It may get worse before it gets better, but a shake up in the Nordics will ultimately bring about positive changes
With forests, fjords and skyscraping peaks casting out their landscape over the millennia and a sisterly bond spanning geography and culture alike, the Nordic countries are also home to a securities industry that’s facing considerably more turbulence than its unchanging surrounds.
In the jurisdictions of the four Nordic giants, banks are dealing with more and more risks, while holding huge sections of the market. SEB claims to hold 70 percent of the sub-custody market in Sweden, and almost 50 percent in the Nordics as a whole. In the global custody fund industry, it claims a 70 percent share of the market in Sweden, and 40 percent in the Nordics, but such success in the region inevitably comes with risks attached.
Gustaf Unger, head of asset servicing at SEB, says: “The operational risks in the asset servicing industry are painfully significant. Given the risks, the massive investment and the regulations, the industry doesn’t really charge that much for the service.”
“The risks and the pressure are just increasing. I think it will change, but whether it will take one year or seven, I don’t know.”
One of many growing risks comes with the implementation of Target2-Securities (T2S). The Nordics are all jumping in at different times, causing a lack of harmony in the region, and rifts between jurisdictions.
Kristian Stangberg, head of securities services at Handelsbanken, explains that Denmark is looking to implement T2S euro settlement in 2016, following with the Danish krona in 2018. Finland will be joining with the fourth wave in 2017. In Norway, plans are not finalised, but estimates say around 2018 or 19, while Sweden has no official timline. With such variation comes even more risk, including that of lost connectivity.
Stangberg says: “It is challenging that the CSDs in our regions all have rather large ongoing changes. Because the markets in the region are quite homogenous, we would have preferred a CSD solution across the region.”
On the settlement side, however, this perceived fragmentation is necessary, if not ideal. Yannic Weber, CEO of Euroclear in Sweden and Finland, says: “It is very important for different jurisdictions to work well together. However, markets moving to T2S at different time-frames is part of the overall T2S master plan to avoid big-bang project risk.”
He adds: “One would assume that there will be more flexibility to adapt to future market conditions.”
Weber cites the parallel implementation of yet more related regulation, this time for CSDs, which must be approached with care: “CSD requirements will be a huge challenge and may represent substantial systemic risks if the timing of the latter is too aggressive and rigid.”
While this fragmentation could exacerbate any negative effects that T2S might bring, it’s just one of many worries among the banks, big and small. Harmonised trading throughout the EU is expected to lead to more trades, while the Alternative Investment Fund Managers Directive (AIFMD) could lead to an increase in accounts created. By providing the additional collateral required for these trades, banks could struggle to provide enough collateral to comply with the rules surrounding those trades. Even the biggest market players could find themselves prioritising certain dealings, and others may even consider it not worth the hassle.
Unger says: “SEB is the largest custody player in the region, and significantly larger than the second largest, but even we are finding the additional investment costs painful. The smaller players will struggle a lot, and they might even find it easier to get out of the custody business altogether.”
That said, requirements around collateral are not necessarily aimed at these small market players. They’re designed to protect the whole market in the event of a default and if a small player goes out of business, although regrettable, the European market is unlikely to come crashing down around it.
Stangberg, however, rejects the idea of a collateral shortfall altogether: “Collateral may get expensive,” he says, “but there’s not going to be a shortfall. If you are willing to pay enough, there is going to be collateral around.”
“Handelsbanken is in the process of upgrading its collateral system, we are updating the IT system, and we now have quite a good strategy in place.”
Both banks are, in fact, more concerned over the costs passed on to them, simply due to other market participants complying with the rules applicable to them. Nordic banks are amending their platforms in order to cope with the extra burden that T2S will bring, and so trading parties have to alter their own systems in order to integrate with them.
Weber says: “It will require them to make major IT investments and may well lead to further business concentration.”
As well as the changes in internal infrastructure, Stangberg is concerned about indirect costs incurred before they have even made any changes. He says: “Some of the CSDs use tiered pricing at an account level. With the introduction of AIFMD, many clients want to segregate their assets, and suddenly we face a tiered pricing structure that is much higher than before. In general, the cost of regulation is increasing and it is hard to push those extra costs towards the client, so we find ourselves squeezed in the middle.”
To cope with this, some of the big regional players have partnered up with the US banks in a bid to break in to the global custody service. In return, they’re provided with a way into the Nordics. SEB has enlisted Brown Brothers Harriman (BBH) in an aim to create virtual scale and bring more consolidation to the market.
“We are not big enough to offer a top end global custody service over time, and in the next 10 years the industry will consolidate even more,” says Unger.
“On the other hand, we are a financial institution-focused bank, so we have to have a strong global custody product. It was crucial to find a high-end partner, but one who doesn’t compete on our home turf. The agreement works both ways; if you, as a large global custodian, want a footprint in the Nordics, it’s good to have one of the big Nordic banks on your side.”
Having used BBH as a sub-custodian for 100 years, Unger is confident in SEB taking the next step in their partnership: “We know them and they know us; the difficulties of any marriage are reduced when it’s with someone you know.”
Handelsbanken is also considering a partnership with a US institution, and believes it has just as much to offer.
“On the global custody side, we are quite certain that we need to work together with someone. It has been Northern Trust in the past, and we hope it will be again,” said Stangberg.
“In sub-custody, we have a clear Nordic and Baltic focus. We have one agreement and one relationship manager across all four countries and one centralised operation. We have a very strong position in global custody in Norway; with some good mandates from well-known names, and our clients like us.”
Having dealt with AIFMD in 2014, and tackled T2S in anticipation, the Nordics face one more challenge, and Unger believes this could be the biggest upheaval yet.
“We have managed AIFMD reasonably well, but those volumes are a fraction of what we will face with UCITS V. The additional risk we take as a depository has resulted in difficult decisions that we have to make with our clients,” he said.
“At the moment, even though it affects the whole market, there is no market standard of how to deal with the liability issue of AIFMD and UCITS V, and that is frustrating. We can live with not having everything settled for AIFMD, but I feel that for UCITS V the industry should have a market standard in place. That worries me a bit.”
Expected to come in to full effect in March 2016, the UCITS deadline is perhaps closer than it seems, and while it promises to modify and simplify UCITS depository functions, a cynic could predict more chaos before the benefits make themselves known.
But, the future for the Nordics is not all bleak. By integrating with the rest of the EU and the global financial market, this oft-segregated region reaches new opportunities, and can do nothing but grow from here.
SEB is now serving many real estate managers and other alternative managers with depository services that, before AIFMD, didn’t need a depository.
Unger argues that the regulations will also have positive effects on banks that are correctly positioned.
He said: “There are opportunities with market players that we have had no relationship with in the past. It’s additional income and it brings an interesting client segment even closer to the bank. Really, it’s not all bad.”
