Financial Journalist

Financial News 7 - 13 December

Revenues are up in Asia, although assets have fallen. Crisis management saw deals through, says Gerry O’Kane

While the rest of the custodial world has been preoccupied with the ramifications of the euro and the continuing consolidation in the industry, custodians in Asia have had problems of their own. They have had to contend with riots in Indonesia and foreign exchange controls in Malaysia, not to mention the collapse in Asia’s equity markets.

Asset values fell by an average of over 25% between June 1997 and September 1998. According to Goldman Sachs, currencies have seen an average depreciation of 50%, while national growth figures which have averaged 7% over 25 years, have plummeted to 2%.

“We’ve had a few interesting moments:’ comments Paul Smith, wryly. Smith is the managing director of the Bank of Bermuda in Hong Kong, which is one of the biggest global custodians in the region, focusing on leading asset management companies such as Invesco, Schroders and Fidelity.

Since 1989 with capital flooding Asia’s markets, custodians’ have been preoccupied with cajoling regional regulatory institutions to implement internationally recognised standards and upgrade IT to handle trading. Being a global custodian is an expensive business. Deutsche Bank spends DM250m annually on IT for custody alone. That is over 10% of the bank’s total IT spending. During the recent upheavals in Asia the emphasis on strengthening the infrastructure seems to have paid off. “The regional infrastructure has held up incredibly well,” says Smith. “The set-up worked and everyone was able to settle and it was much better than expected, especially when you consider the collapse of asset values and the wild gyrations in forex. Institutionally we also held up very well and we benefited from our major sub-agencies such as HSBC, Deutsche Bank, Standard Chartered and Citibank.”

And the issues were taxing. Between February and May this year it was not only the equity markets of Indonesia that saw fall. Riots broke out in Jakarta, tanks moved onto the streets and Chinese areas were torched. For Bank of Bermuda it was a matter of crisis management.

“It was a matter of having to make sure deals went through, for example ensuring the delivery of stock prior to payment. We always had issues with credit,” explained Smith. He spares no praise for HSBC which he used as sub-custodians in Indonesia and argues that what saved many was the use of internationally recognised institutions.

“We pushed our clients to deal with international brokerages and protected them by getting all cash held with us in the shape of our sub-custodians.”

As Smith acknowledges that it was a delicate line to walk. “We have to be happy executing any trades and can’t dictate who you should trade with; the other hand there were the realities and our clients took our advice and in the end were grateful.”

Other custodians found themselves literally in the thick of the rioting in Indonesia. Standard Chartered had to check on share certificates being held by the registrars. Two of the largest were located in one of the areas torched - Jakarta’s Chinatown - and that involved sending staff to the riot-damaged areas and eventually on to Singapore where some of the registrars had fled. just as things were calming down in Jakarta, Malaysian prime minister Dr Mohamed Mahathir caused mayhem by imposing drastic foreign exchange controls that brought foreign trading in Malaysian equities to a halt. From September 1, sales of ringgit assets could only be freely converted to foreign exchange after a one-year holding period. Likewise, interest and dividends were not convertible for a year.

“The Malaysia move came as a complete surprise and we weren’t prepared for it,” confesses Smith. But he adds he doesn’t know anyone else who forsaw it either, no matter what they might now say. “The worst of it was we had no contingency plans on how to handle it and nor did anyone else,” he says. Apart from the confusion of the situation in Malaysia, the custodians had to start making contingency plans for other countries as rumours that Thailand and Indonesia might follow Malaysia. ” We were pushed to looking at credit risks and long currencies and all credit facilities on assets has to be tightly held and carefully watched,” explains Smith.

But as far as the custodians were concerned, Malaysia caused the biggest problems. “It was a nightmare from an investment fund perspective,” trumpets Smith. He points out that after the restrictions on foreign exchange, all beneficial owners of securities had to be identified and a separate account for each maintained at the Malaysian Central Depository (MCD). “There were serious impracticalities in breaking Global Custodians’ Omnibus accounts down into the underlying owners names, especially under the deadlines,” says Smith.

But the problem continues. With many South East Asian funds having a significant portion of stock in Malaysia, the custodians have the problem of valuations. “Defining the currency values with accuracy is impossible and generally we’ve proposed to segregate those assets in escrow: ‘ says Smith. He accepts that both asset managers and custodians are still addressing this issue by trying to come up with schemes on how to get out of the market - usually with some form of asset-swapping scheme.

Some custodians are reluctant to talk openly about Malaysia. One custodian would only say that the industry still sees a considerable uncertainty in the Malaysian market for the next 12 months. “Dr Mahathir is bringing in a series of measures to manage his way out of the problem before the September 1, 1999 deadline of reopening the exchange markets. He only bought himself a year and my contacts indicate that all funds will try and get out at the same time with the consequence of the market plummeting.”

Ironically, the biggest bane in the Asian custody world currently is not the more “volatile” markets. It is the fallout of the Hong Kong Monetary Authorities foray into protecting the former colony’s exchange.

By August 31, US investment bank, Salomon Brothers, estimated that Hong Kong’s Financial Secretary Donald Tsang Yam-kuen had ploughed HK$117 billion (US$15 billion) into the futures and equities markets: nearly 15% of Hong Kong’s reserves. His move into equities raised eyebrows, not only because it had become the biggest defence of an equity market by a government ever seen anywhere, but because it threatened Hong Kong’s laissez faire reputation.

Anil Daswani, Salomon’s head of Hong Kong research, believes that at least one US fund took a zero weighting on the index because regulations forbade it from investing in markets which were being manipulated.

Smith of Bank of Bermuda says: “Initially the 31st market turnover was twice any previous daily record but the system held up. We did have some failed trades but they were far less than 1%; any problems were people problems rather than the systems; people couldn’t keep up with the sheer volumes.”. But it has been the subsequent fallout that has annoyed custodians.

“The issue has become hedge funds. On the one hand, the SFC wants to establish hedge fund trading but it also wants to find out about any fund going short. They want to find out about the levels of coverage and how fast coverage is provided,” explains Smith. This is causing a nightmare in reporting.

Smith is fairly outspoken in his criticism of these new pressures. “They’d find it nice to find a culprit [for hedge fund pressures] and blame them for [the governments] intervention in the market place,” he says. He argues that it is not his fund managers who have been involved in hedge trading and the government knows it. “But it can’t go after the proprietary desks of investment banks - the big boys underwrite too many bond issues.”

But while it has been a busy year, it has not been too much of a blow to revenues. Although assets have fallen in value and fees are based on a percentage of assets held, the increased level of transactions because of market volatility, increased liquidity and foreign exchange considerations - has pushed revenues up.

Consolidation in the global custodian industry may be in full force but local market presence and a commitment to global standards remains critical. It was the custodian’s experience of local conditions that helped save the day in Asia.

Asia’s equity markets