The 2011 general election in Finland could mean the end of the Loppu system. Iain Morse reports
Next April’s national election may have major consequences for the Finnish custody industry. “We still have the ‘Loppu’ or ‘end-client account structure’ for Finnish investors holding securities issued in Finland,” cautions Paivi Kuitunen, director for business development at Evli Bank in Helsinski. This system is designed to provide transparency about the ultimate beneficial owner of securities, and the Finnish tax service uses it as a source of securities ownership data.
In a country which tends to elect multi party governments, the retention of the Loppu system is a political hot potato, prompted by left-wing fears that its disposal would make tax evasion on dividends easier than at present. There are in excess of 921,000 individual accounts of this type, with local custodians settling and clearing between 360,000 and 526,00 trades monthly.
According to the Bank of Finland’s statistics the aggregate nominal value of issued securities in Finland is approximately €275bn. Of this total approximately €125bn is in equities, €100bn in bonds and €50bn in money market instruments. These assets are under custody in Finland. Not all, however, are subject to the Loppu system as foreign investors are exempt and permitted to use nominee accounts. In September, foreign investors in Finland owned equities worth over €68bn, about half of the market. Nor are Finnish investors barred from using nominee accounts for foreign securities purchased via foreign exchanges. The result is that they can buy shares more cheaply from a foreign stock exchange.
“This is not sustainable or justifiable,” warns Kuitunen. “It imposes extra costs on domestic investors and prevents us from exploiting the potential advantages and cost savings of using a central depositary.” Netting, one of the most obvious savings from the use of a central depositary, requires volumes not available to many Finnish custodians putting through deals using the Loppu system. Inevitably, Finnish custody remains complex, paperless, but requiring bespoke IT systems.
Reform of the account system is also holding up Euroclear’s long-planned introduction of a single clearing and custody platform for both Finland and Sweden. Indeed the account system has already led to the abandonment of an early plan to amalgamate clearing for the Nordic countries with the UK and Benelux countries. “The next issue facing us is the implementation of Target 2 Securities,” adds Kuitunen. ‘We need to make these changes before its advent or we will face cost duplication on IT systems.”
There remain 81 investment firms and banks authorised to hold client securities under custody. These include the three biggest banks in Finland, all of which have strategies to act as local custodians for the Nordic region, Sweden, Finland, Denmark, and possibly the three small Baltic republics, Latvia, Lithuania and Estonia. Norway, meanwhile, has opted for a policy of institutional independence with its own central clearing depositary and markets.
Audited data on market share is not available but by common consent; Nordea Bank Finland, part of the Danish Nordea group, is the largest local custodian. The Finnish OP-Pohjola Group sits in second place, with a large share of the retail market as well as institutional clients. Danske Bank takes third place after some years ago purchasing Finland’s Sampo Bank, which was split from the still independent Sampo Insurance Company. Swedbank and Handeslbanken also offer third-party local custody services in Finland but after this most of the remaining providers only service client or captive assets. There is no legal requirement for pension insurance companies to use external custodians; some perform this function in-house.
Finnish custodians are required to obtain a licence from the Finnish Financial Supervision Authority. The capital requirements for a local custodian are not high; the minimum capital requirement is €730,000, increased to €5m if also providing investment services. However there is no sign that any of the global custodians are going to become local custodians in the Finnish market. Even JP Morgan, the only global custodian with a permanent office in Helsinki, uses local custodians for local assets. Indeed, Nordea sold its global custody division to JP Morgan some years ago.
The global custodians are more interested in the non-Finnish assets of tier-one and tier-two investors. Some of these, notably the seven largest pension insurance companies, have substantial assets under management. They have also diversified out of domestic Finnish equities and bonds. “Finland is small but very globalised,” observes Jyrki Partanen, JP Morgan Worldwide securities services country executive for Finland. All tier-one investors include private equity, derivatives and hedge funds in their portfolios. “They need the services of a global custodian for these new asset classes,” he adds. “They also want state of the art collateral and risk management.”
Nevertheless, even the tier-one investors still tend to be overweight domestic equity and bonds. “These holdings in domestic securities are often strategic and not very actively traded,” cautions Mats Rastedt, director, Nordea Bank Securities Services, Finland. Many Finnish clients holding domestic securities are also less interested in paying high fees for value-added services than low fees for plain vanilla service from a local custodian. “Many bonds are held to maturity,” Rastedt adds.
“The premium on the custody service for them is typically very low.” Nordea and its rivals, like Pohjola, offer services such as stock lending, but in Finland strict tax rules make this unprofitable. “Most of our lending arises as a result of handling settlement failure,” says Rastedt.
Competition among the global custodians for tier-one investors is intense. An RFP issued by any of the pension insurance companies can be expected to attract competitive tenders from several global custodians. But the role of third-party pension consultants in Finland is small. The management resources needed for review will typically come from within the relevant institution. As a consequence, reviews tend to be less frequent than in other markets such as the UK or the Netherlands.
“Fees are still very competitively priced in this segment of the market, although local relationships can be a deal breaker,” says Partanen. Having a local, Finnish-speaking team is regarded as an advantage. Once established, custody relationships tend to be medium to long term. “Our clients have a shrewd idea of how much they should pay for our services, and they a strong focus on risk management,” he says.
If the Loppu system is abolished after April next year, the market segment fought over by local Finnish custodians will undoubtedly become more competitive. We can expect the pan-Nordic local custodians to consolidate their market shares. “Our current position as a full service local custodian is sustainable,” argues Rastedt. “We expect to be in this market for years to come.”