SUB CUSTODY: Prematue takeoff

Central and eastern European securities markets have attracted massive overseas investment – but their infrastructure isn’t quite ready. Christine Senior reports

The eastern European securities market has attracted enormous interest from western investors over the last few years. But that growth has not necessarily been matched by a corresponding development in the infrastructure to support it. Lipper Feri’s figures show that investments by European equity funds investing in the CEE – defined as Russia, eastern Europe, the Baltic states and Turkey – rose from e5.3bn in 2002 to e38.6bn in July 2007.

Lipper Feri uses a fairly broad definition of central and eastern Europe. But, however the CEE is defined, both the level of investment and the quality of the infrastructure to support the local securities markets across the region vary enormously.

Citi estimates that the market capitalisation of the five CEE countries of Poland, Hungary, Romania, the Czech Republic and Slovakia, currently at e204bn, with Warsaw taking the lion’s share at 57%, Prague 16%, Budapest 15%, Bucharest 10% and Slovakia 2%.

A handful of sub custodians operate in the region to service those assets, and by and large it is these that are used by the global custodians. HSBC Investor Services operates in the region using local market specialists, primarily ING and HVB/Bank Austria, which is currently undergoing a rebranding after its acquisition by UniCredit. Northern Trust also uses four local sub custodians, but the majority of its business in the region also goes through Bank Austria and ING.

Multi-market approach

Service providers operating across the region have an advantage, says Stephen Brown, regional head of network management at Northern Trust. “The multi-service providers really dominate the landscape, now they can spread their development and infrastructure across multi-markets, increase the depth of functionality, harmonise services and ultimately reduce costs,” he says.

“Scale is critical for survival in a business where margins are decreasing.”

Citi operates sub custodian services directly in Poland, Hungary, the Czech Republic, Romania, and Slovakia, which form its CEE ‘cluster’. It also operates in Russia, one element of its CIS cluster. Rowena Romulo, managing director of Citi Global Transaction Services, says having established itself in the region gives Citi an advantage:

“We operate our own clearing network,” she says. “Having a footprint there allows us to work directly with the regulators to remove impediments or help shape regulation in the markets to achieve higher efficiency.”

Deutsche operates sub custody businesses in three markets in the CEE – Poland, Hungary and the Czech Republic – and also in Russia and Turkey. BNP Paribas is currently setting up its own sub custody business in Poland and Hungary, having previously used local sub custodian HVB/Bank Austria there.

One reason for this move was to extend its custody offering in eastern Europe in the wake of the expansion of the EU. “We wanted to grow our local clearing and custody network and consolidate our position,” says Philippe Kerdoncuff, head of new markets development at BNP Paribas Securities Services. “Also we see those two countries have strong growth and interest from investors. And the BNP Paribas group has been present in those two countries for more than 15 years and we wanted to leverage the position the group has in those countries.”

One feature of asset servicing prevalent across the region is the lack of nominee accounts. This is proving a handicap to efficient operation of securities administration. Progress is being made, but slowly and patchily. Hungary has already established omnibus accounts, Slovakia has already approved the necessary legislation to introduce them, but in the Czech Republic introduction of the accounts is still under consideration by the regulator. In Poland omnibus accounts are expected to be implemented by the middle of next year.

Segregated accounts
In the absence of omnibus accounts individual clients need to have segregated accounts even when the custodian is servicing the same securities on behalf of a number of clients. This brings added complexity and bureaucracy, wastes time and increases costs.

Hungary and Poland both have central securities depositaries, the KDPW in Poland and Keler in Hungary. The Czech Republic, on the other hand, is still in the process of setting up a single CSD. It already has a settlement and clearing depositary, the Univyc, which is owned by the Prague Stock Exchange, but registration is via a state owned utility, SCP. Consolidation of the two is planned but the government is dragging its feet on the sale.

“The government has not decided how much it wants for the registrar SCP,” says Andrew Carter, director of global transaction banking at Deutsche Bank. “It’s a question of money. Univyc wants to consolidate with SCP into a central securities depository which would closely resemble those in Hungary and Poland. Univyc approached the government, but the government hasn’t yet agreed on the value of SCP.”

Russia is perhaps the market where the lack of suitable infrastructure is most disrupting
the administration of securities settlement. With no central securities depository (CSD), no delivery versus payment or receive versus payment, and the registration of securities trades having to be done physically, procedures are slow, cumbersome and costly.

“There is no national depository centre,” says Carter. “NDC and DCC are the two largest, and there are a number of other depositories. In alignment to that you have a system of registrars – Russia has a system of 70-plus registrars at the moment. When you undertake a trade you need to write it in the respective registry, because we have no single CSD which can perform that function.”

Russia is proving particularly slow in upgrading its system, which is a problem given its success at attracting western investments. HSBC Securities Services estimates that its clients’ assets in Russia almost tripled between the beginning of­ 2006 and the end of August this year, from £115m (e166m) to more than £300m.

“Russia doesn’t have the right level of infrastructure to support the level of business," says Ian Twine, network manager for the region at HSBC Securities Services. “Because you have the involvement of registrars and you are reregistering assets in a physical form, it’s similar to the way the UK market worked in the early 80s. I think a lot of investors forget it’s an emerging market.”

Other problems in Russia centre on tax reclaims, which are possible but take a long time, and lack
of information in English for some processes, including corporate actions.

“We get information on corporate actions in Russian which we have to translate into English,”
says Carter. “There is no single source of corporate actions in the Russian market. We cannot interface with the various CSDs through SWIFT and reporting to the Central Bank on rouble payments is not in SWIFT. This means your ability to automate the various processes you undertake as a custodian is limited.”

The fledgling Serbian market is in many respects quite advanced. It has a central depository, real-
time gross settlement, almost instantaneous DVP. But on the downside it operates a system of regulated and unregulated stocks. The regulated market requires more transparency from companies, including, for example, the obligation to provide half-yearly reports. But so far only two companies and nine government bonds make up the regulated market, while the unregulated market offers over 1,600 stocks.

Struggling to keep up
“The biggest problem in a lot of eastern Europe is the number of instruments available for foreign investors,” says Twine. “Listings on certain exchanges are very limited, a large number of companies are still state owned, the IPO pipeline is slow or non-existent and some asset classes are not even available to non-residents.”

Serbia does recognise the nominee concept, but the decision on whether to use one omnibus account or separate accounts for individual clients is not clearcut. HSBC decided against the omnibus account.

“My original view was we’d open up an omnibus account because it would make life easier for our clients to open custody accounts,” says Twine. “Having visited the country I have now decided we will open up a segregated account structure because while the nominee concept is recognised, issues would arise in taxation and if any of our clients wanted to partake in proxy voting.  If we had a position of securities held by more than one client in an omnibus account structure we wouldn’t be able to split vote.”

In some ways the CEE nations are suffering from the consequences of being so successful in attracting foreign investments.  In 15 years or so they have been transformed from managed economies into free market economies. The development has proceeded at a staggering pace. Little wonder then that the infrastructure is struggling to keep up.

“Because the economies are experiencing robust growth and developing at an extremely fast pace and especially since they need to get up to the standards in the EU, there will be a lot of changes in the regulatory landscape in the coming months and years,“ says Romulo. “Normally what you see is the clearing and settlement structure is not able to keep up with the pace of growth. That is still
a challenge.”

© fe November 2007



The tension between urgency and inaction will continue to influence sustainability discussions in 2024, as reflected in the trends report from S&P Global.
This white paper outlines key challenges impeding the growth of private markets and explores how technological innovation can provide solutions to unlock access to private market funds for a growing…


Luxembourg is one of the world’s premiere centres for cross-border distribution of investment funds. Read our special regional coverage, coinciding with the annual ALFI European Asset Management Conference.