach and interpretation to this law. We keep in contact with the FSA to discuss these issues.

Tiina Norberg, Swedbank: The AIFMD primarily affects fund management companies, but also has a bearing on the custodian, especially on the depositary function. The custodians are worried because their liability increases significantly. There is a liability to replace assets if they’ve gone missing, which we haven’t had previously, and that requires a lot of thinking. That also makes the sub-custodian selection process more important. That process needs to be reviewed and enhanced.

The high liability will make custodians review what kinds of markets and instruments they want to offer to fund management companies, and they may have to decline some riskier ones. That will put the fund managers into a difficult situation. We have helped our clients to understand all these new challenges both on their side as well as the ones their depositary will be facing. The clients are grateful for an open dialogue on this complex area.

Funds Europe: Does it create problems if the FSAs interprets the rules differently?

Burgess: It’s another challenge, especially for those of us who are present in many different markets. If you look at the Nordics, the interpretation may be different for each individual country.

Sairio: It’s especially challenging when regulators are not that keen on giving you guidance. It’s a waiting game in that the local FSA is looking at the depositaries to find out how the depositaries interpret the law, and the depositaries are waiting to see if the local FSA will give any recommendations or guidance.

Burgess: A lot of it is down to interpretation. If you take the example of lost securities, what is deemed as lost? Is it something that’s not available? Or is it really, physically lost, never to be returned?

Norberg: It is important to have an ongoing dialogue with the FSA and harmonise the interpretation of new rules in order to build a good business model and avoid later misunderstandings.

Sairio: We could go on for another few hours on this topic. It’s my favourite at the moment!

Funds Europe: Institutional investors in this region have been less eager to outsource middle and back-office functions than their peers in other countries. Are they now beginning to realise the benefits of outsourcing, and what is driving this trend?

Norberg: The trend is for more outsourcing due to increased regulation. The smaller and mid-sized companies, especially in fund management, find it increasingly difficult to understand all the risks and requirements that are put on them. That goes for fund administration, fund accounting, transfer agency, and a number of affiliated services.

Burgess: It comes down to access to data, data robustness and timeliness. Being able to aggregate data, from various systems, is key. A number of fund managers we speak to have existing in-house systems that are coming up for review and they are asking, do we upgrade the existing system in-house, or do we look elsewhere to see whether the system is fit for the future?

Ålenius: Sweden and the Nordics are coming to a harmonisation with the rest of Europe. In Luxembourg, unlike in the Nordic region, pretty much no one would calculate their own net asset values (NAVs). In Sweden, we come from a fairly local market, but now we are taking a step forward and understanding the benefits of independent valuation.

The flip side is that in Luxembourg, the administration fee is paid by the investors in the fund, but here it is a part of the management fee, so the incentive in Sweden isn’t that big when you look at the costs of administration. But I am convinced we will get there in Sweden, eventually.

Sairio: Another driver for this outsourcing trend is Ucits IV. It has pushed players who are in a few different jurisdictions to centralise or outsource their operations to places such as Luxembourg or Ireland.

Funds Europe: As regulatory and administrative costs put pressure on profit margins, could it no longer make business sense to service certain clients? What are your strategies for dealing with such cases, and how will that affect fee structures?

Ålenius: For us, it is important to attract clients that can benefit from our sub-custody network and the extensive service we can provide to clients as a global player. Not all clients will benefit as much as others from that.

Burgess: We’ve always been consultative with clients in our approach to fees. Being transparent about fees for each product enables clients to understand the value of what they pay for. We will continue on that basis.

Sairio: One interesting thing is the new types of investors, which AIFMD brings into this whole picture, such as real estate funds and private equity funds.

If and when all of these investors have to look for a depositary bank, it’s going to be an interesting discussion as to whether we are willing and able to offer depositary services to them. Would we, as a big depositary bank in the Nordics, offer depositary services for a private equity company, which is investing in road infrastructure in Siberia? If so, how will we make sure we are doing a good job?

We’ve discussed the strict liability under the AIFMD. How can you manage and safeguard these types of investments and assets in a professional way, which satisfies our compliance and risk departments, the local FSAs and, not least, the client? That will be an interesting discussion and, to be quite honest, I don’t yet know how we will settle the problem.

Ålenius: The depositary must be willing to accept that risk, and be capable of handling that risk in those markets you’re describing, so I agree.

Norberg: The risk factor will be a big part of looking at client profitability. The risk may be so high that the client is not interesting any more, because you need to reserve a lot of your own capital.

The European Market Infrastructure Regulation (Emir) will bring custodians into a situation where the services that clients require will use a lot of the bank’s capital and liquidity. All this is costly, and maybe the internal risk ratings mean it is not profitable to take on some kinds of client, but that remains to be seen.

Burgess: We need to bear in mind that the majority of the clients we’re talking about are sophisticated investors. They understand their profile. They understand the regulatory changes. They understand the risk profiles, capital risk requirements and liquidity. When we have conversations, most of them are open and transparent. Part of our strategy is to pick our clients carefully based on those conversations.

Sairio: Openness and transparency are the key issues in these types of discussions. We’re not any more seen as merely service providers to the clients. It’s becoming more of a partnership, where these types of discussions are easier to handle.

Funds Europe: To compensate for downward pressure on fees, it’s been said that custodian banks must offer more value-added services. What are the most promising business lines for your organisations, such as derivatives clearing, collateral management, and back and middle-office outsourcing?

Norberg: All of those are in demand. Right now, derivatives clearing and collateral management are topical thanks to the Emir, so custodians need to shape up their offering towards fund management companies and hedge funds in this area.

Burgess: Luxembourg is important because many of the Swedish fund companies distribute globally, through Luxembourg. We’re also seeing an increase in enquiries about master-feeder structures, and how we can help them there. One that we haven’t mentioned is exchange-traded funds. They are a compelling new offering for which we have seen an increase in demand.

Ålenius: Remember that value-added services can still be within the core services. For us, value-added services are part of our role as a proprietary sub-custody network. On the depositary side, the business model we have is to offer a multi-prime brokerage model, so the Swedish funds finally have the opportunity to act in the same way as their European colleagues.

Funds Europe: Do you draw the comparison between fee pressure on one side and new things that you can offer?

Norberg: Yes, you need to broaden your offering. Custody is nowadays a commodity. That is not where you really make money going forward.

Funds Europe: Have clients accepted the onset of the Foreign Account Tax Compliance Act (Fatca) and begun to plan for it? Will you be offering services to help clients with their Fatca reporting, and if so, what are the costs and technical issues involved?

Burgess: Some clients are more aware of it than others. From our experience, fund clients have been engaged, prior to the end of 2012, in trying to understand what it means to them and what they need to do. We’ve held a number of industry events where we brought bodies together in an open forum to discuss the challenges. My perception is the pension and insurance side has been less engaged so far.

Ålenius: Many of the financial institutions have been waiting for the final Fatca regulation, which has only been available for a few weeks. Considering the one-year delay, clients are still not yet fully engaged with the topic but they are beginning to review solutions now.

Norberg: We have proceeded from the principle that in an aeroplane, you put an oxygen mask first on yourself, then you help others. We have been working with the compliance department of our own bank primarily, but based on that experience we have helped our customers with advisory services.

The issue of disclosing client data to a foreign regulator has been controversial because it contradicts Swedish legislation. We have raised the issue with the local FSA and the US to explain the contradiction.

Ålenius: Many clients will look to us to perform tasks required for funds to be compliant with Fatca. All financial institutions will be responsible for compliance with their obligations under Fatca. However, US financial institutions and foreign financial institutions will be permitted to contract with service providers to assist them in performing certain Fatca-related services.

Funds Europe: Could Fatca reporting be one of these value-added services, which actually help bring in some extra income for service providers?

Sairio: To some extent, but the main issue is know your client, and that has to be done by the asset managers themselves, so it will be difficult to find any opportunities there.

When it comes to reporting, I know that in Finland, the local tax authority has made an agreement with the US Inland Revenue Service that all the Fatca related reporting would go via the Finnish tax office, which means the reporting formats and channels already exist.

That decision may have taken away an opportunity from the asset servicers, but I don’t think that’s a bad thing, because it simplifies the initiative.

Funds Europe: Has the balance of competition between locally based and foreign custodian banks in the Nordic region changed in recent years?

Ålenius: Yes. There is a harmonisation with Europe and we have seen some of the large global depositaries open up a depositary here in Sweden. Competition is good for the investors. If Ucits VI will allow for depositary passporting, we could see some big changes, especially for certain types of funds, though maybe not for the largest and most sophisticated fund management companies.

Burgess: We’ve seen a change, but there’s still a healthy balance between the players. In any market, you always need the local providers, who have the local intelligence and connections. In our different structures, we all partner with the local players, while making use of the global presence of others, which is good for the underlying investors.

Norberg: The trend is that a number of international players have popped up, but there is always somebody for everyone, so the clients are diversified. Some of them, the top-tier ones, such as the AP pension funds, weren’t even including the local players in their RFPs [requests for proposal] when they were looking for a depositary. They are happy with a global player. Their needs match each other, whereas there is always a need for a local depositary to service local clients, who like to have the local touch.

Funds Europe: Which clients in particular like the local touch?

Norberg: The smaller and mid-sized ones. Ideally, the local service providers should team up with the global ones, and offer the best of the two worlds to their clients.

Ålenius: Competition is good for the Swedish market. As a depositary, you are the representative of the investors in the fund, and if you have a number of players offering these kinds of services, we will all contribute to having good competition in the market.

Norberg: The strong advantage for the local players is exactly that they are local, and they may have a different dialogue with some of those mid-sized or smaller companies. Maybe it is easier to be an adviser to a local company when you are local yourself.

Sairio: One important feature that the clients appreciate from the local players is their cash management capabilities. The local banks are better linked to the local cash systems – this gives a competitive advantage in some client segments.

Funds Europe: Perhaps another advantage for the local players is that they have senior management close by at all times?

Burgess: It’s not just at the senior level, it’s at the other levels as well. Some day-to-day contacts, in certain markets, still prefer to be able to speak in their own language, and to have somebody local to do that.

Ålenius: Even though you have a global business model, the local presence and the local knowledge is key. No global player thinks they can come into the Swedish market without having that, because speaking the Swedish language is important for clients, as is understanding some Swedish tweaks on the regulation.

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