Bankable Insights_The Custodian Edition_Mar 2022_v16

The Custodian Edition: A collection of the latest insights and perspectives on topics related to the future of custody is collaboration.

Bankable Insights The Custodian Edition

The future of custody is collaboration March 2022

Foreword

Welcome to our first edition of The Custodian for 2022. Of all the lessons we’ve learnt over the challenging past two years, perhaps the most important is the value of collaboration. Among our clients, within our custody business, and across our footprint, we’ve witnessed countless examples of how working together can strengthen our industry for mutual benefit.

It’s now generally accepted that no one intermediary can fulfil all a client’s needs alone. This realisation combined with rapid advancements in technology are fuelling collaborative projects that are bringing innovative developments to our industry – particularly in the post-trade ecosystem. Rather than a flash-in-the-pan trend, we believe this is the beginning of a shift in industry culture, redefining how we derive solutions, create products, and drive industry change.

Most of the positive outcomes from such collaborations – particularly technology-driven ones – have been concentrated in developed capital markets. Yet there is huge potential for this to cascade into emerging and frontier markets, especially as regulatory environments open to foreign investment. And with the benefit of hindsight (drawing learnings from developed-market experiences), these markets have the potential to leapfrog more advanced markets in the application of market-enhancing technology.

It’s important to remember that collaboration is about more than product innovation and official partnerships. And with its many layers comes many avenues to influence change – not just for the benefit of investors, intermediaries, and issuers, but for communities and our environment too.

In our lead article, ‘Collaborate to regulate’, we discuss the benefits that arise when market participants and regulators join forces. Many regulators across our footprint are rapidly evolving the constructs of their capital markets – with COVID-19 and new digital capabilities as catalysts. These regulators’ willingness to work with experienced intermediaries will be critical to success – as will the abilities of such intermediaries to share learnings, best practices, and details of their clients’ pain points.

Among all the talk of digital revolution, we still see a permanent role for human touch in our industry. In ‘The future of custody: How data and technology are transforming conversations’, we reflect on how this people-business is fusing with technology. By working in partnership with technology providers – especially around the evolution of digital currencies – intermediaries now have an opportunity to evolve from service providers into strategic partners.

Fruitful collaboration can also occur beyond the confines of distinct sectors. In ‘Shared values for share values: The overlap between Islamic and ESG investing’, we explore the commonalities between the two and assess how these can be strengthened for future investment potential – and for the advancement of a more sustainable world.

On the subject of responsible investing, in ‘ESG in EM shifts into top gear’, we analyse its increasing momentum in emerging and frontier markets. Here, we again see a clear role for collaboration – not just to improve the infrastructure enabling inflows into ESG-focused investments, but also around the governance of ESG reporting.

Next, we pivot to increased yield-seeking in the Middle East, in the ‘GCC: Investor appetite growing but risks persist’. With better-than-expected recovery following the COVID-19 pandemic, a surge in IPO activity, and bold liberalisation underway, GCC regulators will do well to collaborate with intermediaries who have helped charter exponential market growth elsewhere.

And finally, in ‘Why financial inclusion needs commitment across the capital markets value chain’, we share our recent dialogue with securities exchanges and depositories around the critical need for broader capital market participation, especially in emerging and frontier markets. To achieve greater financial inclusion – which is in line with our Bank’s broader sustainability ambitions – technology and collaboration will once again be essential.

We hope you enjoy these articles and look forward to collaborating with you in 2022.

Collaborate to regulate

How targeted engagement helps investors access emerging markets

It is easy to underestimate the pace of change in frontier and emerging markets. Barriers to commerce are falling quickly, with many governments in Asia, Africa and the Middle East committed to making life easier for investors, as a means of attracting overseas capital and knowledge. Some even see an opportunity to steal a march on Europe and North America, by embracing smarter regulation and digital finance. Benefits can be seen in markets where local regulators are open to discussions with market participants to help them make this transition.

Lessons from Greater China

When it comes to nimble regulations, frontier and emerging markets can take inspiration from China, Hong Kong and Taiwan, whose regulators long ago realised that when it comes to financial services, success means quickly updating the rules to reflect changing circumstances and technology. This has never been more important than over the past 18 months, as COVID-19 lockdowns presented a stark choice between innovation, on the one hand, and paralysis on the other.

Regulators across Greater China have been open to suggestions for how to adapt the rules to the new environment while reducing network risk. In Taiwan, for instance, foreign institutional investors seeking to open a brokerage account must submit physical paperwork in order to do so – something made much more difficult by social-distancing and remote-working during the pandemic.

Financial institutions, including Standard Chartered, have been working with the Taiwan Depository & Clearing Corporation to find a better system, one that is more resilient to this kind of disruption. The result is the eSMART system, which will allow securities dealers to digitally handle, transfer, and maintain various book-entry transfer documents via the new platform.¹ It is hoped that the platform will launch before the end of this year.

Regulators in the region are amenable to easing such pain-points, but first they must know where they are, which is why industry engagement is important. In China, for instance, until recently there were two different regulatory and quota regimes for Qualified Foreign Institutional Investors (QFII) and for RMB Qualified Foreign Institutional Investors (RQFII).

This system complicated the repatriation of profits, hindered trading and created a burdensome amount of documentation. Standard Chartered and other financial institutions made representations to regulators such as the People’s Bank of China, China Securities Regulatory Commission and the State Administration of Foreign Exchange in order to explain how the system could be streamlined to encourage more activity.

China’s regulators listened. In June last year, they published new QFII/RQFII rules to simplify market access and expand the scope for investment. These included more flexible funding arrangements, relaxation of the rules surrounding the repatriation of profits, and the elimination of the quotas.²

This was not only helpful to global banks and our customers but, by making foreign exchange easier, it also furthered the Greater Bay Area concept, the policy to enhance the links between the economies of Hong Kong, Macau and Guangdong, each of which have their own currencies and regulatory regimes. There remains plenty of scope for tighter links in the future.

For instance, currently, trading between Hong Kong and China via Stock Connect grinds to a halt if there’s a public holiday on either side, and sometimes for days beforehand.³ Standard Chartered is advocating a new system that avoids this downtime, so that investors can react in a timely way to market fluctuations on those days.

Helping higher-barrier markets improve access

Regulators in Greater China understand that they can attract greater investment into their market by working with market participants to create smarter regulations. This realisation has spread to other frontier and emerging markets that may not be associated in investors’ minds with receptive administration and regulation. Standard Chartered works across Asia, the Middle East and Africa, and we are witnessing this transformation firsthand, along with some impressive growth rates.

Take Kenya. There, recent governments have devoted time and energy to improving the business environment, and the results are paying off – the East African nation now ranks above countries such as Italy and Chile in the World Bank’s widely watched Doing Business ratings.⁴ This spirit of reform has extended to financial services, including when it comes to open conversation.

A law in 2019, for example, reduced the threshold of shares that a bidder would need to acquire a company from 90% to 50%. With just half the equity, the new owner would be able to buy-out the minority shareholders on a mandatory basis and then de-list the company from the Nairobi Stock Exchange.

Given that the Doing Business index includes the protection of minority shareholders as one of its key metrics, having such a low threshold was likely to have a negative effect on Kenya’s ranking, which Kenya’s national assembly is keen to improve still further.⁵ Leading Kenyan and international banks, including Standard Chartered, lobbied the government to revise the legislation, and in February 2020 the 90% threshold was restored.⁶

Indonesia is another country often perceived as presenting high barriers to entry, an impression compounded over the past year by the disruption caused by the pandemic. There, Standard Chartered, together with custodian bank association ABKI, has worked with the Indonesia Central Securities Depository (KSEI) to expedite the launch of the eASY.KSEI platform, to help mitigate the disruption of COVID-19. The platform allows investors to attend general meetings of shareholders virtually, where previously physical attendance was required, and it includes an e-Voting and e-Proxy system.

eASY.KSEI went live on 20 April 2020. Its advantages go beyond social distancing: being an archipelago of five main islands and thousands of smaller ones, travelling around Indonesia can be challenging, so digital solutions make sense. The same is true of the Philippines: there, the central bank, the Securities and Exchange Commission and the Philippine Depository & Trust Corp have permitted the electronic submission of reports and documents during the community quarantine, and have accepted digital signatures. Standard Chartered is working to persuade them and government departments such as the Bureau of the Treasury and Bureau of Internal Revenue to make these changes permanent, in order to unlock the efficiency-gains of digital processes.

Sharing experience through engagement

This kind of engagement should not be seen so much as lobbying as the sharing of experience. By sharing what we’ve learnt from working not only in their domestic markets but in many others, Standard Chartered can engage regulators on the developments and changes that would drive greater market participation.

This collaborative approach also allows us to help our own clients reduce their risks from operating in such markets. That in turn makes frontier and emerging markets more attractive to investors, expediting their national growth and strengthening their resilience to external shocks.

The future of custody: How data and technology are transforming conversations

Custodian banks are becoming less like service providers to their customers, and more like strategic partners. While the human element remains key, the topic of conversation is turning to the digital revolution.

People and machines

For a long time, custody was seen as the boring part of banking. While it is true that scale, safety and stability remain watchwords for the sector, the emergence of entirely new classes of digital assets and systems of transfer means that innovation and custody are now going hand in hand. The transformational implications offer a rebuke to the lazy argument that custody is being downgraded and “commoditised”.

Many intermediaries sit between an investor and an issuer. Ensuring that these intermediaries work together in the speediest and most efficient way possible is one way that custodian banks can offer their clients an improved service, allowing them to feel that they are more closely connected to the markets. This is particularly important for Standard Chartered, given that many of the issuers are in challenging frontier and emerging markets, while many of the investors are sitting in Western nations and expecting the same level of delivery as if they were investing in developed markets.

Five years ago, technology had not developed enough to attempt more ambitious, multi-party collaborations, but today there is a clear technological glidepath to a whole new way of doing business. The main impediment is trust - distributed ledgers appear to be the most logical way of enabling this new mode of doing business, but one institution trusted by all parties needs to “own” the blockchain.

If this can be resolved, the future will arrive very suddenly. No longer will collateral need days to move from one clearing house to another: tokenised digital assets offer the potential to remodel the entire ecosystem around instantaneous transactions, particularly if central (or even commercial) banks start issuing digital currencies that are recognised by financial institutions.

Already, the digital tokenisation of assets is expanding the financial services sector and offering the potential to build bridges between traditional and digital markets and ecosystems. These are uncharted waters, and the rules of the game are still emerging. Custodians need to be nimble in order to navigate this change, and promote a culture of agility and responsiveness within their organisations.

Preserving the human touch

Ultimately, custody and security services remain a people game, based on personal relationships and conversations about how to solve problems and understand requirements. Nowadays, many of these conversations are about digital assets, and there is a sea-change in the kind of people being hired into custody teams.Talent is arriving from fintechs, crypto-specialists and tech giants - people who understand the emerging shape of the new digital landscape and have the skills to navigate these changes.

That is not to say that banks can do everything for themselves. Custody is an implicit part of asset servicing and teaming up with the right partners is crucial, whether they be fintechs or more conventional suppliers. This is not just in the “pipes and plumbing” of asset flows but also in improving digital client servicing and creating integrated experiences that deepen and cement relationships.

When it comes to navigating change, data and analytics are likewise crucial. Data can be looked at in two different ways. Custodian banks sit on powerful quantities of data, and giving clients access to it in a way that is compliant, insightful and most of all easy to access is an important requirement.

A second aspect of data is driving custodian banks’ processes through a data-centric model that allows better connections and interoperability between services across the ecosystem, both the banks’ own services and those from third parties. Again, it comes back to client services - enabling clients with greater predictive power and forging a strategic partnership.

Shared values for share values: The overlaps between Islamic and ESG investing

Strategic alignment between ESG and Islamic investing has the potential to unlock new long-term investment trajectories and trends.

As ethical investing grows at pace, it is worth remembering that this category extends beyond the Environmental, Social and Governance (ESG) space. Islamic finance has been with us for decades, and its growth is going hand-in-hand with that of sustainable finance. Indeed, there are many commonalities between the two that could be strengthened still further.

Much has been written about the growth of ESG, and Islamic finance is likewise benefiting from a cultural megatrend towards ethical investment. Global assets managed by the Islamic finance industry grew by 14% in 2019 to USD2.88 trillion, even as major Muslim-majority economies were held back by low oil prices.¹ Assets are likely to rise to US$3.69 trillion by 2024, according to the 2020 Islamic Finance Development Report released by Refinitiv and the Islamic Corporation for the Development of the Private Sector.

Likewise, ESG finance is growing very fast. USD777.6 billion of sustainable finance bonds were issued during the first nine months of this year, up 57% on the same period of 2020. Almost half (USD362 billion) were green bonds supporting environmentally friendly projects, followed by social bonds (USD170.9 billion), which support human development and health, and sustainability bonds (USD143.7 billion), which are a mixture of green and social bonds.²

Investors’ pursuit of ESG assets is being mirrored by the corporate sector at a governance level. The integration of ESG factors into due diligence questionnaires, internal controls and investment practices has been underpinned by corporates’ rising demand for ESG indices and standards.

How Islamic investing converges with ESG

Both Islamic investing and ESG reflect a desire among a growing proportion of global investors to align their portfolios with their personal values. Both recognise that long-term, sustainable growth is only possible within an environmental and social context that is conducive to that growth, and that people with means should promote the responsible stewardship of the human and natural environment.

Convergence of ESG and Islamic finance streams is heavily dependent on the fundamental principles forming their respective foundations.

Shikkoh Malik
Head of Group Fiduciary and Fund Services and
Global Securities Services Islamic Champion,
Standard Chartered

If we analyse the focus of ESG fundamentals then they could be translated to: Planet corresponding to Environment; People corresponding to Social; and Profit – for and with a purpose – to Governance. With this 3P lens it’s clear that both ESG and Islamic finance focus on similar underlying elements.

There are also parallels at a practical level. Sharia-compliant investing requires the exclusion of certain industries, such as tobacco, alcohol and gambling. Likewise, ESG investing uses negative screens to omit companies whose activities are not aligned with the investment mandate – and in many cases, these negative screens will include industries (such as tobacco) that are also incompatible with Islamic financial instruments.³

However, ESG also uses positive screens to search not only for compliance, but for supererogation; that is, doing more than the minimum that negative screens dictate. Sharia scholars are now calling for such an approach to be brought to Islamic finance too, in order to identify and finance those enterprises that best embody the promotion of social and environmental responsibility. For both types of screen, the sharing of ESG data could be valuable.

More than an overlap

Research from Refinitiv’s EIKON database, which covers over 6,500 publicly listed companies, shows a clear link between sharia compliance screening and stronger ESG performance.⁴ Sharia-compliant companies – those to which Islamic financial institutions will direct capital – have ESG scores that are on average 6% higher than non-compliant ones, particularly for environmental (7.3% higher) and social (7%) scores. Non-financial sharia businesses perform even better, with ESG scores 10% above average. This complementarity has led to calls for the further integration of Islamic and ESG screening processes.⁵

A more direct connection is already visible in the issuance of ESG sukuks (sharia-compliant securities), which totaled a record USD4.6 billion in 2020.⁶ In the first quarter of this year, ESG sukuk issuance reached USD2.5 billion, more than half 2020’s full-year total, suggesting even stronger momentum. Islamic ESG funds are also multiplying in number, albeit from a smaller base, reaching a value of USD756 million in the first quarter of 2021 following the launch of several Islamic Socially Responsible Investment funds in Malaysia and Indonesia. More funds will be launched as the Islamic finance sector seeks to redress the unemployment and social damage caused by the COVID-19 pandemic.

There is increased awareness within the Islamic finance ecosystem to build on the fundamental commitment to social benefit, and for the sector to play a leading role in this space.

Khurram Hilal
Group CEO,
Standard Chartered Saadiq

Aiming to work towards a sustainable economy that is linked to a prosperous, peaceful and just environment is a focus that would allow Islamic finance to drive and contribute to this positive change.

Khurram Hilal
Group CEO,
Standard Chartered Saadiq

People, planet and profit with a purpose: these ideas will be the animating factors behind an ever greater share of global investment, as the Millennial generation – including Muslim Millennials, who were raised to be environmentally and socially aware – assume leadership of the world economy. In addition, the regulatory landscape is shifting in such a way as to increase the transparency of ESG reporting across the board, including data relevant to sharia investment. Strategic alignment between ESG and Islamic investing therefore has the potential to unlock new long-term investment trajectories and trends, while creating new opportunities for Islamic financial institutions and investors.

ESG in Emerging Markets shifts into top gear

With a number of emerging markets being disproportionately impacted by climate change, the need to tackle carbon emissions has never been greater. In response, issuers, investors and intermediary providers across Asian and Middle Eastern markets are increasingly incorporating ESG (environment, social, governance) into their decision-making processes.

ESG – a critical component in modern-day portfolio construction

The volume of ESG investments in Asia is gathering momentum. According to MSCI, 79% of allocators in the region had either increased their ESG investments “significantly” or “moderately” in response to COVID-19, while a further 57% expected to either “completely” or “to a large extent” integrate ESG factors into their investment analysis by the end of 2021.¹ MSCI continues that $5 billion was invested into sustainable funds in Asia in the final four months of 2020, bringing AuM in the region to $25.4 billion, a 131% year-on-year increase from 2019.²

Although direct ESG investing per se in the Middle East is somewhat lagging relative to other major markets, the region has extensive experience in supporting Islamic finance and Shariah-compliant funds, bonds and insurance. Operators of Shariah funds already have a solid grasp of the S constituent in ESG as their mandates require them to adopt an exclusionary investment approach - eschewing assets likes tobacco, arms and alcohol. The region’s deep rooted expertise of Islamic finance therefore puts it in good shape to develop a wider gamut of ESG products moving forward.

With more investors embracing ESG, corporates in Asia and the Middle East are having to respond. A recent study by international law firm Baker McKenzie found almost 46% of businesses in Asia are taking sustainability more seriously than before the pandemic, while an additional 90% acknowledged they considered ESG issues when making acquisitions.³ Corporates across these emerging markets are also ramping up their ESG reporting - while some are adopting the disclosure guidelines laid out in the FSB’s (Financial Stability Board) TCFD (Task Force on Climate related Financial Disclosures).

Financial Market infrastructures are also keen to promote best practices around ESG. In October 2021, Standard Chartered joined the Singapore Exchange (SGX), DBS and Temasek to develop a joint venture – Climate Impact X (CIX) - a digital global exchange and marketplace for high quality carbon credits. Meanwhile, the Korea Exchange together with the domestic regulator - the FSC (Financial Services Commission) launched an integrated ESG information platform in December 2021, giving investors easy access to ESG data on listed companies. Even in recently liberalised GCC economies such as Saudi Arabia, the country’s Stock Exchange issued ESG reporting guidelines for publicly listed companies. While ESG reporting and adoption in emerging markets is improving - it is not without its challenges.

The main hurdle continues to be data

The barriers impeding ESG adoption across Asia and the Middle East are not unique to these regions but are global problems. Data is perhaps the biggest obstacle facing the ESG market right now. The main issue is that a lot of ESG data – especially when used to measure things like social impact – is subjective and hard to properly quantify. While a number of major issuers in emerging markets are open to publicly sharing ESG data, the reporting standards are varied as a result of these data discrepancies. This will have knock-on effects elsewhere in the investment chain.

Most notably, if the quality of ESG data being published by issuers is inconsistent or unreported, there will be a downstream impact on investors and their ability to report ESG measurables accurately to their own end clients and even regulators. Without material improvements in data quality, substandard reporting and greenwashing – namely when companies or investors make misleading claims about their green credentials – risk becoming more entrenched - thereby undermining the ESG market.

ESG reporting is also inconsistent because of the sheer abundance of ESG data providers and ratings agencies. These data providers assign ESG ratings to issuers - yet their processes are not always aligned – in what can lead to significant dispersions in ESG scores. For example, one rating agency may weight environmental factors heavily in its ESG scoring process yet another might be biased towards governance resulting in different sustainability ratings being awarded to the same company – leading to confusion among investors – especially those who are new to ESG. This is something which merits urgent resolution.

Delivering better data

In order to prevent greenwashing and strengthen ESG reporting, there needs to be better data standardisation and criteria at a local and regional level. Initiatives being led by policymakers and regulators to facilitate this in Asia are already underway. Similar to the EU’s Taxonomy Regulation, the ASEAN Taxonomy is a classification system for sustainable activities.⁴ This benchmark could go a long way in helping companies and investors in ASEAN with their ESG reporting. In addition, China – along with Hong Kong, Japan and Singapore - are working closely with the EU to develop a global taxonomy standard otherwise known as the Common Ground Taxonomy (CGT).⁵ The Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) have already confirmed they will adopt the CGT as and when it is introduced.⁶

Elsewhere, the People’s Bank of China (PBOC) is keen to promote green and sustainable products while it is also taking a lead on the development of mandatory environmental information disclosures. In addition, Hong Kong’s SFC introduced enhanced disclosure requirements for ESG funds and climate focused funds. The authorities in Thailand have been proactive on ESG as well with listed companies and funds now subjected to enhanced sustainability disclosure rules while a taxonomy is also reported to be in the pipeline. And finally, Korea’s FSC is imposing mandatory ESG disclosure obligations on all KOSPI-listed companies beginning in 2025 in an effort to help strengthen sustainability disclosure rules.

A number of regulators are also looking to sharpen ESG data standards through technology and innovation. For instance, the Monetary Authority of Singapore (MAS) is conducting a pilot developing a digital platform for sustainability-linked data in what should help investors access and benchmark ESG information.⁷ MAS is also expected to announce disclosure rules for retail ESG funds later this year.

ESG picks up in emerging markets

Emerging markets in Asia and the Middle East might not be as advanced in terms of their ESG adoption as Europe. However, momentum is gathering pace as investors demand companies globally to tackle climate change and become more transparent about ESG. Moreover, a number of markets in Asia and the Middle East will look to learn from the EU’s ESG experiences and apply those lessons accordingly in the development of their rules. In other words, being a second mover does carry some advantages.

Gulf Cooperation Council (GCC): Investor appetite growing but risks persist

With interest rates lingering at unprecedented lows across a number of developed markets, institutional investors are scouring emerging economies – especially those in the Middle East - for alpha. Scott Dickinson, Managing Director, Regional Head, Financing and Securities Services, Africa and the Middle East at Standard Chartered, shares his insights into some of the changes currently sweeping through the GCC.

A region abuzz with activity

Although emerging economies were disproportionately impacted by COVID-19, many of them – including here in the GCC – have enjoyed a better than expected recovery, with the region attracting renewed investor interest. Accelerating investor inflows into the GCC has been the region’s buoyant IPO market.

In Saudi Arabia, there were nine listings in 2021 on the Tadawul including that of the exchange’s parent group – the Saudi Tadawul Group Holding Company, which raised $1 billion in the biggest exchange IPO since Euronext went public in 2014.¹ Already in 2022, there are three IPOs scheduled to take place in Q1.

As a result of this flurry of activity, the Tadawul’s market capitalisation increased exponentially in 2021 and now totals $2.8 trillion, while it is also ranked as the 17th largest exchange in the world in terms of liquidity.² Similarly, the Abu Dhabi Securities Exchange [ADX] saw a resurgence of listing activity in 2021 including a high-profile IPO by ADNOC Drilling, which raised $1.1 billion – the largest ever listing on the ADX.³ As a result, ADX’s market capitalisation jumped exponentially, and now totals $370.31 billion.⁴

Dubai, having staged just one solitary IPO since 2017 – announced on November 7 that Dubai Electricity & Water Authority will go public in what could turn out to be the city’s largest listing to date, with the company being valued at $25 billion. Bloomberg reports a further 10 state businesses in Dubai could IPO - while family owned firms are also being encouraged to list as well.⁵ That so many of these IPOs are oversubscribed is indicative of the surging investor interest in the GCC region.

Getting the investors into the GCC

Amid the challenging macro headwinds and FX risk in certain other emerging markets, the GCC – owing to the fact that its currencies are pegged to the USD – is seen as being a more stable investment destination. The region has also made it easier for investors to gain entry into the local markets. Sparked by the oil price collapse back in 2014, GCC markets have doubled down on their reform efforts as they sought to diversify their economies beyond commodities and attract foreign investors into their domestic markets. A number of countries – such as Saudi Arabia - which hitherto were very difficult to access have since loosened their entry requirements for foreign institutions. They did this – for example – by reducing minimum AUM [assets under management] thresholds for qualified foreign investors [QFIs] while also easing restrictions on foreign ownership of domestic securities. In addition to opening up their capital markets to foreign investors, several GCC economies have introduced new products for institutions to trade.

Having created a framework to support securities lending and borrowing, the ADX launched a derivatives market in November 2021 [along with a central counterparty clearing house {CCP}], allowing investors to trade single equity futures. This comes more than one year after Saudi Arabia inaugurated its own derivatives market and domestic CCP. By launching new financial products [and financial market infrastructures], GCC countries are enabling foreign investors to better hedge their risk, which will be vital in helping to attract inward investment.

Barring the dislocation inflicted by COVID-19 in 2020, investor flows into the GCC have been largely solid since the region started implementing its ambitious reform measures. Positive market liberalisation initiatives have been a major driver behind the inclusion of the UAE, Qatar, Saudi Arabia - and most recently Kuwait - onto the various global indices, a result of which is that these countries have experienced significant inflows from a number of passive and active fund managers tracking these benchmarks. Although large global institutions have piled into the GCC markets recently, a lot of the transactional activity currently taking place is being fuelled by regional cross-border investors.

Barriers to entry still an issue

While several markets in the GCC have made extraordinary progress by opening themselves up to foreign investment, issues do remain. Accessing the GCC as a whole can be difficult as the account opening processes in individual countries are not harmonised. For example, cross-border investment in the region is partly precluded by the absence of transferable NINs [national investor numbers] making it harder for allocators to build up positions across multiple markets. Such complexities are sometimes off-putting for foreign institutions.

Other impediments are perhaps more serious. Geopolitical risk continues to be an ever-present problem in the GCC, while some institutions increasingly baulk at what they perceive to be inadequate levels of transparency from corporate issuers – although efforts to strengthen bilingual reporting, for instance, should be applauded. And finally, with more investors being pressured into incorporating ESG [environment, social, governance] metrics into their asset allocation strategies, the GCC could find itself disadvantaged as so many of its corporates either participate directly in or are heavily reliant on energy intensive sectors such as O&G.

Going from strength to strength

The GCC is awash with activity – fuelled by a deluge of IPOs and index inclusions - both of which are expediting investor inflows into the region. Facilitating these inflows further has been the decision by a number of local regulators to pursue bold market liberalisation reforms. Despite inflows being healthy, work still needs to be done in the GCC to make entry into their markets even more seamless.

Why financial inclusion needs commitment across the capital markets value chain

Capital market infrastructure providers have a long tradition of supporting and protecting investors through an emphasis on investor education and financial literacy. With Covid-19 turning a spotlight on the importance of diversity in building sustainable capital markets, calls are growing for advancing the objective of financial inclusion: that is, giving individuals and businesses better access to affordable financial products and services that meet their needs.

It is our view that enhancing investor diversity is vital because inclusion plays a fundamental role in creating resilient capital markets, particularly in emerging economies. With this in mind, we recently approached securities exchanges and depositories in Africa and the Middle East to understand how these infrastructure providers drive financial inclusion and discuss efforts to create more inclusive capital markets.

Making a meaningful contribution

While everyone surveyed recognised their general obligation, respondents had mixed views about their ability to take on full responsibility for creating an inclusive future. On the one hand, some argued that removing the key impediments to broader market participation was beyond their sphere of influence. On the other, some believed market infrastructure providers were in a strong position to drive inclusion because of the mutually beneficial and non-competing nature of their interactions with other market participants.

Between these two polar views, respondents acknowledged they could control several operational, commercial and strategic levers – such as cost, product diversity, investor education, technology and strategic partnerships – to make markets more inclusive.

In this article we share some insights on how depositories and exchanges are pulling these levers to reach a broader client base and drive financial inclusion.

Market costs

Cost being a key consideration, depositories and exchanges have taken strong measures to improve operational efficiencies and reduce fees. For instance, in South Africa, securities depository Strate has turned to e-voting to significantly lower costs for issuers and intermediaries. In Zimbabwe, Chengetedzai provides free demat services and electronic accounts to investors.

Egypt’s stock exchange has proposed a 20% trading fee reduction for H2 2022, while Nasdaq Dubai has waived the minimum trading fee and minimum clearing/CSD and settlement fees for equity trades. The Abu Dhabi Securities Exchange introduced a 22% reduction in trading fees in February 2021.

While doubtless welcome by participants, the highly intermediated structure of capital markets makes it challenging to validate the impact of these initiatives in enabling financial inclusion.

Product diversity

Exchanges typically encourage participation by offering products and services that serve a broad range of investors. Inclusion is further supported by creating small and medium enterprise (SME) boards that allow a wider range of companies to raise capital. In addition, exchanges are beginning to offer various innovative services.

These include Zimbabwe Stock Exchange’s Receivables Marketplace platform, which provides working capital solutions by selling quality receivables to financiers – an effective solution for a region where access to financing is a major hurdle for SME growth.

Additionally, nine stock exchanges in the Middle East and North Africa have joined the Refinitiv AFE Low Carbon Select Index, which allows investors to assess the Environmental, Social, and Corporate Governance (ESG) practices of listed companies. Such tools help address the absence of verified ESG credentials, which limit opportunities for issuers and investors, and ensure markets become more inclusive.

Depositories, which have traditionally served financial intermediaries such as custodians, brokers and issuers, are also evolving. Many have introduced products and services that offer direct access to retail investors, enabling them to open and manage their own accounts, and avoid intermediaries designed to serve institutional investors. For example, in Kenya, the equities depository has developed a facility for investors to use their CSD balances as collateral for cash loans. In South Africa and Bahrain, depositories are using established platforms to deliver registry services to smaller issuers of unlisted securities.

These measures not only create new revenue streams for infrastructure providers but also improve asset safety and offer greater processing efficiency to issuers and investors in unlisted financial assets. Moreover, deploying institutional-grade infrastructure in unlisted and private markets creates opportunities for the collateralisation of financial assets in unlisted entities and potentially improves market participation.

Investor education

The efforts of infrastructure providers in promoting financial literacy and investor education include combining traditional initiatives, such as global investor days, “ring the bell” campaigns, masterclasses and training courses, and social media influencer campaigns. Exchanges, supported by government agencies and regulators, are leading this charge.

Young people are a crucial demographic and infrastructure providers are fueling their interest with initiatives that involve gaming, coding and film-making. For example, Mauritius held a financial literacy and personal finance app design contest, and a documentary/short-fiction competition addressing the impact of digital transformation on the financial services sector.

Technology enablement and strategic partnerships

The capital market infrastructure landscape has grown to include fintechs and start-ups that offer products and services across the value chain. Exchanges and depositories are forming strategic partnerships with these entities to adopt new technologies that help enhance access to previously underserved customer segments at lower costs.

For instance, in Nigeria, the CSCS is pursuing a promising financial inclusion strategy that includes onboarding two fintechs as depository participants and collaborating with the central bank’s Debt Management Office to augment its retail offerings to reach both young investors and those in the informal sector.

Looking ahead

The examples in this article illustrate how depositories and exchanges have made several incremental contributions to financial inclusion. Capital market infrastructure providers continue to strive to deliver cost-efficient and safe solutions – even though ensuring the value is delivered to where it’s needed the most may be beyond their control.

In addition, the opacity of current commercial structures makes it difficult to ascertain the collective impact of interventions on inclusion. In the circumstances, measuring the impact of interventions and transparency across the investment lifecycle will be crucial to driving inclusion in the post-trade industry. The participation and commitment of economic players across the entire capital markets value chain, including investors at all levels, is required to make meaningful progress on financial inclusion.

As one respondent said: “It will take the sum of all players in an intermediated environment to create and sustain an inclusive system.”