HSBC Securities Services Middle East Securities Services in MENA Markets a Comparison with International Benchmarks November 2006
Agenda • Middle East Capital Markets: An Overview • Middle East markets and G 30 recommendations – A comparison • Suggested improvements for MENA markets
HSBC’s Custody and Clearing Global Network covers 37 markets of which 11 are in the Middle East HSBC’s global network includes 9, 500 offices in 76 countries and territories
Middle East Capital Markets - An Overview
The Region – Economy and Capital Market • • Market cap more than USD 1 Trn. Key drivers Ø High oil price, creating huge liquidity Ø Repatriation of Arab money back to the Gulf Ø Diversification and privatisation efforts More stocks are opening up foreign investors – some countries allow up to 100%, left to the discretion of the companies Stable exchange rate, no restrictions on repatriation No tax in most countries Electronic trading, stocks held in dematerialised form Significant growth (assets - 200%, trxns 140% over 2004) Needed – more robust regulations, institutional investors, international settlement and custody practices
The Region – Market Settlement features • Account structure ØSegregated accounts - Beneficial owner markets ØOmnibus account structure not allowed Impact: Longer time to market, increased paperwork and costs • Settlement practice ØSD varies from T to T+3 ØStock moves on T, cash on SD ØTwo accounts – depository and trading (broker access) ØBefore trading, stock should be in trading account ØHence no fails, but little scope to control movement of stock after trade – risk for sale trades Impact: Settlement exposure, inadequate custodial control, front running risk
The Region – Market Settlement features • Securities Lending Ø No short sales, no stock lending Ø Securities lending announced in some markets but yet to take off Impact: Low volumes and portfolio yields • Custodian services Ø Market settlement between brokers, not with custodian Ø Role of custodian not well understood, but changing Impact: Inadequate risk management
Typical Structures for Foreign Institutional Investors (FIIs) FII Global Custodian International Broker Local Sub-Custodian Local Broker Local market settlement
Middle East markets and G 30 recommendations – A comparison
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Eliminate paper and • Eliminate issuance, use, transfer, and retention of paper certificates automate • Market participants to automate elements of process such as confirmations and trade allocations. • Use of electronic communication • Avoid duplicate recording of data and manual addition of information
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Eliminate paper and • Dematerialized securities automate • Issuance of electronic trade notes in MT 515 format to facilitate STP • Online connectivity to depositories
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Eliminate paper and • Dematerialized securities automate • Issuance of electronic trade notes in MT 515 format to facilitate STP • Online connectivity to depositories Harmonize messaging standards & communication protocols • Adopt ISO 15022 as global standard for straight through securities messaging
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Eliminate paper and • Dematerialized securities automate • Issuance of electronic trade notes in MT 515 format to facilitate STP • Online connectivity to depositories Harmonize messaging standards & communication protocols • Adopt ISO 15022 as global standard for straight through securities messaging – to be used across all market participants to achieve 100% STP
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Eliminate paper and • Dematerialized securities automate • Issuance of electronic trade notes in MT 515 format to facilitate STP • Online connectivity to depositories Harmonize messaging standards & • Adopt ISO 15022 as global standard for straight through securities messaging – to be used across all market participants to achieve 100% STP communication protocols Develop and implement reference data standards • Identify, develop and adopt universal securities, counter party and relevant generic reference data standards • Issuers, exchanges to make all relevant information available to market for a fair price and timely basis
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Eliminate paper and • Dematerialized securities automate • Issuance of electronic trade notes in MT 515 format to facilitate STP • Online connectivity to depositories Harmonize messaging standards & • Adopt ISO 15022 as global standard for straight through securities messaging – to be used across all market participants to achieve 100% STP communication protocols Develop and implement reference data standards • All ME markets should make use of International Securities Identification Numbers(ISINs) for securities transactions • A central regional authority should be appointed and entrusted with the function of assigning ISINs for all Middle east listed securities
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Eliminate paper and • Dematerialized securities automate • Issuance of electronic trade notes in MT 515 format to facilitate STP • Online connectivity to depositories Harmonize messaging standards & • Adopt ISO 15022 as global standard for straight through securities messaging – to be used across all market participants to achieve 100% STP communication protocols Develop and implement reference • All ME markets should make use of International Securities Identification Numbers(ISINs) for securities transactions data standards • A central regional authority should be appointed and entrusted with the function of assigning ISINs for all Middle east listed securities Synchronize timing • Operation of payments and forex systems should not reduce efficiency or increase risk in the clearing and settlement systems and vice versa. between clearing, settlement, and payment systems • Develop a comprehensive action plan to increase efficiency and safety of cross border securities transactions
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Eliminate paper and • Dematerialized securities automate • Issuance of electronic trade notes in MT 515 format to facilitate STP • Online connectivity to depositories Harmonize messaging standards & • Adopt ISO 15022 as global standard for straight through securities messaging – to be used across all market participants to achieve 100% STP communication protocols Develop and implement reference • All ME markets should make use of International Securities Identification Numbers(ISINs) for securities transactions data standards • A central regional authority should be appointed and entrusted with the function of assigning ISINs for all Middle east listed securities Synchronize timing • The Middle East markets are not true DVP markets as there is no simultaneous cash and securities settlements. between clearing, settlement, and payment systems • Several Middle East markets settle direct with brokers as against the custodians who are the settlement agents appointed by institutional investors.
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Automate and standardize institutional trade matching • Market participants to collectively develop and use fully compatible and industry accepted technical and market practice standards for automated confirmation and agreement of institutional trade details on the day of trade.
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Automate and standardize institutional trade matching • Trades executed by brokers on the exchange auto match and flow into the depository systems for settlement. • Pre-matching of trades between brokers and custodian is upon receipt of client instructions and broker trade note via facsimile.
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Automate and standardize institutional trade • Trades executed by brokers on the exchange auto match and flow into the depository systems for settlement. • Pre-matching of trades between brokers and custodian is upon receipt of client instructions and broker trade note via facsimile. matching Expand the use of central counterparties • Assess the potentially substantial risk reduction and efficiency improvements of using a central counter party.
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Automate and standardize institutional trade • Trades executed by brokers on the exchange auto match and flow into the depository systems for settlement. • Pre-matching of trades between brokers and custodian is upon receipt of client instructions and broker trade note via facsimile. matching Expand the use of central counterparties • The clearing house run by exchanges in the Middle East should provide a central counter party system that will guarantee that trades between members are settled and eliminate default risk.
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Automate and standardize institutional trade • Trades executed by brokers on the exchange auto match and flow into the depository systems for settlement. • Pre-matching of trades between brokers and custodian is upon receipt of client instructions and broker trade note via facsimile. matching Expand the use of central counterparties Permit Securities Lending and borrowing • The clearing house run by exchanges in the Middle East should provide a central counter party system that will guarantee that trades between members are settled and eliminate default risk. • Relevant authorities should permit securities lending and borrowing as a method for expediting the settlement of securities transactions.
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Automate and standardize institutional trade • Trades executed by brokers on the exchange auto match and flow into the depository systems for settlement. • Pre-matching of trades between brokers and custodian is upon receipt of client instructions and broker trade note via facsimile. matching central counterparties • The clearing house run by exchanges in the Middle East should provide a central counter party system that will guarantee that trades between members are settled and eliminate default risk. Permit Securities • Securities lending and borrowing is not permitted in all ME markets Lending and • Lending allows increase in portfolio yields while maintaining ownership benefits and related entitlements on lent securities. Expand the use of borrowing • Borrowing avoids failed trades & reduces financing costs of failed settlements
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Automate and standardize institutional trade • Trades executed by brokers on the exchange auto match and flow into the depository systems for settlement. • Pre-matching of trades between brokers and custodian is upon receipt of client instructions and broker trade note via facsimile. matching central counterparties • The clearing house run by exchanges in the Middle East should provide a central counter party system that will guarantee that trades between members are settled and eliminate default risk. Permit Securities • Securities lending and borrowing is not permitted in all ME markets Lending and • Lending allows increase in portfolio yields while maintaining ownership benefits and related entitlements on lent securities. Expand the use of borrowing • Borrowing avoids failed trades & reduces financing costs of failed settlements Automate and standardize asset servicing processes • Market participants to advise investors all details of corporate events in an automated, timely manner and in compliance with industry standards. • Harmonize and make transparent the processes, documentation and communication of information connected with foreign ownership restrictions
G 30 – Recommendations - 2003 Creating a strengthened, interoperable Global Network Automate and standardize institutional trade • Trades executed by brokers on the exchange auto match and flow into the depository systems for settlement. • Pre-matching of trades between brokers and custodian is upon receipt of client instructions and broker trade note via facsimile. matching central counterparties • The clearing house run by exchanges in the Middle East should provide a central counter party system that will guarantee that trades between members are settled and eliminate default risk. Permit Securities • Securities lending and borrowing is not permitted in all ME markets Lending and • Lending allows increase in portfolio yields while maintaining ownership benefits and related entitlements on lent securities. Expand the use of borrowing • Borrowing avoids failed trades & reduces financing costs of failed settlements Automate and standardize asset servicing processes • Corporate event information is sometimes delayed on exchange websites and if available are often in Arabic that involves translation delays and thereby delayed relay of information to investors. • Foreign ownership limits are monitored by the exchanges/depositories
G 30 – Recommendations - 2003 Mitigating Risk Financial integrity and risk management practices • Settlement and clearing service providers should have in place risk management processes to enable them conduct business in safe, sound and prudent manner. • Users of services of clearing and settlement service providers must establish robust due diligence procedures and counter party risk management controls.
G 30 – Recommendations - 2003 Mitigating Risk Financial integrity and risk management practices • Due diligence should be carried out on settlement participants both upfront, while admitting for membership and ongoing. • In case custodian is settling the trade, broker limits should be blocked till custodian confirms the trade
G 30 – Recommendations - 2003 Mitigating Risk Ensure financial integrity of clearing and settlement service • Due diligence should be carried out on settlement participants both upfront, while admitting for membership and ongoing. • In case custodian is settling the trade, broker limits should be blocked till custodian confirms the trade providers Ensure final, simultaneous transfer and availability of assets • Link securities transfers to fund transfers in a way that achieves effective delivery versus payment (DVP). • Make transparent at which stage finality of transfer is achieved with rules that enable the receiver to re-use securities and cash without further delay.
G 30 – Recommendations - 2003 Mitigating Risk Ensure financial integrity of clearing and settlement service • Due diligence should be carried out on settlement participants both upfront, while admitting for membership and ongoing. • In case custodian is settling the trade, broker limits should be blocked till custodian confirms the trade providers Ensure final, simultaneous transfer and availability of assets • ME markets do not practice a true delivery versus payment (DVP) settlement system – stock moves on T, cash moves on T+2/3 • In most markets, securities move out on trade date itself without confirmation of investor. • Concept of trading account reduces investor control over his holdings.
G 30 – Recommendations - 2003 Mitigating Risk Ensure financial integrity of clearing and settlement service • Due diligence should be carried out on settlement participants both upfront, while admitting for membership and ongoing. • In case custodian is settling the trade, broker limits should be blocked till custodian confirms the trade providers Ensure final, simultaneous transfer and availability of assets Ensure effective business continuity and disaster recovery planning • ME markets do not practice a true delivery versus payment (DVP) settlement system – stock moves on T, cash moves on T+2/3 • In most markets, securities move out on trade date itself without confirmation of investor. • Concept of trading account reduces investor control over his holdings. • All market participants must regularly review, update and test their business continuity and disaster recovery plans as well as those of a systemically important institution. • Plans should be robust to ensure with reasonable certainty that critical operations will continue with high level of integrity following disruption.
G 30 – Recommendations - 2003 Mitigating Risk Ensure financial integrity of clearing and settlement service • Due diligence should be carried out on settlement participants both upfront, while admitting for membership and ongoing. • In case custodian is settling the trade, broker limits should be blocked till custodian confirms the trade providers Ensure final, simultaneous transfer and availability of assets Ensure effective business continuity and disaster recovery planning • ME markets do not practice a true delivery versus payment (DVP) settlement system – stock moves on T, cash moves on T+2/3 • In most markets, securities move out on trade date itself without confirmation of investor. • Concept of trading account reduces investor control over his holdings. • While the depositories and exchanges have business continuity and disaster recovery plans, it is difficult to confirm the robustness of these plans in absence of testing results. • Regulators must encourage the process of industry wide contingency planning.
G 30 – Recommendations - 2003 Mitigating Risk Ensure financial integrity of clearing and settlement service • Due diligence should be carried out on settlement participants both upfront, while admitting for membership and ongoing. • In case custodian is settling the trade, broker limits should be blocked till custodian confirms the trade providers Ensure final, simultaneous transfer and availability of assets Ensure effective business continuity and disaster recovery planning Advance legal certainty over rights to securities, cash or collateral • ME markets do not practice a true delivery versus payment (DVP) settlement system – stock moves on T, cash moves on T+2/3 • In most markets, securities move out on trade date itself without confirmation of investor. • Concept of trading account reduces investor control over his holdings. • While the depositories and exchanges have business continuity and disaster recovery plans, it is difficult to confirm the robustness of these plans in absence of testing results. • Regulators must encourage the process of industry wide contingency planning. • Market participants must be able to determine what law defines and governs their rights to securities, cash or collateral in a clearing and settlement system.
G 30 – Recommendations - 2003 Mitigating Risk Ensure financial integrity of clearing and settlement service • Due diligence should be carried out on settlement participants both upfront, while admitting for membership and ongoing. • In case custodian is settling the trade, broker limits should be blocked till custodian confirms the trade providers Ensure final, simultaneous transfer and availability of assets Ensure effective business continuity and disaster recovery planning Advance legal certainty over rights to securities, cash or collateral • ME markets do not practice a true delivery versus payment (DVP) settlement system – stock moves on T, cash moves on T+2/3 • In most markets, securities move out on trade date itself without confirmation of investor. • Concept of trading account reduces investor control over his holdings. • While the depositories and exchanges have business continuity and disaster recovery plans, it is difficult to confirm the robustness of these plans in absence of testing results. • Regulators must encourage the process of industry wide contingency planning. • Legal framework, particularly with respect to collateral needs improvement
Suggested improvements for MENA markets
Best practices of international markets • Effective securities market rules and regulations • Access to foreign institutional investors • Well defined roles of market intermediaries • Active involvement of market participants in market development and regulatory initiatives • Robust risk management systems • Effective business continuity and disaster recovery planning
Suggested steps for MENA markets • Simplified account opening procedures – currently some markets require notarization and consularization of documents. • Facilitate omnibus account structure • Recognition of sub-custodians for institutional investors • DVP settlement with simultaneous settlement of cash and securities • Settlement should be controlled by custodian • Restrict access to client holdings to authorized agents of the client • Direct and electronic link to depository systems • Electronic fund transfer and income payment infrastructure • No requirements of pre-funding or pre-advice
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