Denmark has long been a well-regarded domicile for funds, and the back office has a reputation for efficiency and high value at relatively low cost. It’s also seen some changes over the past few years, and expects greater automation and efficiencies over the coming years.
Denmark has long been a well-regarded domicile for funds, and the back office has a reputation for efficiency and high value at relatively low cost. It’s also seen some changes over the past few years, and expects greater automation and efficiencies over the coming years.
The introduction of CCP in 2009 was undoubtedly the biggest event in the post trade market for the past five years. “This has completely re-shaped the operative models and also the revenue situation,” says Ulf Noren, global head of sub custody at SEB. “Going from a situation where exchange trades where settling bilaterally in 1:1 relationship to a situation with netting has not made great wonders to sub-custodian’s gross revenues. On the other hand, this development has been supported by us as it takes on failing link away from the Danish scene and has made the market more attractive from a cross border cost perspective. It might also have contributed to a safer and more predictable market even if all current European clearing models leaves a few things to be desired on that account. A related effect of CCP is that banks have developed more sophisticated and advanced risk management models, partly in response to the nature of a clearing environment but equally so in response to market supervisory powers requirements and own managements ditto for counterparty risk control.
“A surprising effect of the CCP introduction (even if apples not necessarily are compared with apples here)is the lowered settlement rates - an issue that is addressed by an informal CSD/Bank consultation process at this very moment.”
Many international financial institutions tend to class Denmark as being simply part of the greater Nordic market, along with Sweden, Norway and Finland - and occasionally with the Baltic states of Estonia, Lithuania and Latvia.
But there are distinct differences. While Finland, Sweden and Denmark are all members of the European Union, it’s only Finland that is a euro country, and Norway is not a member at all.
But there has been significant consolidation. The stock exchanges of the four countries are closely linked as part of the OMX Group, and the major regional players all offer a one-stop custodial service for the area. The likes of Nordea and SEB all have a significant presence but there is still room for local providers such as Danske Bank. Big international players also have a role, with Northern Trust, State Street and others all making a mark.
“The Danish sub-custody market is dominated by two regional players, SEB and Nordea, in addition to one local player of some size in the sub-custody business, Danske Bank,” explains Noren. “This is a trend that has been evident since 2003/2004 and it shows no signs of stopping.
It can be difficult for a domestic player to punch its weight, says Noren. “For cross border business into Denmark, most definitely so. We will continue to see local Danish banks and smaller regional banks continue losing business to the two Nordic larger players. This is not saying that local players are not doing a formidable job, they are just victims of a trend that has been ongoing for more than a decade and picked up speed some seven or eight years ago.
“As a result of this, regional players have invested heavily into the regional service provision and primarily so into bridging the differences between the four Nordic markets. This focus has also been noted by infrastructure and regulators locally, meaning that regional suppliers to a very high extent now also have taken the role as speaking partners (and thereby to some extent also influencors), something that is of crucial importance to the foreign client base. At what pace will this continue? If nothing else changes, I would say that this will be a quick process but as we stand in front of some really big changes in the post trade universe, of which T2S is the biggest, I predict pace to be moderate for the next three or four years. This is naturally due to a need for the international client base to work out their future European strategy and the sub-custodians’ ability to show viable proof that they have the right thinking and will survive. Very few will.”
Funds
Unlike neighbouring Sweden, where virtually everyone is an investor, Danes simply don’t invest in mutual funds - less than 20 per cent of the population has a stake in mutual fund. And the situation is unlikely to change.
There are tax advantages for Danes to use institutional pension schemes and buy financial products through insurance companies. Bonds and cash savings accounts are also popular.
But there are also regulatory issues that prevent the growth of the mutual fund market. Under Danish law, the manager of a locally domiciled fund is a company that is appointed by the association of investors in that fund. The depositary bank or custodian must be a Danish bank and is often the promoter and distributor of that fund.
Issues
While the back office in Denmark is well-regarded, problems do remain, says Noren: “There are a number of key issues specifically in Denmark:
“First is the comparably weak performance of the CCP - is key features like partialling performed in an ultimate way and has the CCP/CSD set-up added value or introduced new obstacles to efficiency?
“There is also the discussion on punitive actions by the CSD for settlement fails, something SEB generally does not want to see as a first resort, only as a last one when the avenues on efficiency improvements have been fully explored- more on that in the below
“We also have to deal with the full implementation of the practical terms of the shareholder directive. When true voting procedures can be introduced without excessive segregation, a lot will be achieved in the perception of Asset Servicing Quality
“When buying services in Denmark, the focus is still very much on price and reciprocity. It is though encouraging to notice that the quality elements have travelled higher up on the agenda. So has thought leadership. As margins in the industry have become very low, buyers are scrutinising efficiency elements. No one can afford to pay for inefficiency and no one can afford operational mistakes. We believe that this will lead to new operating models being introduced independent from the strong mega drivers like T2S. We also think that providers who can demonstrate sustainable models will be rewarded. Being able to speak the cross border clients voice will also be of ever increasing importance. “
Regulation
As part of the European Union, Danish funds and custodians are going to be affected by the raft of new legislation, but practical changes have yet to filter through, says Noren: “It has not had a great visible impact yet. It will though. We have never seen this amount of regulation in our sector being either implemented or in its final decision stages. Post trade development has become a process that to a great extent is politically driven. For service providers it poses a number of challenges: Management time has to become more and more devoted to this, investment budgets will to a greater extent be consumed by mandatory development and the compliance issue is becoming really big. I suspect a fairly substantial number of organisations will struggle in declaring that they are truly compliant.
“The industry do make their voice heard but it is really hard to do so without intermediary forces like European industry associations or MoFs etc. The key regulatory initiatives to shape this industry going forward are in our view: Securities Law Directive, EMIR, CSD Regulation, UCITS IV & V, AIFMD, PSD, SEPA, MiFID II, Basel Rules and the Dodd Frank Wall Street Reform.”
The future
As to the future, Noren remains positive: “I think that 2011 & 2012 will continue to be financially challenging and that whatever is happening thereafter very much will be dependent of how the regulatory scene plays out. On a positive note, I think that a few banks (in which league SEB intends to stay) will benefit from positional changes primarily driven by T2S (whether or not T2S happens according to plan). This will enevitably lead to further consolidation and pair that with infrastructural changes, you will see a future where every card must be played carefully.
“For Denmark specifically, I would like to see practical implementation of the shareholders’ directive, I would like to see a harmonised practice for the treatment of hold & release functionality among the three sub-custodians so that proper predictability can be introduced and standard autoborrowing functionality implemented across the line. I would like to see true efforts being made by legislators/practitioners allowing proper use of omnibus accounts and I finally would like to see the CSD encouraging increased efficiency efforts rather than implementing punitive fees and worst of it all, a mandatory lending pool!”
