New rule enshrines custodian's role
Custody as a business in the Brazilian market, truly incorporating independent settlement, corporate actions, asset safekeeping and other auxiliary services is a fairly new local concept. It probably gained market attention in 1991 with the introduction of the foreign investor regulation in annex IV. At this point foreign investors deciding to invest in the Brazilian market started to appoint local providers for custody services.
Both historically and presently most pension funds in Brazil divide their portfolios among different asset managers, which aside from performing regular asset management duties, also maintain the custody of the holdings managed by them, including cash balances. To reduce risk with the asset manager, pension funds appoint several at a time to avoid concentration.
Since the introduction of foreign customers into the Brazilian market, which in turn led to this inception of true ‘custodians’, development of the custody industry has been rapid, especially over the last two years.
The custodial concept has been more actively disseminated among local institutional investors, particularly pension funds, as new regulations have gradually introduce the need to establish “Chinese Walls” at various levels – including the segregation of functions between fund management and custodial activities.
Custodial servicing throughout the world is a scale business, which requires massive investments in technology, talent and human resources. In Brazil, although the custody market is fairly new, the implementation of a mature level of service, customer satisfaction and pricing has been strong. However, given the existing tough competition, we anticipate that in the future you will be able to count the number of banks in the custody field on one hand.
Providers are constantly stretching themselves as the time frame between a new feature being considered an added value to becoming a commodity reduces further. To be an effective player locally you need to provide the best technological solutions, have the most knowledgeable team, be au fait with the global custody business and be capable of providing offshore services. We believe that it will only be a matter of time before pension funds are allowed by the regulators to start looking for international opportunities.
Customers expect a full service range from providers including fund valuation, control of pre-defined limits established for each fund and regulatory reports. Internet-based solutions for communication between custodian, market and pension fund are certainly becoming a trend and customers and counterparts are beginning to value the importance of straight-through processing (STP) platforms. The internet is a path that consistent players in the custody market need to have available for customers. Certainly “building” a custody market in this scenario is a challenging task for those who intend to start in this market but have no background in the field.
Although the new Resolution ‘2720’ issued by the National Monetary Counsel on April 24, 2000 (to be implemented in April 2001) is provoking discussion in the market, its purpose is to guide the pension fund industry and provide guidelines for the appointment of a custodian. Despite the fact that the regulation requires some fine tuning it underlines that an independent custodian brings added value to the pension fund industry
In general terms the ‘2720’ as it is known in the market intends to regulate the portfolio of pension funds with the aim of guaranteeing a safe environment with liquidity.
Protection of pension fund shareholders, assurance of long term liquidity and a guarantee that pension funds will not be used for political influence lie at the heart of 2720. For the first time the regulators will have the access to monitor the industry.
The segregation of duties between asset management and custody is underscored as the safest methodology for reduction or mitigation of risk, thus aligning Brazil with the general custody philosophy. And while the deadline for schemes to adjust to 2720 is April 2001, many are already looking for a service provider that can support them under the new requirements.
Consolidation in the market, however, resulting from intense competition and the arrival of new banks trying to establish themselves means services capabilities are being promised by some at very low prices. It is tough to predict whether there will be the delivery all of that is being promised. This in turn could lead to further consolidation and even fewer providers.
Another important change taking place in the Brazilian market that will impact on pension funds is the target determined by the Central Bank of Brazil to implement a new payment system, following Bank for International Settlements (BIS) recommendations. The intention is to operate on a real-time basis, reducing market systemic risk. This change is provoking many discussions with an accent on risk reduction. Ultimately, we believe this will add credence to the value added an independent custodian can bring to the systematic environment.
Although multinationals have been closely monitoring the changes and are taking the custody route to risk reduction, the state-owned companies with the largest pension funds, have been as diligent in looking at a custodian to satisfy these needs.
With the economic stabilisation in Brazil, pension schemes continue to identify opportunity for cost reduction, elimination of internal costs and a shift from a fixed cost to a variable cost based on the fund’s portfolios. Given the size of the pension funds industry in Brazil (assets under custody of $66bn), new independent asset managers – not associated with local banks – are popping up, bringing new expertise and competitiveness to the market. The possibility of hiring one of those providers that are short in capital but in many cases dispose of considerable high technology will necessarily implicate having a good custodian to ensure the safety of cash and assets.
Going forward, the Brazilian custody industry certainly will demand a lot of attention and first class levels of service. Prospects look good, but for anyone trying to be a top tier provider there will be a lot of effort to expend.
Roberto Paolino is with Citibank Brazil in São Paulo