GlobeTax employees ventured to Hong Kong for the 2017 World Forum of CSDs conference (WFC), joining central securities depositories for three days of discussion and networking. Senior depository executives mingled with consultants and service providers to wax philosophical over current and future issues and opportunities surrounding the central clearing and settlement landscape. Below, we overview several of our biggest takeaways from the conference.
Despite national missions, CSDs are strengthening their cross-border ties, working more closely together than ever before. While these linkages are partly driven by regulation—witness the impact of CSDR in Europe—economic motivations also abound. By pursuing basic economic principles like standardization, economies of scale, and positive network externalities, CSDs can increase efficiency and lower costs, thus encouraging inbound investment to their region or jurisdiction.
The trend toward integration was on full display at the conference. The host city boasts one of the world’s most famous CSD integration schemes: the Hong Kong-China Stock Connect and Bond Connect. This mutual market access program allows investors to purchase cross-border securities using their local intermediary and settlement infrastructure. While China’s unique market restrictions motivated creation of the initiative, the scheme nonetheless provides important lessons in reconciling different time zones, delivery versus payment standards, and settlement models across CSDs.
These takeaways are critical, as most CSD integration schemes are regional and benefit from similar standards and models, e.g. schemes in Latin America (Mercado Integrado Latinoamericano) and Africa (East Africa Securities Exchange). As conference participants suggested, the next frontier involves creation of globally integrated CSD networks. Although the transition to global T+0 settlement is likely years away, many cited distributed ledger technology, e.g., blockchain, as the means to arrive at the best practice. The technology evolution will take time, but the benefits will pay off for CSDs. More interconnection means wider market access, which translates to increased demand for CSD services—demand which is desperately needed thanks to the shifting profit environment.
Despite their central role as key settlement infrastructure, CSDs face a complex and changing landscape, forcing them to reimagine their future structure. Competitive threats as other depositaries expand mandates internationally and technology providers enter the custody and clearing space to pursue new business lines. At the same time that CSD margins are shrinking from fee compression, costs are rising fast. Contending with complex investment products and global reporting requirements is not cheap, to say the least.
Fittingly, optimal profit models represented one of the key topics bandied about the conference. Although the depositories have historically served as a somewhat profit-neutral market infrastructure, there is increasing movement toward explicitly for-profit structures. Considering this trend, three questions were posed during panel discussions. First, should CSDs be explicitly structured (or restructured) as for-profit entities? Second, would an explicit for-profit orientation diminish CSDs historic role as market infrastructure? And, third, is it possible to align incentives so that CSDs serve shareholders and the greater marketplace simultaneously?
In contemplating these questions, conference participants generally agreed that CSDs must first serve the market. As commercial organizations, however, CSDs also don’t wish to be disintermediated. Thus, it was widely recommended that the institutions develop new services to stay relevant, offering innovative value-adds layered atop their key function of market infrastructure. Envisioned services would help shorten the custody chain, consolidating the functions of other intermediaries. By taking advantage of the space for growth in service, innovation, and technology, CSDs can remain utility providers while simultaneously pleasing shareholders.
As 53 depositories indicated during Deceval President Jorge Hernán Jaramillo Ossa’s presentation of survey results, withholding tax, transaction taxes, and capital gains reporting represent emerging areas of opportunity for service provision. The survey indicated that approximately 50% of CSDs not presently providing tax support services are considering expanding tax relief offerings.
For that entrepreneurial 50%, withholding tax reclamation represents a particularly compelling opportunity. Although double taxation treaties theoretically allow for recovery of excess withholdings on foreign interest and dividends, they are difficult to navigate in practice. At present, no intermediaries in the custody chain systematically provide assistance. Given the increasingly specialized knowledge needed to contend with the changing treaty landscape, a number of panelists suggested that CSDs could lean on niche vendors and consultants to develop new service offerings.
Speaking to this topic, GlobeTax’s Brett Lewis introduced the firm’s MIDAS platform to allow CSDs to offer withholding tax recovery services on all securities to all members of the custody chain. As key infrastructure providers and arbiters of standards, CSDs are well situated to promote an integrated relief at source solution. If implemented, CSDs could profit while providing a more efficient marketplace. Investors and previously-underserved account holders would secure their rightful entitlements, improving portfolio performance. They would also save money by eliminating the need for expensive and duplicate segregated accounts in local markets, and save time by eliminating the need to file for a standard reclaim. To be sure, financial institutions and custodians would benefit as well. Not only would they fulfill fiduciary responsibilities to key clients like pension funds, but also enjoy new operational efficiencies that deliver additional value to clients—a crucial competitive advantage.
Looking Ahead to the 2019 Conference
When reflecting on the ambitious agenda of the 2017 conference, it is amazing to consider that the World Forum of CSDs is only 6 years old. Since its inception, the organization has filled a much-needed void to provide a space for depositories to gather to discuss best practices and common issues. As financial markets continue transitioning from regional to global integration, the conference will undoubtedly help lead the harmonization charge.