As business becomes thinner and specialisation becomes crucial, Iain Morse reports on the Norwegian custody market

“We, and I suspect all the other Nordic custody banks, are re-thinking our business models,” says Richard Quinn, head of custody at Danske Bank in Norway.

Handelsbanken has tied up with Northern Trust and Nordea has sold its global custody business to JP Morgan. While there are some local depot banks in Norway, none of the pan-Nordic custodians originate in the country.

A number of factors are driving this re-appraisal. In Norway, the advent in 2010 of the Olso Clearing ASA central clearing counterparty (CCP) has compressed the transaction-based fees and commissions charged by local custodians.

“The real impact has not been understood,” says Oslo Clearing CEO, Christian Sjoberg.
“We have had strong local sub-custodians offering remote membership on a transaction fee basis where these often came from cross border netting.” Prior to the advent of Olso Clearing, investment banks were piling cost pressure on the custodians in Norway as elsewhere. “Their business changed when we arrived. Their cross border netting was superseded by us. We are netting away about 99% of all transactions and the custodians have lost 99% of their transaction based revenues,” Sjoberg adds.

Data from Oslo Clearing for November 2012 show 6.3m clearing transactions for cash equities with a total value of NOK45bn (€6bn) with 51,924 settled net transactions. Oslo Clearing also clears a range of derivatives, exchange traded, bespoke, and those issued by deposit banks. In addition, it offers bilateral securities lending on shares quoted on the Olso Børs, where parties know each other but transact via Oslo Clearing. The hundred or so participants include Norske Hydro, Statoil and Storebrand. Oslo Clearing also provides an anonymous securities lending pool including all shares listed on the Oslo Børs, and manages collateral. Lending and borrowing rates on security are published – for instance, Norsk Hydro lends at 1.75% and borrows at 2.75%.

The new Norwegian CSD Verdipapirsentralen (VPS), which is working towards Target2-Securities (T2S), may further reduce the custodian bank’s sources of revenue. “Some custodians may give up some of their basic functions to the CSD as it provides clearing and settlement for shares, bonds, exchange traded funds (ETF) and mutual funds,” adds Sjoberg, VPS is also a member of the Association of Global Custodians whose other members include State Street, Northern Trust, BNY Mellon and Citibank amongst others. Direct access to the Norwegian domestic equity and bond markets does not require the use of a local Nordic custodian.

A glance at the degree of concentration in equity ownership is also telling. VPS data shows that 36.8% of ownership of listed equities is with general government, in other words the Government Pension Fund. No less than 35.8% is with non-domestic investors. Further data from VPS shows that the percentage of all equity trades by value on Oslo Bors effected directly by foreign investors has fluctuated from over 40% in 2010, to 23-24% in January 2013. Over the same period the amount of these trades settled through VPS has been constant at around 80%.

None of this business passes through local custodians, unless they are sub-custodians to a global custodian. Domestic insurance companies and pension funds own only 1.78% according to VPS data at end-January 2011). “The market looks large when you consider the total value of assets under custody, but in reality there is only a small number of tier-one financial institutions and they use global custodians,” adds Quinn.

Larger domestic institutions have diversified out of the domestic market. “We think that domestic pension funds and insurance companies have at least 50% of their assets abroad,” says Ulf Noren, global head of sub custody at SEB in Norway. A majority of these assets are believed to be held directly although data is unreliable. The effect of this is that Norwegian institutions started with a local custodian for domestic assets, then acquired a global custodian, sometimes via their local custodian, but now use the global custodian which may then appoint a local partner.

The VPS has attracted participation from the domestic Norwegian fund management industry. There are 703 funds currently on the VPS. These include SEB, with 132 funds, Nordea with 84, Danske Bank with 82 and Alfred Berg totalling 75, although many offer less than 10. Typically these comprise funds investing into domestic and pan-Nordic equities/bonds, across a number of themes such as growth or income.

VPS is likely to stay in the Oslo Børs suite of companies but the CCP, Oslo Clearing, was sold last December to the Swiss SIX Group for a reported €38m. “I guess there is synergy in the deal because neither we nor SIX are in the EU or euro,” notes Sjoberg. Full implementation will be delayed till 2014. The tie-up with Oslo Clearing will also reinstate the clearing capability for derivatives given up by SIX Group’s sale of its interest in Eurex to Deutsche Börse

The main hunting ground left for local custodians lies among second tier institutions and portfolios of domestic equities and bonds held directly by smaller domestic institutions, corporates or private investors. Business is thin. This is backed up by recent unattributed research seen by IPE. Commissioned by a custodian bank, it shows that Nordic securities services have seen core custody revenues fall by 3% in nominal terms between 2008 and 2011. Over the same period, value-added services have offset this decline and generated some revenue increases. However, revenues from products and services like securities lending have fallen sharply.

The same data shows sources of custodian revenues vary widely in the Nordic region; around two-thirds of these in Norway come from the public sector. Denmark, Sweden and even Finland are much more diversified.

Of all Nordic core custody revenues, just over 50% are earned by global rather than local custodians. As a result, Nordic players are focusing on niches and narrow areas of expertise. There has been movement up the value chain. “Remember that custodians are general clearing members on CCPs and we move our service proposition to other links in the value chain, working with settlements, corporate actions, tax, shareholder rights, and advisory functions,” adds Noren.

Regulatory and tax changes create opportunities to amplify new back- and mid-office service provision for client institutions. Take the so-called Deutsche Bank ruling – discretionary management fees will attract VAT, charged in Norway at a hefty 25%. “Both asset managers and clients are looking for ways to mitigate this by changing the way in which investments are held, from discretionary to mutual funds held in a wrapper,” adds Quinn.

Nordic custodians in this competitive and nuanced market will not bother to offer plain vanilla custody services because these no longer generate sufficient revenue. Offering additional services, taking over back and mid-office functions from clients and finding ways to specialise are key to survival.