Magazine issues » December 2011

ASSET SERVICING: Waiting at the borders

RoadWith asset servicing largely dominated by domestic players at the local level, foreign asset servicers hope that investors will increase their overseas investment, finds Nicholas Pratt.

The Latin American funds market is dominated by Brazil, which along with Mexico accounts for almost 90% of the region’s investment funds.

It is therefore the market that has attracted the most attention from international asset servicing houses seeking to grow their business.

Asset servicers, headed mainly by large custody banks, rely on the ability of clients, such as fund managers, to be able to outsource some of their back and middle-office operations.

In addition to the size of assets under management, Brazil has had a more developed outsourcing market than other countries in the region, since in the late 1990s, when regulators introduced the concept of an independent custodian that carries out both fund administration and custody on behalf of fund managers.

“It is not obligatory but it is viewed in a positive way,” says Alejandro Berney, head of Latin America securities and fund services, Citi.

However, the potential of the Brazilian investment market for outsourced services is tempered by domestic forces that mean the conventional Brazilian on-shore funds market offers fewer opportunities for international asset servicers.

The absence of a trust law has led pension funds to establish mutual funds of their own for which they appoint a local administrator to perform almost all of the asset servicing.

Consequently, the domestic asset servicing firms have a very strong hold on the market and have scale as a consequence, which makes it hard for any outside asset servicing firm to make a dent, especially if they are starting from scratch.    
Citi is one of the few international asset servicing firms to have a significant share in the Brazilian market and it tends to specialise in funds that have “added value”, says Berney, such as exchange-traded funds

(ETFs) and private equity funds with a mutual fund structure. Citi launched the first ETF in Brazil with BlackRock, the world’s larges ETF provider, almost two years ago.

International investment by Brazilian investors, however, is practically nil. Of the $1 trillion in the mutual funds market, less than $3 billion is invested overseas. The international asset servicing firms could act as a useful conduit if there were more.

The lack of opportunity is not because the option for Brazilian investors to invest abroad is not there. Three years ago Brazil allowed for offshore investing and there are now a number of funds that allow investment offshore but the take-up has been very low, says Berney.

The high interest rates in Brazil and the many years that Brazil was closed to offshore investment means that there is no tradition or culture of international investing and the growth in that sector has been very small. Also, with the Brazilian currency appreciating, many investors have not wanted to take the risk of investing overseas.

However, there could be a reversal in the attitude towards overseas investment. In recent years, the major concern was that the Brazilian investment market would be flooded with international money as Brazil became and investment hot spot. There has subsequently been a marked drop in the Selic, the Brazilian benchmark interest rate, from 12.5% in mid-2011 to an all-time low of 7.25% (as of June 2013 the Selic stood at 8%).

This drop in rates coupled with recent devaluation of the real has led Brazilian pension fund managers to start looking abroad in search of yield and for global asset managers to flock to Brazil in an effort to win investment mandates from outward flows that could be as high as $45 billion.

“I think it is the right time to launch these products because there will be a change of heart regarding overseas investment,” says Berney.

For international asset servicers, this would be a welcome development says Thalius Hecksher, global business development director at Apex. “This is a trend that is gathering momentum as Brazilian asset managers realise the benefit of offshore fund structures and the relatively low cost of setting them up.”

An additional development fuelling the trend is the increasing interest Brazilian high-net-worth investors and family offices are showing in the global equities market, says Hecksher.

There is a similar rates pressure for domestic pension fund managers in Mexico where pension fund assets have almost doubled in four years and exceeded 2 trillion pesos ($164 billion) in the
first quarter of 2013. At present, Mexican pension funds are only allowed to

invest 20% of their assets overseas but the head of Mexico’s pensions regulator, Consar, has called for this cap to be raised to relieve the pressure on domestic funds and prevent any kind of price bubble emerging.

The Chilean investment market is much smaller than Brazil or Mexico but there is also a demand among local asset managers to invest beyond national borders, says Edouard Deugnier, head of sales and relationship management for Southern Latin America BNP Paribas Securities Services. “Some asset managers are looking for solutions to grow and sell products outside Chile – international fund structures that can be serviced in Ireland or Luxembourg and be passported and sold back to other Latin American markets, the US as well as Asia and Europe. This is a trend we have seen increase in the past six to 12 months.”

Regulation has also been helpful in opening offshore markets to Chilean investors as well as attracting international asset managers seeking to distribute their products in Chile. The Ley Unica de Fondos bill will end the 35% capital gains tax currently applied to overseas investors and also scraps the 19% VAT paid in administration fees.

“The idea is to put Chilean asset managers on a par with global asset managers and to remove the current fiscal and tax barriers that exist,” says Deugnier.

The legislation was presented to congress in 2011 and expected to come into effect in the coming months.

The regulation is testament to the country’s ambition to become an international fund servicing centre in the same way as Ireland, Luxembourg and Singapore have achieved in their respective markets. But Chile faces competition from Colombia which, despite having a smaller investment funds market, is growing very quickly and has also made regulatory changes.

New legislation was introduced in June 2013 that is designed to promote the value of outsourcing fund administration and custody to third parties rather than performing these roles in-house. The rule changes were prompted by the bankruptcy of a large domestic broker Interbolsa in 2012 which highlighted the potential problems of the current structure with managers doing so much in-house.

However, says Berney, there is unlikely to be an immediate rush of business for international asset servicers.

“The regulations and accounting standards are different in Colombia and it is not possible to come in with a global platform and expect to start servicing Colombian asset managers.

It is still a very nascent market and many managers are still to be convinced of the benefit of outsourcing.”

Nevertheless, competition between international asset servicers within Latin America is likely to increase in coming years. The large US providers - Citi and BNY Mellon especially – that have been present for some time are now being joined by the Europeans.  Ireland-based Apex opened an office in Uruguay in January 2013 to act as its operational centre for Latin America. Meanwhile BNP Paribas Securities Services opened offices in Chile and Colombia in March 2012.

So far, the Latin American asset servicing market has been dominated by domestic players or, in terms of global custodians, the large US players. Deugnier feels that European providers can compete with the domestic and US providers.

“The growing size of the market, its regionalisation, added to clients’ needs to safely invest globally makes it necessary for asset managers to have a larger number of providers to choose from.

“The European players are able to bring their experience of a multi-currency, multi-regional market added to their flexible, diversified service model, and focus on asset protection. This is what clients are looking for. They are entitled to something different from what they had from their historical providers."

©2013 funds global latam

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