Colombia: Investors are urged to use the legal counsel suggested by the custodian to realize efficiencies - for example, the reduction of time necessary to file the appropriate documentation. "As in Brazil, the investor and the custodian should ensure documentation is accurately completed, the subcustodian should be used as the local administrator, all funds should be repatriated, and each foreign exchange funded individually," said Bankers Trust's Mr. Dwyer.
India: Most of the difficulties in India are systemic and cannot easily be avoided, most custodians agreed.
The most important recommendation for investors is to select only the most reliable counterparties when trading, said Northern Trust's Mr. DeLew.
The settlement process introduces broker risk for several days or more, so the selection of only the most creditworthy brokers available is advisable.
If possible, trade in jumbo certificates of large denominations for certain company issues, which minimizes the volume of paper at settlement. The certificates usually are traded by institutional investors, sometimes trading at a discount to the more widely accepted small denomination certificates.
One custodian listed specific guidelines for India:
Stick to the Bombay Stock Market/National Stock Market.
Settle trades over the counter, not through the clearinghouse.
Check your global custodian's arrangements. Does it use a quality subcustodian?
Ensure your global custodian has good procedures in place to track stock out for registration.
Check the global custodian's and subcustodian's information collection routines and procedures.
Israel: "Negotiate a longer settlement with the broker," said Terry McCaughey, director, Midland Securities Services, London. "It is possible to extend settlement to T+1 or T+2 for OTC trades. If clients do not wish to trade off market, they can utilize procedures we have agreed with our subcustodian - they will handle the purchase/sale of currency and fund trades for one day, at no cost to the client, to allow settlement to take place on T+1."
Pakistan: Careful analysis of available counterparties is strongly advised in Pakistan. Inefficient broker back-offices can result in settlement delays and improperly endorsed certificates. Broker exposure can result from improperly endorsed certificates having to be returned after payment has been effected.
One custodian recommends "clients should provide trade instructions as early in the settlement cycle as possible. (This gives the subcustodian time to) attempt to pre-match trade details with the counterparty. In addition, certain brokers offer a 'delivery against payment' service for an additional fee. Using this service reduces counterparty risk inherent in the typical market settlement, during which payment is made on the Monday account day but shares are not received until the following Wednesday."
The Philippines: One custodian regularly reports the status of share certificates, enabling investors to determine whether their brokers are chronically causing registration delays.
And for sales that require splitting of share certificates, a number of custodians said, clients should provide trade details and settlement instructions before T+1. This allows the subcustodian to approach the registrar for certificate splitting prior to settlement, avoiding the risk inherent in assigning the responsibility to the counterparty.
Noting the risk of the brokers' registration practice, another custodian suggests investors require counterparties to register directly in the name of local subcustodian.
Russia: "Investors should fully understand the risks involved before investing in Russia," said Marshall E. Molloy, vice president and communications officer with Chase Manhattan Bank, New York. "Investment managers should perform detailed on-site due diligence on the companies and their registrars before making any investments."
An investor should start the approval process early. There is often a great deal of paperwork involved. Allow ample time.
Sub-Saharan Africa: Understand - in detail - the trading, settlement and payment systems of the particular market to fully anticipate where risk and difficulties may arise.
Venezuela: "As the documentation process is involved, the investor and custodian must use caution to ensure it is complete and accurate. If the documents appear to have been tampered with (staples removed, seals or stamps not aligned) they will be considered incomplete and rejected by the governing body. In addition investors are advised to keep accurate records; this is beneficial for filing repatriations, as well as tax filing," said Bankers' Mr. Dwyer.
"We recommend careful consideration of the issues prior to investing in this market, as the government over the last year imposed outright exchange controls and a high level of bureaucracy surrounding the granting of repatriation requests. Delays of weeks or months are common in repatriating of assets. Brokers should be selected carefully, as bankruptcies in this industry were common over the last year and settlement practices are not fully delivery vs. payment," said one custodian.
Global custodians are taking steps to minimize - not eliminate - the systemic risks in the emerging markets.
"We continually monitor the development of improved regulatory infrastructure and market practices in these types of difficult markets. In the case of India, we have appointed multiple custodians in order to have sufficient capacity for our clients' custody needs. In Venezuela, we keep in close contact with our appointed custodian to monitor registration and repatriation issues. In Russia, we are conducting due diligence review to monitor developments capital markets," said one custodian.
"We have recently developed a market information guide, which provides detailed information relating to all the markets including advantages and disadvantages. This service is made available to clients in diskette form. We also provide clients with 'guidance notes' with regards to applications to invest in all emerging markets," said another custodian.
"The lack of infrastructure poses operational difficulties that are very difficult to overcome. This custodian recognizes the risk inherent in the current market structure and recommends several ways in which its clients can reduce counterparty risk. For purchases, the bank recommends clients trade 'delivery vs. payment.' .... Payment is made in U.S. dollars only after the subcustodian verifies the shares. For sales, we recommend clients ask their counterparties to deliver bank checks to our subcustodian."
Here are steps custodians are taking in various countries:
Brazil: One custodian assigned additional staff to perform regular manual cash and securities reconciliation at the levels of CVM identifier and individual security. The procedure supplements the automated reconciliation process that takes place with each agent bank.
Another custodian created an umbrella omnibus: the client opens the account through the custodian and appoints the subcustodian as the local administrator.
India: One custodian continues "to lobby regulators in India to streamline the approval process for foreign investors. We support industry efforts to develop central depository capabilities or, at a minimum, to increase the standard size of certificates from 100 to 1,000 shares to substantially decrease the amount of paper that must change hands with each trade settlement.
"Our subcustodian ensures that inspection of certificates is accomplished in a meticulous manner. The subcustodian has a regular program of follow-up with registrars to ensure the registration process and subsequent share illiquidity are kept to minimum timeframes. We have also developed a smoothly functioning partnership with a local CPA firm to handle all matters relating to taxation."
Pakistan: One custodian dedicates "additional staff to interface with our agent bank to monitor and control performance in a very pro-active, hands-on manner. We reconcile cash, securities and registration weekly, which is exceptional relative to demands made by other custodians on our agent."
Another respondent said: "We have worked closely with our subcustodian to develop delivery vs. payment settlement over the last year, whereas the system had previously required a two-day lag between delivery of value and receipt of value, resulting in an undesirable level of broker exposure."
"Our subcustodian provides weekly updates of open corporate entitlements and income payments," another custodian reported. "Reports are reconciled against the bank's internal records regularly. Out-for-registration reporting is provided on a daily basis, which informs our clients of the unavailability of securities for sale. The bank monitors its subcustodian's performance on a monthly basis and addresses any operational issues immediately. Regular calls are made to the subcustodian to discuss open operational issues and market changes."
The Philippines: "We closely monitor outstanding LGTs and make personal visits to brokers with any trades outstanding longer than eight business days. No securities purchased or converted are accepted without proper (Central Bank registration documentation). Exceptions are documented by specific written instructions from the client clearly stating that repatriation of funds related to securities will not be possible until proper documentation is obtained."
Another custodian said: "We advise clients to require trading counterparties to register directly in the name of our subcustodian, to eliminate the practice of registration in the broker's name in the marketplace."
One custodian provides daily status reports for shares out for transfer. In addition, a monthly report is provided that shows the status of outstanding certificates by broker. Both reports allow clients to monitor the efficiency of their brokers. Open income and corporate entitlements are reconciled on a regular basis. The subcustodian's performance is monitored against the bank's standards; performance problems are addressed immediately.
Russia: One custodian "implemented operating procedures with the registrar companies in an attempt to mitigate the very real risks of investing in this market. However, the infancy of this approach makes it difficult to establish whether this innovative approach - now being copied by all other market participants - will actually serve to fully mitigate potential exposures."
South Korea: "An Investor Registration Card - required to trade in the South Korean market - is obtained from the Korean Stock Exchange after a lengthy, paper-intense process. We have obtained an omnibus IRC number. The omnibus IRC allows a new client to invest in Korea and avoid this application process," said one respondent.
Venezuela: One custodian provides clients with assistance in filing required documentation. The custodian reviews documents for completeness and provides clients with assistance with required tax filings.
"We have worked with our subcustodian to develop settlement practices that eliminate most of the broker exposure issues previously inherent in the process. We have also developed successful relationships with CPA and law firms in Caracas that streamline the application, tax preparation and repatriation filing processes to the extent possible given the environment."
This year's profile of international securities lending indicates significant changes from last year's survey results. The inclusion of a broader field of the global custody industry, in particular the major custodians from Europe and Canada, has propelled Canada and the United Kingdom to notoriety as major players in securities lending based on outstanding loans, for combined fixed income and equity.
The analysis is even more pronounced when fixed income is viewed separately - with the top three positions going to Canada, the United Kingdom and Germany at 40.3%, 29% and 8.8%, respectively, of the outstanding loans in the fixed-income category.
The top three equity positions go to Japan, Canada and France, with 25%, 15.2% and 14.7%, respectively, of the outstanding loans in the equity category. In equities, the United Kingdom slips to No. 5, with a respectable 6.8%, following Germany at 12.9%.
The international securities lending business continues to experience strong growth in the emerging markets. One reason, according to a custodian: "increased borrowing demand from brokers and hedge funds to facilitate their trading strategies, including short selling and derivatives used as hedging tools. Addi-
(See Custody on page 26)
Total custody assets550,000
For U.S. clients474,100
The bank network covers 64 countries, of which two are proprietary subcustodians.