Iain Morse reviews the custody market in Norway
Norway is a standout in the Nordic region, with no plans to join the EU or the euro. “Recent events, such as the Greek crisis, will help reinforce this attitude,” thinks Caspar Holter, senior pension consultant at PensjonFinans in Oslo. As a result, Norway is better able to protect the infrastructure of its capital markets from the chilly winds of consolidation sweeping across the Nordic region. Oslo Børs offers a low cost custody facility for all Norwegian listed bonds and a Norwegian central counterparty (CCP) has just opened for business. “The CCP will have a negative impact on the agent bank business,” judges Richard Quinn, head of security services at Fokus Bank, also in Oslo, and part of the Danske Bank Group. “Preserving Norwegian market infrastructure is important for the economy and issuers.”
Meanwhile, major pension reforms, due to take effect from 1 January 2011, will reduce the maximum state pension entitlement. “Norwegian defined contribution (DC) pensions started in 2001, with mandatory occupational pensions introduced in 2006,” notes Jan Otto Risebrobakken, director of communications at Norwegian insurance company Storebrand. “There are now over 700,000 employees in new DC plans set up as result.” Premiums are expected to rise as the state pension falls. Storebrand has 31.6% of this market, followed by Vital (29.7%), Nordea (15.7%) and Sparebank1 (8.8%), and the remainder is with a handful of smaller providers. The total DC market is currently worth approximately NOK30bn (€3.8bn) with annual premiums in NOK6bn (€762m) range.
In theory, this should create new business for global custodians, but providers like Storebrand own domestic depository banks and do as much as possible of their custody in-house. Little looks set to disturb this in the very near future. Employers are obliged to pay all the costs and charges of running a DC scheme on behalf of employees; charges are bundled, expressed as fixed cash sums and a percentage of fund value, including custody costs. “DC schemes often use mutual funds,” adds Holter. “Our clients, the employers, have virtually no interest in custody as a separate subject. “There is no direct communication between custodian and investor.” Nevertheless, the domestic DC providers do use foreign sub-custodians and a growing number of asset managers are contemplating the direct use of global custodians.
“Regulations oblige a fund manager seeking Norwegian DC pension business to do this through a Norwegian mutual fund as the trustees must be domiciled here,” notes Helge Arnesen, portfolio manager at Folketrygdfondet in Oslo. But behind the vertical business structures of firms like Storebrand and Vital, there is a steady rate of defection from domestic custodians to global ones by Norwegian asset managers. “You start with a [depository] bank and local custodian here,” continues Arnesen, “but it is more and more commonplace to use them for domestic assets and appoint a second, global custodian to custody non-domestic assets.”
Norwegian investors have a well developed appetite for non-domestic equities and bonds. Meanwhile, there are tight restrictions on domestic hedge funds and the available domestic private equity and real estates are limited by the small size of the national economy. “Domestic custody is slowly dying. Reaching a sub-custodian via a local Norwegian custodian is not the optimal solution as it puts up costs, and does not facilitate straight-through processing,” says Arnesen.
Norway has also implemented EU legislation relevant to both private pensions and the financial services industry, including IORPS. “The implication of this is greater transparency and attention to cost attribution, which will work in favour of the global custodians,” continues Arnesen.
Perhaps this accounts for off-the-record scepticism around the industry about data over custodians’ market share in Norway, excluding the two government pensions funds. Everyone agrees that domestic custodian DNB NOR, which remains free of corporate ties to global rivals, is still the largest in domestic assets. Second comes Northern Trust and its local partner Handelsbanken, which effectively sold its custody book to Northern Trust. In third and fourth places come JP Morgan and Fokus.
A typical attribution of market share to these custodians, excluding the government pension funds, would be 35% to DNB NOR, 15% to JP Morgan, (which bought the Nordea bank custody business in 2007), and 12.5% each to Northern Trust/Handelsbanken and Fokus Bank. But whether this attribution reflects the market share of all Norwegian-owned assets, including foreign assets, is quite another question. Portfolio diversification is catalysing change in the custody industry here as it has elsewhere.
A closer look at DC pension funds make this point. These are typically arranged in three risk adjusted life style funds with successively lower allocation to equities and higher allocations to bonds as the member ages to retirement. The Storebrand range starts with 80% in equities but only 16% in Norwegian equities, going from only 13% in cash and bonds, to 18% domestic bonds, and 26% domestic cash. Allocations to Norwegian equities and particularly to bonds tend to be long term and not very actively traded. Investment grade NOK denominated bonds, in particular, tend to be held to maturity as is the case in Switzerland.
For Quinn, this is custody at its plainest, most vanilla. “Fees on these domestic assets are low. Bonds may be illiquid because they are so rarely traded, while domestic shares like Statoil are held in strategic allocations,” he says. Neither has stock lending been a feature of the Norwegian scene; domestic regulations prevent a mutual fund from lending over 5% of fund value to a single counterparty and clients show less interest than in Sweden or the UK. This means that custody fees, particularly on domestic bonds, can fall to as little as four tenths of a basis point (0.04%). The overall custody fee on portfolios of this kind may not exceed 1bp. “These very low fees need to placed in the broader context of relationship banking, custody being just one of a range of services on offer to the client,” Quinn adds.
So custody in Norway is still all about broader business and social relationships, except for the case of the two government pension funds, which use State Street, JP Morgan and Citibank, and a handful of major corporate funds and life and pension companies. “Reviews of custody relationships and costs are not as frequent as is the case in some other markets, although we are seeing more of them,” notes Mireille Andersson, country head for Northern Trust. But the credit crunch is causing fiduciaries to review costs.
“This market has changed a lot in the past five years,” says Peder Sunde, Norwegian country head for JP Morgan Securities Services. “It will likely continue to change in the next five.” The big question hanging over the market is when and how DNB NOR will sell its custody business outright or go into partnership with a global custodian. “We are here for the long term,” adds Sunde. “The cost of investing in straight-through processing (STP) and providing best service requires a global footprint.”