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Asia-PacificJuly 1 2004

Japan provides missing piece for regional custody solution

Asia Pacific’s geographical diversity makes the idea of a regional approach to custody seem far-fetched. But, as Francis Maguire reports, if the Japanese market can be cracked, then a regional solution may be possible.
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Cross-border payment and settlement, much debated in Europe, take on a whole new meaning when it comes to the Asia Pacific. Even the region’s geophysical properties have ensured that national borders are clearly defined, with each of the main markets remaining fiercely independent.

Vertical integration of exchanges, depositories and clearing houses is the norm in the countries that make up the Asia Pacific region and the possibility of taking a regional approach is much further off than it is in Europe.

For all its cracks, the single currency in Europe catapults it ahead of the Asia Pacific region, where the concept of ‘the Asian dollar’ is still theoretical.

Keeping distinctions

Paul Hedges, global head, securities services and sales and relationship management at Standard Chartered, says: “Vertical integration was practically invented by the Asia Pacific markets. And to a certain extent, that the stock exchanges tend to own the clearing house and depository has provided a sophisticated and efficient mechanism. Unlike in Europe – where there has been cross-border consolidation such as the formation of Euronext – each country in Asia Pacific remains distinct.” But, he adds, the efficiencies of integrated markets come at a price.

“Our customers in Asia Pacific tend to be smaller institutions and therefore benefit from the economies of scale we can offer them. It also means that there is a broader range of services the custodian needs to provide. As well as a regional offering, we have included fund accounting and research services and have moved from the traditional role of custodian to being a full securities services provider.”

Sub-custodians are very market-specific. Unlike institutions that cater to the global market, what makes a sub-custodian effective in one Asia Pacific country may not apply in another. Key operational skills and the ability to deliver straight-through processing are taken for granted.

The differentiating factor is what might be called an institution’s local savvy – the depth and breadth of its knowledge of the local market. In Asia Pacific, this counts for a lot – particularly in Japan, which remains so inaccessible that many think of the region as excluding Japan, and treat its largest market completely separately. Much of this is down to the huge amount of resources needed to deal with the new regulations being introduced.

Charles Savage, senior vice president, custody and clearing, at HSBC in Tokyo, says: “Regulation is a challenge here. Japan is a big market and relatively efficient. However a lot of inefficiencies unique to Japan do still exist and are now being addressed. But, apart from the fact all the guidance notes are in Japanese, the regulatory approach taken is often slightly different to that in other markets.”

Cumbersome changes

Tax changes relating to foreign investment in Japanese government bonds have proved to be a cumbersome process – something that proved difficult to put into practice and make work operationally, and a new US/Japan tax treaty has generated significant documentation.

These are just two examples of how the role of the sub-custodian is crucial.

Mr Savage adds: “There is a need for a combination of regional and local presence, and what global network managers are finding is that – rather than inventing a regional solution – there are many benefits to be had from having one custody agreement and consistency of reporting in Japan.” Furthermore, a delivery versus payment (DVP) vehicle has recently been introduced to the secondary market, linking a real-time electronic pre-matching system to an automated DVP settlement system.

More hurdles lie ahead. The Japanese authorities have just passed a law to mandate the dematerialisation of Japan’s 2500 listed stocks by 2009, and the Tokyo Stock Exchange is looking to introduce electronic proxy voting. At present, while a central securities depository already exists in Japan, it holds only 60% of the issued shares, and of these only 50% has been dematerialised. These moves alone are enough to ensure the continued need to the local presence of a sub-custodian in Japan for some time if pan-regional investment is to be seriously considered.

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Charles Savage, senior vice president, custody and clearing, HSBC

Growth in foreign presence

Another interesting trend in Japan that has occurred in the custody market is the position of foreign banks and sub-custodians. Five years ago, the Japanese banks held the major market share in custody services, often on the back of reciprocal arrangements and the perception of greater market influence. But concerns about the creditworthiness of Japan’s banks meant that those foreign banks with a presence in Japan were able to get a foot in the door.

HSBC, for one, has witnessed phenomenal growth in the past five years. While Mr Savage is unwilling to give concrete figures, he says that over this period HSBC has seen assets under custody grow 65-fold, while daily transaction volumes have increased by a factor of 25.

Today, half of the six largest custody providers in Japan are foreign, with HSBC, Standard Chartered and Citigroup taking market share from the Japanese banks. Mr Savage adds that although the credit issues surrounding Japanese banks have largely disappeared, the continued growth of business for foreign sub-custodians is coming from the interest in pan-regional solutions.

Growth in Japanese business

This is echoed by Standard Chartered’s Mr Hedges. He says: “Where our customers have expanded to include Asia, fund managers have included Japan. Our Japanese business has grown from zero in the past five years.”

Mr Hedges also notes that, although a large and important market in any regional offering, Japanese banks have not capitalised on the demand of a regional view. He says: “Because Japan has OECD status it has had huge flows of activity and the importance of the Nikkei in the MCCI index should not be under-estimated.”

However, it seems that it is the OECD element that may also have been the cause of a certain level of complacency among Japanese banks, preventing them from seeing the larger regional picture. “The post-trade services from Japanese banks tend to be vanilla operations with little tendency to add value or customise services. But fund managers are starting to expect a different level of service, similar to what they get in the rest of Asia,” says Mr Savage.

Cross-border harmonisation

Europe is now attempting to harmonise cross-border differences and build a centralised settlement platform around the Euroclear plans for a single settlement engine in order to operate more effectively as a region. Long before Europe began addressing the infrastructural needs of presenting a true, regional solution, AsiaClear was being discussed. Although now a dead duck, in 1992 when the issue was first proposed, it seemed that Asia Pacific could lead the way in the creation of a central utility and in enabling a pan-regional model. Today, there is still interest and flows between Singapore, Australia and Hong Kong. If Japan can be cracked, regional custody solutions may well be on the cards again.

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Read more about:  Digital journeys , Asia-Pacific , Japan