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Securities did not always exist in a dematerialised, intangible ‘account money’ form. Initially, when establishing their jointstock companies, issuers had to print out the subscribed capital, which was embodied in shares at the time of issue, so ‘materialised’ forms actually existed. Customers could grab or even take them home after the purchase (subscription) and their investment, so their ‘share’ of a company was safe at home. These securities were, of course, purchased not only by private individuals, but also by institutional investors, who, as legal entities, could keep them in their own vault, but even more so at the financial institutions with custody right that provided such a service. As it became a ‘custodian’ stock, the ‘custody’ responsibility was already handled by the custodian bank in return for a ‘custody fee’.
SO, WHAT DOES THE WORD ‘CUSTODY’ REALLY MEAN? SAFEKEEPING OF SECURITIES
From the moment the securities were issued and traded, over-the-counter or stock exchange securities trading, custodian banks keeping securities were also actively involved in the settlement of sales and purchases. In the countries of the CEE region, securities markets restarted in the early 1990s following regime changes, opening their doors to national stock exchanges, issuing companies, investors and other financial actors. At that time, the custody business was almost an entirely manual activity, consisting of the safekeeping, blank endorsement and, in the case of sale and purchase, the physical movement and delivery of securities.
The securities were kept in huge, secure vaults by banks, with insurance. When a securities sale and purchase agreement was concluded between a seller and a buyer, the custodian moved the securities from its own vault to the vault of the counterparty’s premises. So the securities were not yet ‘dematerialised’ and ‘immobilised’. Later, local Central Securities Depositories (CSD) and Clearing Houses fit into this ‘custody’ and ‘sale-purchase’ settlement process. These institutions kept securities accounts and records of the securities delivered to them in physical form and their serial numbers to the custodian Banks and Investment Service Providers in local markets. So, in effect, custodian banks no longer kept securities portfolios for their customers, but only kept a mirror account in their books of the balance that had actually rested in the clearing houses. Applying the burden of physical custody and movement, they entrusted this activity to the CSD, also for a custody fee. The word ‘custody’ thus includes safekeeping, a kind of asset management, storage, registration, and the execution of securities trading supplemented by customer information. The information consisted of sending statement of holding and transactions as well as corporate event notifications.
WHAT MAKES SECURITIES SERVICES ‘MORE’?
In the early 1990s, companies that had become limited companies and were already privately owned, prosperous and funded by foreign investments, went public, and several new issues and subscriptions took place one after the other. The strengthening of stock exchange turnover was also boosted by the appearance of foreign investors. CEE markets have become ‘emerging markets’, where it was still worth investing, making exchange rate gains, earning dividends and, in the meantime, investing in debt securities due to huge deposit interest rates, including lending to the State in the form of government bond purchases. Capital-intensive financial institutions with foreign registered and founded offices focusing on retail customers have emerged as they realised that providing custody service within the corporate business was also a rewarding business. A strong expansion process began, where in addition to Erste Bank, Bank Austria, Hypovereinsbank, Citibank, ING Bank, Deutsche Bank, BNP Paribas, locally established financial institutions with local registered offices also competed. It was already clear at that time that foreign investors (Pension Funds, Insurance Companies, Investment Funds) were influenced by the decisions of their portfolio managers in which CEE securities market should buy securities, and globally it was also a ‘cost and risk’ factor at which custodian bank should open an account. In America, a law that had existed for 50 years provided very serious risk management and investor protection.
WHAT REGULATIONS WERE THESE?
It was Section 17f (5) of the US Investment Company Act of 1940, which made the lives of custodians bitter. In total, one or two capital-intensive banks in the region had guarantees which were provided by the parent company and were required by law. It was only after the turn of the millennium that the (thousands of) securities accounts of the American global custodian banks and the securities held in them could be fully circulated. It was after the start of the new millennium that local custodian banks were able to ensure that the market value of shares held in securities accounts was covered by the Bank’s share capital, and that an ‘insurance company’ would talk to them at all, thus meeting the appropriate ‘Eligible Foreign Custodian’ rating.
Although the GDR (Global Depository Receipt) and ADR (American Depository Receipt) programmes could be launched before that, enabling the purchase of CEE regional securities on the US market. They were the securities of the best-performing listed issuers (‘blue chips’), which were issued as secondary securities in the form of certificates of deposit. Custodian certificates could be issued by large foreign custodian banks, such as BNY Mellon or J.P. Morgan embodying a claim on the primary security. The custodian bank was obliged to hold underlying securities corresponding to the amount of certificates of deposit issued by it, and kept that portfolio separate (blocked) at a domestic custodian as a sub-custodian.
HOW CAN THE SECURITIES MARKET BE SAFE? ONLY BY INFORMATION TECHNOLOGY
Along with share capital requirements and insurance, custodian banks and the broker-dealers representing large foreign investors also had serious IT and operational process requirements. Of course, a national securities market or the securities markets of an entire region, (not to mention serious economic measures by governments), can only be secured through appropriate regulations, laws, risk management, investor protection and automated trading platforms and clearing workflows with an appropriate and reliable IT background. There is a constant need for securities market participants to ensure that their workflows meet the STP (Straight Through Processing) requirements and customer expectations, to finally end manual labour and to enable all securities service-related processes to take place without human touch from the first step to the last. The solution is simple: IT development, automation and digitisation. When the securities markets in the CEE region restarted, there were two types of custodian banks in terms of IT. One is where the ‘Western European’ parent company prepared the professional knowledge and IT background, the other is where they have tried to develop their own system. In the early 1990s, these systems were still very simple, mostly securities registration systems, which dealt with analytics in addition to the customer master data and operated in isolation, with no interfaces with other systems.
DIGITISATION, AUTOMATION AND STP PROCESSES
In the mid-1990s, but mostly towards the end of the 1990s, they began to introduce and use MT54X (ISO 15022) SWIFT messages in the custody business. Although settlement messages were received via the SWIFT network, they would still end up in the printer and were not connected to securities account management systems. The involvement of the Central Clearing House in the circulation of the securities market also depended on digitisation. It became necessary to create a platform where account managers could record and later transmit their settlement instructions using import files (later channelling SWIFT communication as well). At the end of the 1990s, in Hungary, for example, by joining KELER VIBER, it became possible to settle securities transactions against money on the basis of DVP (delivery versus payment), which, in addition to government securities, has been extended to all listed and over-the-counter securities that can be accepted by the platform. Central and Eastern European money and capital market participants (including clearing houses) had a long way to go before these island-like systems were interconnected and an STP clearing process could be set up in the early 2000s. Thus, an immediate settlement could be established, during which the buyers and sellers were not out of possession because the securities and money changed hands at the same moment. In 10 years, they had to make up for 50 years of securities market regulation to meet Western European standards. Economic experts first recognised the need and hunger of the securities market for digitisation. Bearing this in mind, one of Hungary’s leading IT companies, Dorsum, was established, which exploded into the securities market in the late 1990s with its Clavis system, and became one of the first companies to be able to serve the IT needs of various market players.
THE LAST 20 YEARS WERE TRULY THE INDUSTRIAL REVOLUTION OF INFORMATICS
Beginning from the 1990s every company developed a Twenty-Twenty concept, (Where do we want to see ourselves in 20 years?) which, in addition to economic growth, also included an effort towards automation in the operation and processes of securities market operators. This was also supported by the industrial revolution in information technology and digitalisation. With the appearance of the Internet and digitalisation, an amazing flow of information and technological development has begun in the capital markets. One example of such innovation was the Xetra trading platform, operated by the Frankfurt Stock Exchange. In 2015, 90 percent of all stock trading on the German stock exchange was conducted there. Xetra now has a 60 percent market share across Europe. More than 200 trading participants from 16 European countries, as well as Hong Kong and the United Arab Emirates, connect via servers.
PROFESSIONAL SERVICE FOR INVESTORS HAS FINALLY BEEN PUT INTO THE FOCUS
Key features of the new IT solutions:
- Providing Mid and Front solutions at the same time
- Web-based online platforms
- Cloud services
- Mobile and tablet solutions
- Android and iOS applications
- Easy implementation
- The user experience and the user interface are of paramount importance.
These activities result in financial products that dazzle the market by pre-determining customer ratings, incorporating national and EU legislation and regulations, filtering out risky products and providing information to investment firms through a spectacular interface on investment options that offer personalized financial products tailored to individual preferences. Such IT solutions are the various Wealth Management Platforms and mobile applications, which are supported by artificial intelligence in communication channels.
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