For custodians, the formation of Euroland always promised to deliver both opportunities and problems. But, after just five months of dealing with the euro, they are discovering that the problems aren’t as deep as they might have feared, whilst the opportunities seem vast in comparison. Not surprisingly, the most immediate impact of the euro has been a widespread decline in foreign exchange revenues.
The upside, according to the custodians, will more than offset any short-term dip in revenue. “We are already seeing the positive effects of capital being more fluid within Euroland,” says Fred Settelmeyer, Mellon Trust’s location manager for Europe. “The day is drawing closer when pan-European asset allocation will become the norm.” Northern Trust is equally positive: “Euroland is now a domestic market,” says Lucille Knapp, Northern Trust’s head of European business development for custody. Knapp believes that Europe’s pension funds and investment managers have started to change their approach to asset allocation. “They are restructuring portfolios,” she says, “and they are reviewing internal restrictions on investments. Now they may consider their domestic market to be wider than their own country and rather ‘Euroland’. The euro has given a fresh impetus to fund trustees and managers to take a look at the whole investment process - and that includes their custody arrangements.”
Along with other custodians, Northern Trust is reporting a distinct shift in the way funds are managed. “One impact of the euro is that we are seeing pension funds more regularly appointing external managers,” Knapp says. Deutsche Bank has noticed the same trend, according to James Cassidy of its custody services business. “As funds diversify their assets, they are adding external managers to complement internal resources,” he says. “And, for those plans which are overfunded, there’s an increasing amount of attention being paid to passive investment vehicles.”
For global custodians, the advent of the euro could hardly have come at a better time. The pensions funding crisis was already forcing many changes to the continental investment scene, with cross-border equities high on the list of priorities in the chase for better returns. The introduction of a single currency has served to facilitate and accelerate that process of change, with institutions now discovering that they need an entirely different level of support from their custodians. “An increased investment in overseas equities does lead to a greater requirement for care,” says Knapp. Mellon Trust’s Settelmeyer thinks there are additional forces driving the changes in Euroland. “Technology is playing a huge role,” he says, “especially in terms of dematerialisation and standardisation. Central securities depositories, exchanges, global custodians, agent banks, and fund managers are all merging, partnering or linking. Technology is helping to achieve this consolidation.”
Industry consolidation has been a significant by-product of the euro. Eight European exchanges are now discussing a new business model for equities trading, and both Euroclear and Cedel, the two international central securities depositories, are mapping out their versions of the future for clearing and settlement in the region. At the same time, the European Central Securities Depositories Association (ECSDA) is promoting a network of bi-lateral links between the member depositories (see page 54).
These initiatives, if successful, are likely to mean that an increasing amount of core settlement and safekeeping work is delegated to depositories, leaving the custodians free to concentrate on the more valuable areas of data processing and information delivery. This prospect might suit global custodians like Northern Trust: “There’s a growing focus in Europe on risk and compliance issues,” says Northern Trust’s Knapp, “and getting as close to the trade as possible through straight-through processing will help us to provide the most accurate information on a timely basis.”
Another product area which has benefited from the euro is cash management. Clients of custodian banks have long complained about the difficulties of pooling cross-border cash balances and the need to maintain a large number of demand deposit accounts. With the euro as a standard settlement currency, cash administration has been made substantially simpler, and custodians have begun to offer a variety of off-balance sheet investment vehicles - like short term investment funds (STIFs) - denominated in euros.
Amidst all the euphoria about the positive aspects of the euro, there are still some major issues. “In order to create a single investment market, Euroland really has to deal with the harmonisation of tax regimes,” says Mellon’s Settelmeyer. “That will be critical if we want a level playing field.”
Far from being the technological and operational disaster that some had predicted, the introduction of the euro appears to have provided a significant boost to the global custodians. They have long argued that they are much more interested in value-added services than in core securities movement and control functions, and Euroland looks like giving them an early opportunity to prove themselves. Richard Greensted