Heather McKenzie finds that the wide variety of CEE markets, from Russia to Albania, are waking up to the need for financial infrastructure
During the past year the economies of the central and eastern European countries have experienced rapid growth with financial markets developing at a fast pace. Such growth has proved attractive for global custodians, but apart from Citi the main players in the market are not necessarily those that play a major role elsewhere in Europe. Unicredit, ING, RZB are all significant players in the region.
The sheer scale of the region means that countries are at different stages of development. Russia is by far the heavyweight. “Russia is one of the biggest countries on the radar screens of our clients,” says Rowena Romulo, securities and fund services branch management head for Europe, Middle East and Africa, at Citi Global Transaction Services. “Citi has seen a significant increase in volumes and assets under custody in Russia, with growth of around 300% year on year. Russia is the market everyone wants to invest in.”
Because it is a relatively young and dynamic market, Russia does pose some challenges and difficulties, she adds. For example, there is still no single central securities depository (CSD) - securities can be held in different locations and settlement done using different methods. “This remains a cause for concern and Citi, along with some of the other foreign players in the market, started lobbying the Russian parliament in 2006 to try to get some working groups established to address this issue. However, a new parliament has been elected and the presidential election is coming, so it is unlikely there’ll be any significant improvement in the next year.”
Lilla Juranyi, global head of custody at ING Wholesale Banking Securities Services, agrees the registration process in Russia is “difficult and very expensive”. Sometimes stock has to be delivered over long distances to be registered at the appropriate registrar. “The registration process may also vary among the different registrars, so standardisation is still far away. The responsibility of the local custodian is quite great, to arrange registration in due course and minimise the risk to the client by an efficient registration.”
ING in Russia has developed a ‘local nominee’ structure where registration is very simple, if the transaction is made between two clients of ING Moscow. In such a case, ING is registered as a local nominee, thus the investors can avoid the long and very expensive process. Ownership is transferred within the book of ING Moscow.
But it’s not all bad news in Russia and some progress has been made. The currency, the rouble, was liberalised in January 2007 and the remaining limitations on investments in Russian financial instruments were lifted, which, says Romulo, explains the dramatic growth in the Russian market.
Juranyi says Russia is “inevitably” ING’s biggest market in the region, on the basis of assets held on behalf of clients and also in terms of interest among foreign investors. “Our Moscow office is the biggest income contributor to ING’s custody business.”
In addition to Russia, ING is present in seven CEE countries - Bulgaria, the Czech Republic, Hungary, Poland, Romania, Slovakia and Ukraine - all of which have some strength, she says.
Ukraine is one of ING’s top growth countries with the longest client list, while Poland, the Czech Republic, Slovakia and Hungary are considered mature markets and the growth potential and thus the interest of foreign investors is limited compared with countries further east, says Juranyi.
“In Russia, Ukraine and Romania we expect further significant growth and development of the local infrastructure that will attract more and more investors,” Juranyi adds. “These investors will mainly be foreign, but we are seeing increasing assets by local investors as well.”
Juranyi says liberalisation and improvement of the local legislation in these countries will assist future investments both by foreign and local investors. “Pension funds and investment funds are in the start up phase, so in the coming years quick improvement of these forms of collective investments is envisaged. Also special value added services such as securities lending is either restricted or, if allowed, it is a dormant market at this stage.”
The Austrian bank RZB has custody operations in 18 CEE markets and is directly involved in 14 countries, the biggest footprint in the region compared with its competitors, says Martin Hofer, head of custody at RZB. “We are continuing to invest, hire people and look for new software solutions in this region. RZB has been among the first providers of fund administration services in CEE countries, for example.”
Like Citi and ING, RZB views Ukraine as one of the most interesting countries in the region, but also one of the most complex. “It is very difficult to build up a solid international custody functionality because there are many political problems concerning the registration process and repatriation of funds,” says Hofer.
An area within the region that RZB has found to be fruitful is south-eastern Europe (SEE). The bank was the first to start custody operations in Albania and while some people would regard SEE as a poor region, Hofer says there is “a tremendous amount of investing going on, there are good education systems and money being sent back to families by expatriates. There is a lot of value and potential in the SEE markets.”
Initially, most of the SEE countries did not allow their citizens to invest abroad, but people from abroad can invest in the country, says Hofer.
This is the reason RZB started by offering fund administration and custody to the retail investors within these countries. “We are working with regulators to allow their citizens to invest abroad and to bring big pension funds, investment companies, broker dealers and custodians into these countries for non-domiciled capital. The aim is to make it easier for non-domiciled financial institutions to do business in these markets by bringing them as close to Western standards as possible. In some cases, we have to develop work-around solutions for our clients to make our local custody products look more like those they are familiar with.”
Hofer says generally, the SEE markets are more willing to change and are more open to RZB’s solutions than some of the markets in the north-eastern CEE. “These markets tend to cling on to authorities and laws they are familiar with. SEE countries have been faster in taking up advice from us. These markets are just starting to build CSDs and thinking about the regulations they need. In most cases they are mirroring western European markets,” he says.
Romulo says the remainder of the CEE markets, such as Poland, Hungary, Romania and the Czech Republic, although not growing as fast as Russia, have experienced good growth and political stability. “In these markets, the focus is more on harmonisation and alignment with Europe,” she says. “New instruments are being introduced, pension and tax reforms are being implemented, some markets have introduced nominee, or omnibus accounts and there has been a lot of work done to improve STP, particularly with the CSDs. The overall aim is to make the markets more safe and efficient for clearing and settlement. The challenge is that such changes take time, and they don’t always keep pace with the growth of the markets.”
Juranyi agrees that progress takes time. “The main challenges in these countries are the frequently changing environment and the not very clear new regulations that can be interpreted quite often in different way by the different agents. This causes difficulties in the predictability of investments. The development of the capital market is relatively slow, sometimes the regulators do not easily understand the specialities of foreign investors’ status, the status and responsibilities of global custodians, the need for nominee [omnibus] accounts, in some countries the difficulties with the repatriation of local currency etc.”
Despite these and other difficulties, CEE is very popular among foreign investors, says Juranyi. However, a good understanding of the procedures and the market infrastructure should be present before entering the markets.