New rules mean mutual funds must use third-party depositaries, not local banks. Nicholas Pratt looks at how a market, where Citi was the only foreign player, may change.
Much of the drama in this year’s World Cup in Brazil belonged to the host nation. From pre-tournament public protests, to a defeat against Germany that will last as long in the Brazilian psyche as 1920s Weimar Republic hyperinflation has lasted in the thoughts of Germany’s fiscal authorities. However, Brazil’s quarter-final opponents, Colombia, made some headlines of their own with their star striker James Rodriguez winning the Golden Boot for being the tournament’s top scorer.
Similarly Brazil dominates the Latin American funds market with more than $1 trillion in assets under management and is the market in which global custodians are most likely to offer direct custody services. But it is in Colombia that there has been the most activity lately.
BNP Paribas Securities Services (BNPPSS) launched a direct custody service to compete with long-term incumbent Citi. Furthermore there are rumours of two more global custodians joining the Colombian market.
Key to all of these developments are some recent rule changes in the investment funds market, namely Decrees 1242 and 1243. These changes were announced in June 2013 in the wake of the Interbolsa scandal that took place a year earlier and saw Colombia’s biggest brokerage collapse. The Decrees are designed to bring more transparency to the funds market to make it more robust and also to encourage greater activity. The funds industry in Colombia accounts for only 6% of GDP as opposed to 15% in neighbouring Chile and almost 60% in Brazil.
Decree 1243 specifically addresses asset servicing and rules that any investor in mutual funds must appoint a local third-party custodian to provide depositary services. Under the decree the custodian must be appointed by the end of 2014 and then the assets must be transitioned by the end of the first quarter of 2015. Up until now the vast majority of mutual funds have been run by the local banks and they have kept custody and clearing in-house. It will therefore be a significant job for the depositary banks operating in the country.
It is also just more than two years since BNPPSS decided to establish a fiduciary trust company in Colombia and just over one year since it opened and began offering local custody services to both local investment banks and other global custodians looking to operate in Columbia. Up to then, Citi dominated the local custody market and was one of only two providers, along with local player CorpBanca, offering a local custody service.
The first thing that BNPPSS did was move its in-house entities to the new custody service. It has also been able to implement a small number of mid-sized clients and have a number of conversations with prospective customers, says Alvaro Camuñas, BNPPSS’s regional manager for Spain, Portugal and Latin America. “We have spoken to a number of investment banks and also global custodians, some of which are not even operating in Colombia, with a view to offering them a sub-custody service.”
TAX RECLAIMS POSSIBLE
Prior to BNPPSS’s entry into the market, international investors or custodians would have had only one provider, Citi, to choose from and Camuñas is confident that he has identified a number of services not previously available to clients.
“It was always said that tax reclaims were not possible, but we have worked with one of the big four consulting firms, and the Colombian tax authorities, who agree that it is possible to offer these rebates. Secondly, it is also possible to perform FX [foreign exchange] transactions with another counterparty other than the custodian should the manager wish to do so.”
While Camuñas recognises the benefit of Decree 1243, he is also cognisant of the tight deadline involved. “Ideally I would like another six months to prepare. It is a big challenge to implement depositary banking services in less than a year. However, BNPPSS already provides depositary services in 16 countries so we are looking to take advantage of that capability. We are confident it will be a success.”
Camuñas says BNPPSS has a 21% share of the depo banking business and he expects that to exceed the bank’s 25% target before the year end. The fact that Citi enjoyed a near monopoly prior to BNPP’s arrival should make for some interesting conversations between incumbent Citi customers and prospective BNPP suitors as the battle for custody mandates ensues.
“When there is a monopoly this generally means that prices are high and service is poor but moving provider is a big step and it does not happen overnight.” Nevertheless Camuñas anticipates announcing two or three new mandates before the end of the year.
However, when it comes to the depository banking business that will result from Decree 1243, they will all be new customers for Citi and BNPPSS given it was a task previously performed in-house. There may be further business for both custodians if the scheme is extended to cover pension funds and other securities within an investor’s portfolio.
There may be two new entrants to the market. Deutsche Bank is rumoured to be considering a move into local custody in Colombia. The bank had not returned a request for clarification.
Meanwhile, Banco Itau and incumbent local custody provider CorpBanca have agreed to merge their Chilean businesses and a similar merger will take place in Colombia although it is not expected to be operational until at least 2016. Given the short timeline involved in Decree 1243, any custodian looking to enter the market in order to take advantage of the rule change may find time against them.
Brazil remains the main focus for JP Morgan and its sub-custody strategy. In 2011 it decided to take its sub-custody mandates back in-house, a process that has taken 12 to 18 months says Rowena Romulo, head of direct custody and clearing at JP Morgan.
It is also offering direct custody services to other parties (international investors and other global custodians without a direct custody service) but Romulo says this is “the icing on the cake”.
There are no plans to launch a direct custody business in any other Latin American market, says Romulo. The economic benefits of bringing existing sub-custody mandates back in-house is the main factor in such a decision, hence the move in Brazil.
But for Camuñas, Columbia is the most exciting market in Latin America for custody and one where the opportunities in the short and medium term will grow.
Citi has offered local custody services in Colombia for more than 30 years and has seen a number of competitors come and go in that time from HSBC to BankBoston to Santander. “There has always been a choice in the market for clients,” says Ricardo Hesse, securities services head for Citi Latin America. “We have the advantage of being there for many years and a large presence in the region.”
As if to demonstrate the benefit of its size, Citi recently launched its execution-to-custody service in Colombia (as well as Brazil, Chile, Panama, Peru and Mexico) which provides its customers access to execution and settlement services alongside custody and clearing.
Hesse does not expect that the arrival of BNP Paribas will signal a fierce battle for the few global custodians operating in Colombia mainly because both Citi and BNP Paribas will be busy implementing the many institutions that will have to appoint a depositary due to Decree 1243. “With so many new customers coming on to their platform all the providers will have their hands full so I do not expect to see many clients changing provider.”
The deadline for appointing a depositary is December 14 and Hesse estimates a third of the market has yet to act. While he expects all the appointments to meet deadline, Hesse’s biggest concern is that many clients will leave it until the last minute. Should this occur, there may be a need to phase the implementation process, though precedents in other countries will help.
Mila, a project to integrate Andean and Mexican stock exchanges creating one with a size to rival Brazil, is another development that Hesse says will move the Colombian market.
“The premise of Mila is that issuers will be able to reach several markets and their investors through one point, but the reality is that more work is needed. The volumes are very low,” says Hesse.“But once Mexico joins, that will change things. The sheer volume of the Mexican market may hopefully bring Mila to life.”
©2014 funds global latam