UniCredit held its Central and Eastern European (CEE) Roadshow at its London office on May 4, 2017.
Topics around the local market environment, regulation, standardisation, and innovation generated a series of interesting and lively debates. As market leaders in CEE, UniCredit was able to share with its clients its expert views on how change is affecting the region, and what investors should be looking out for.
The CEE Roadshow provided a refreshing take on how CEE markets are progressing, as well as a deep dive into topical issues like Blockchain. The event proved informative and provided excellent networking opportunities throughout the day and at the reception afterwards.
The audience and speakers were diverse and travelled from a number of different markets. In addition to UniCredit representatives from Bulgaria, Croatia, Hungary, Czech Republic, Slovakia, Slovenia, Austria, Serbia and Romania, attendees included global custodians, broker dealers, and market infrastructures.
CEE weathers the Volatility
Dan Bucsa, global chief economist at UniCredit since 2012, provided a lucid overview of the macro issues, and how these will play out in CEE.
Geopolitical events including the recent US Presidential election and Brexit have created volatility internationally. Inflation in the US may need to be restrained through Federal Reserve interest rate rises and this has caused concern in emerging market economies, which have obtained financing through US dollar denominated debt. Many CEE markets are, however, better insulated from these challenges than other emerging economies, and this should make them prime targets for foreign investors looking for growth opportunities and returns.
The Eurozone area, a critical driver for CEE export-based economies, has rebounded, and CEE markets – while small in global terms – are open to foreign direct investment (FDI). Flows into listed securities have been further driven by the rapid expansion of exchange traded funds (ETFs). CEE markets generally are enjoying stable growth, although Hungary has proven particularly impressive, and this has been abetted by strong domestic consumption and EU funding. However, there are clear fiscal risks emerging in Poland and Romania, particularly as the latter is facing a budget and pensions deficit.
A number of markets in CEE are illiquid and have small market capitalisations. While some markets have limited penchant to list state owned enterprises, certain countries including Romania and Hungary are witnessing IPO activity and this will drive further liquidity. Privatisations and market reforms including enhancements to corporate governance rules in Romania have been rewarded with the prospect of an upgrade to emerging market status from frontier by the FTSE Russell. This will result in further flows, especially from index tracker products.
The economic story is not universally positive in CEE. Turkey has seen its current account balance widen, while the Central Bank will need to deal with high structural inflation. The political uncertainty in the country has certainly aggravated Turkey’s challenges too. Russia is also struggling. While the country has recuperated from recession, its recovery has been sluggish with GDP growth unlikely to exceed 1.5% to 2%. US and EU sanctions continue to hinder Russian growth, but the Central Bank has been proactive, and has reduced interest rates to stimulate a recovery, although rates remain high at 9.25%.
UniCredit: A Pan-European Provider
Slavomir Bena, deputy head of the Financial Institutions Group at UniCredit, delivered a powerful message to clients stating that the bank has implemented a number of transformations, and this would help it further deliver excellent services to clients in CEE.
UniCredit is a Pan-European commercial bank delivering a unique CEE network to its clients which include major global custodians and broker-dealers. With the new industrial plan Transform 2019, the new management has taken a series of measures, including a 13 billion euro rights issue earlier this year and the disposal of some assets, and in particular of Pioneer, Poland’s Bank Pekao and a 30% stake in Fineco Bank. This will ultimately help the bank reach its CET1 ratio target of 12.5%, and allow it to invest further into its CEE markets.
The bank is also addressing some legacy issues in Italy, reducing the amount of non-performing loans, introducing a stricter discipline on risks anda lower cost structure; improved customer service and investments in digitaltechnologies. UniCredit is focusing on CEE and remains committed to the region and its clients. This strong message resonated with a number of participants in the room.
Standardisation can be Tough
The depth and breadth of discussions around standardisation in CEE markets was excellent, providing invaluable insight on a continuously evolving region to clients. International investors want market standardisation, but progress in CEE is mixed, the audience was told. Attaining standardisation across CEE markets is achievable, but it requires market participants including infrastructures, regulators and custodians to collaborate and discuss with each other the key challenges, and how they can be solved effectively. In circumstances where national law may not square with EU Directives or Regulations, local market participants need to engage with the authorities to bring about change and conformity.
Efforts to harmonise and streamline the settlement of European securities in Central Bank money through Target2Securities (T2S) were implemented throughout 2016 and 2017. However, settlement volumes in CEE markets remains low and a number of market infrastructures and participants in the region have yet to fully acquaint themselves with T2S.
End users in Hungary point out the Forint is not a T2S settlement currency, and are adopting a cautious approach towards the platform. KELER, the Hungarian CSD, joined T2S in February 2017, but eligible transactions are still input manually, and a net result of this is that clients have not noticed any changes. Meanwhile, Slovakian stock exchange rules oblige market participants to settle through the exchange and not the CSD. As CDCP will not offer partial settlement, it is ineligible to settle through T2S.
Nearly all countries though introduced T+2 as the Central Securities Depository Regulation (CSDR) bedded in. Serbia, which is in ascension talks with the EU, introduced T+2 for its CSDs in 2016 ahead of CSDR. Slovakia’s CDCP CSD has made structural improvements to its processes including the implementation of ISO 20022 standards; the establishment of a hold and release mechanism; and a move to delivery versus payment (DVP).
Other markets including the Czech Republic introduced SWIFT communication channels ahead of CSDR. However, implementation of CSDR has been difficult as CSDs in CEE have different operational processes; technology interfaces while some still have low levels of straight-through-processing (STP).
But Standardisation is not Improbable
UniCredit representatives continued to share their thoughts about standardisation, pointing out that while it would not be easy to achieve in CEE, it was certainly not impossible. Again, the depth of expertise and knowledge among the team enabled for a stimulating discussion.
In theory, consolidation of market infrastructures – such as exchanges, CSDs, and Central Counterparty Clearing houses (CCPs) would be a sensible option in CEE if they wanted to have a better chance of harmonising the rules around T2S, CSDR and even corporate actions. It would also help pool liquidity – which is in limited supply in CEE –into a single or reduced number of trade and post-trade venues.
Harmonisation of cross-border regulations such as the CSDR, Alternative Investment Fund Managers Directive (AIFMD), the Markets in Financial Instruments Directive II (MiFID II) and UCITS V across diverse markets is always challenging. EU Directives give local regulators manoeuvre for interpretation, and this can result in fragmentation. Equally, the cross-border implementation timings do not always align, and some countries may enact rules later than others. Poland, for example, introduced AIFMD three years after its initial deadline.
The custody industry has a long track record of collaborating on industry best practice, sound implementation of regulatory initiatives, and harmonisation. Successful cooperation among industry stakeholders was evidenced recently with the launch of the Association for Financial Markets in Europe (AFME) Due Diligence Questionnaire (DDQ), which standardises network managers’ due diligence on their sub-custodian providers. In such an environment driven by collaboration, standardisation is possible.
Change Enablers
Gregor Hense, Senior Product Manager, Clearing & FX products at UniCredit, gave an articulate overview of Blockchain, which clients commended for its informative nature.
Gregor highlighted that Blockchain, a shared digitised ledger created by the mysterious Satoshi Nakamoto, has been discussed extensively among the custody industry since Sibos in 2015 as a tool by which to force efficiencies, and curtail intermediation across the investment process. Blockchain is based on several key components, namely consensus and trust among users in confirming transactions; security through extensive cryptography and encryption; and smart contracts, or automated, self-enforcing agreements, which incorporate logic.
The excitement about Blockchain is comparable to the Gold Rush insofar as a lot of organisations and people are looking to monetise the technology, but only a few will reap the rewards. Blockchain could benefit the custody world through improving transparency; enabling automation around transactions and reconciliations; and removing errors in these processes. The markets where Blockchain is likely to see the most interest is in emerging economies where public trust in legal systems and financial institutions may be limited, and people may view the technology as more reliable.
Incorporating Blockchain into the custody world may sound like an ideal fit, but there are complications. For a start, the custody chain between issuer and end client is complex and variable by market. Many of test cases around Blockchain in payments so far have been trialled on fairly straightforward processes. The interconnectedness of the custody world means any technology like Blockchain has to be subject to universally agreed standards or even regulations. There is currently no global rule-book for Blockchain as there is for payments.
Blockchain can also be split into two – private versus public. The custody industry – given the discretion it must handle client data with – will not use a public Blockchain and is more convinced by the opportunities of creating permissioned private Blockchains, where there are superior controls and regulatory oversight. While Blockchain will make a difference in a number of financial and non-financial areas, the complexity and systemic importance of custody and securities services may mean its adoption takes longer.
The Future of the Regional Custodian
A lot has been written about the increasing competition between domestic CSDs and agent banks, but is this really happening? A panel made up of a number of industry participants delved into one of the more controversial issues impacting the custody world. The noteworthy discussion looked at some of the drawbacks of using a single market provider or domestic CSD for custody.
The reality is that a domestic CSD – in addition to settlement – can provide vanilla custody but agent banks generally offer more services, such as intraday and overnight credit lines which are not within the remit of market infrastructures. If an end investor is directly connected to a CSD in a local country and there is a significant market event, this can accentuate counterparty risk. While CSDs certainly enrich the sub-custody process, they tend not to compete with the agent banks.
The panel then explored the viability of the single market custody provider. European-wide rules like T2S, for example, mean that global custodians and broker-dealers want seamless connectivity to the platform, and going through lone market providers unnecessarily complicates the process. Clients are looking for providers that can give them regional coverage through a single point of entry as opposed to having a number of individual providers in all of the markets, who will have unique contracts and legal agreements.