| Fundamentals | 2011 42

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essentialsA special focus on the Nordic region

he Nordic region is going through a period of profound changes in the market infrastructure. On the trading side we can see the same pattern in our region as has happened on many other markets already, i.e. the fragmentation of trading is continuously increasing, and especially for many of the blue-chip shares the multilateral trading facilities (MTFs) regularly have more than 30% of the total trading volumes. The implementation of equity central counterparty (CCP) clearing during 2009 and 2010, which in itself is common practise in Europe and thus naturally a key component of all major markets' infrastructure, has been the biggest infrastructural change in the region for decades.

CCP clearing has certainly reduced the counterparty risk as such, and also reduced the total cost of trading on the Nordic exchanges. As a consequence of this we have seen an increased number of new trading members on the local exchanges, and hence we should see further improved liquidity on the market which in the end will directly benefit the end investors as this should among others lead to narrowed spreads.

In the Nordics we usually like to portray ourselves as a coherent region rather than individual markets when it concerns securities markets. We must however remember that the Nordic markets are still quite different; we have a fragmented post-trade market infrastructure, local legislation and market practices, different currencies etc. As an example, several initiatives have been started over the years to consolidate the CSD infrastructure in the region, however due to various reasons - sometimes political, sometimes technical - nothing concrete has happened on this front. The latest initiative that has been closed is the Euroclear platform consolidation in the Finnish and Swedish markets, first as the overall single platform programme was discontinued, and second as the potential back-up plan, to consolidate the Finnish and Swedish CSDs by re-using legacy platforms, was recently considered to be too complex. Now the focus in all four markets is more and more on Target 2 Securities (T2S), and on analysing what is the most efficient model for each market. A lot of the work is concentrating on how to adapt the direct holding structure to T2S in a way that on one hand secures a cost efficient process, while still meeting the eligibility criteria set forth by the European Central Bank (ECB), and on securing a legally sound process, including among others settlement finality. Close co-operation centralThe Nordic markets co-operate closely to solve the matters

related to the direct holding structure, however as there are market differences we are likely to end up with slight variations in the models. The starting point is that currently in the Nordic markets we have in total around 10 million end-investor accounts that are held with the local CSDs. In Finland as well as in Norway the legislation prohibits the nominee registration of local investors’ holdings.

One model that all Nordic countries are investigating at the moment is a ‘layered model’, where a large number of the accounts at the CSD level would be pooled in T2S, thereby limiting the number of accounts in T2S. As a consequence the Nordic markets would from a T2S perspective be more similar to the so-called omnibus markets. It would naturally still be possible for individual end investors to have direct accounts in T2S if they so wish.

One of the most important targets with T2S is that by effectively consolidating all national settlement systems in Europe into one, it should be as easy to settle trades from any market in T2S as it is to settle domestic trades. For Nordic investors this will bring clear benefits as it will make it easier and more cost-efficient to invest in other European markets. Equally, there is a clear expectation that T2S will make the Nordic capital markets more attractive for the non-Nordic investors.

One must however remember that the settlement processes in Europe are already today well harmonised and efficient, and hence the further benefits that can be extracted from the settlement process are limited. Today the risk and complexity, and hence the costs, are to a large extent in the so-called asset servicing area, which includes among others corporate actions processing.

These processes are still very much dependent upon variations in local legislation and practices, and will remain so even when T2S is implemented. As a consequence the total benefits from T2S to investors may be quite small, at least in the beginning. Even though custodians are able to run the settlement processes more efficiently in T2S, in practice removing the need to use sub-custodians in the settlement flow, they naturally still need to handle the asset servicing part with the same quality and care as today.

In order to do so the most efficient way forward is likely to include using local sub-custodians as is the practice today. These institutions are today and for the foreseeable future best placed to handle processes such as complex corporate actions, handling the reporting obligations to local authorities, consultation on local market development etc., i.e. tasks that require strong local expertise and a meaningful local presence.

Mats Råstedt, head of business infrastructure, Nordea

Nordic essentials: Mats Råstedt

43 2011 | Fundamentals |

he situation in the Nordics does not differ that much from the situation in Europe as a whole. We do notice that we experience a map where there are too many CSDs and CSD platforms and too many agent banks. There is a fierce competition for volume and lower transaction fees. This will drive consolidation so in a Machiavellian way it is good. We applaud all efforts in Europe to dismantle national barriers – it is not that the effort is being made but how that can cause some doubts. The development in the post trade arena is driven by political and regulatory forces in Europe, so also in the Nordics.

We think that a lot will happen in the next few years and some of the major features can be found here: CSDs: Will lose revenues and they will be subject to increased competition following T2S. The domestic monopolies are threatened and especially so if the obligation to issue securities in the national CSD is removed. This will force CSDs to consolidate and among these we will see attempts to move to other places in the value chain, especially so by starting to compete in the asset servicing space and develop further in issuer services areas. We expect some CSDs to try to become banks and for those that already are, to enhance their bank offering. We also fear that some will apply the utility view and just raise fees in order to compensate revenue losses. In the Nordics, we had hoped for more of the Single Platform project but as things stand right now, the only single platform within that project is CCI. The rest is fragmented. Sweden and Finland will remain as two platforms with some assimilation in the jurisdictional model, in the merging of fixed income and equity platforms locally and with some adoption to European standards. No more than that. The Link Up markets project has been very silent lately so also here were one of the markets that signed up (Norway) seemingly has abandoned the whole thing. Agent Banks: Operational models must be re-engineered. Winners can be found among those that manage to drive operational costs down and still keep innovation and safety levels high. Agent banks need to demonstrate safety in this unsecure environment and in addition to sound and strong financials, risk and collateral models will be essential. Agent banks must grow regionally in order to replace revenue lost to netting effects and as a result of fee pressure. This will make it very challenging to be a single market provider. We see that the search for quality in agent banks has been re-introduced (it is not only reciprocity and price any more) and so is the agent banks’ ability to visualise the future state of the industry and to take us there. Banks will have more than a handful to deal with the regulatory flood and effects of the T2S discussion. CCPs: It is not much of a business case in being a CCP today. It is in very bad need of consolidation and we believe it will start to happen - soon. The European CCPs work with very difficult and complicated risk models and eventual interoperability initiatives are not making it any

clearer. In the Nordics, we see that many small and mid-sized member firms are experiencing cost and complexity increases instead of the wanted cost efficiencies and simplicity gains. It is time for Europe to make a choice of what CCP model is wanted – the silo model or the user-owned user-governed option. As a personal opinion, I would prefer one CCP – the efficiency gains would widely beat the competition aspects.

It is not possible to discuss Europe today without spending time on T2S. For the Nordics and the Baltics, all markets have signed the MoU (but the exciting time will be when full commitment is expected). We have mainly non-Euro currencies as only Finland (and as of Jan 2011 also Estonia) currently use the euro. All markets are direct holding markets so finding a layered account structure is crucial to T2S commitment. The CSDs in the markets are concerned that they can continue to provide and further develop investor accounts and related services. Another possible stumbling block is the governance structure. Being a buyer in a T2S world is very interesting and we find seven different scenarios for how institutional sub-custody buyers might behave. These range from: doing everything themselves, via use of one European provider, a limited number of regional providers, to mixed strategies and finally to continue as is.

The settlement cost will become very transparent in the T2S environment and we believe that the commercial value of a settlement transaction in the future will be fairly limited. On the other hand, risks previously assumed by sub-custodians will now be highlighted and transparent and we firmly believe that we are going towards an unbundled fee structure in the not too distant future. Will T2S happen? We think so but there are some question marks. The business case is to a large extent building on UK participation. Without the UK, the business case looks weak but still not weak enough to be a stopper. The direct holding market will be very important and as said, we believe there is a sentiment among those to sign, eventually. The project needs further harmonisation and the governance structure must be appropriate for all participating countries.

By the way, SEB believes that changes triggered by the T2S discussion will become reality even if T2S fails!

Going into regulations and their effects would require more space so let’s just agree that there are a lot of them at various stages of implementation and shaping. This is a politically driven process that gives very little room for the industry to influence. More of the spending in investments becomes mandatory and many players feel and will feel increased strain in finding investments innovation. Management time is to a great extent consumed by regulatory work and compliance areas are burning the midnight oil.

It is very important that the custody industry does not let itself be trapped by regulators and regulators only. Some common ground must be found and some actions must be concerted.

Ulf Noren, global head of sub-custody, SEB

Nordic essentials: Ulf Noren