Emerging markets are some of the most consistently lucrative areas for investors, but navigating them can be equally frustrating for those unfamiliar with their varied tax regimes, regulatory infrastructures and other market nuances. Securities services providers have carved out a niche by providing domestic expertise in emerging markets around the world, offering local services and knowledge in the most and even the least liquid of markets, but by definition these are some of the riskiest areas in which to do business for investors and providers alike.
Part of the problem is that there is no clear definition of what constitutes emerging, which leads to disagreement regarding the status of particular markets and thus the approaches taken by providers there. The Emerging Markets Index of the MSCI (Morgan Stanley Capital International) is often used as the benchmark for emerging market status, but not all agree on its categorizations or even structure; FTSE (split between Advanced and Secondary Emerging markets) has its own lists, as does Dow-Jones, and the three are not always in agreement.
The clearest differentiator between an emerging and a developed market, says Ramy Bourgi, head of emerging markets for Societe Generale Securities Services, is liquidityan alternative to the classifications of the international financial community. There are many markets that you might call emerging, but from a custodians point of view, we are more relaxed about the classification, says Bourgi. Likewise, just because a market is emerging doesnt mean it is as risky or exotic as others in its class: South Africa, for example, remains on the Morgan Stanley EM Index, as well as Morocco and Egypt, China, India, he says, but we are very comfortable with those markets. In one telling example, each of the four BRIC countries of Brazil, Russia, India and China make almost all the emerging market lists, yet they are comparatively quite stable and well serviced by providers. In these markets the investors and products are sophisticated. Pension regulations exist, for example, says Bourgi. And these markets are beginning to invest overseas, they are becoming more demanding, and they need the expertise of a global custodian.
Especially for service providers entering a new market, the amount of risk involved in setting up shop in an emerging market is great. A considerable level of due diligence is required before entering a new market, especially an emerging one, requiring a thorough examination of the infrastructure in place. We look at segregation laws and how strong the client is in case of default, Bourgi says. We look at the regulated environment, the independence of the stock market, whether there is a depository, the capitalization of counterparties, settlement periods, the link-up between players in the market, the strength of foreign influence and repatriation of course.
Bourgi says some of the most promising emerging markets, in addition to the BRIC markets, are those in Eastern Europe and North Africa. Of course, SGSS considers itself a leader in those markets, especially North Africa, where it has a strong presence providing custody and other services to domestic and international clients, including other global custodians. Bourgi says SGSS clients are asking them to move into Tunisia, Algeria and Libya as wella challenge SGSS intends to pursue. In fact, its Tunisia business will be operational by 2011.
SGSSs recent joint venture with the State Bank of India (SBI) is another example of the custodian following customer demand in emerging markets. If you look at India, and you look at the competition, you have foreign custodians who cater for the foreign investor, and the domestic custodians that cater for the domestic players. Although it already had a presence in India, SGSS JV with SBI creates the markets first local/global custodian.
The key to servicing clients in emerging markets is to remember the custodian may be the only liaison between investors and the market. Clients dont just want you to settle a transaction, Bourgi says. In emerging markets, clients want you to be the eyes and the ears in the market, especially when the market is very new to them. They now expect the custodian to do a lot of work to help them measure whether the risks and the rewards are matched. Bourgi says even the most expansive custody networks must be aware of their limitations: You cannot cover every market in the world and be successful.”