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“We Are a Prepared and Confident Central Depositary”

06.11.2012 16:50 / Interfax

Following a decade of debate, the government has acknowledged the need for Central Depositary in the Russian market. On Tuesday, Federal Financial Markets Service (FFMS) accredited the sole contender for the CD function, NKO ZAO National Settlement Depositary (part of Moscow Exchange MICEX-RTS Group). NSD CEO Eddy Astanin tells us whether NSD is ready for the role of the sole central depositary, and what the future holds for the Russian stock market and the NSD.

- NSD is now Russia’s sole central depositary. How does it feel?

- We are prepared and confident. Judging by the clients’ mood, they have already accepted us in this role. For instance, at the moment we are talking to Euroclear about the final details of our interaction process.

- Euroclear have publicly announced that they will settle security trades. Is that the case?

- If their account receives securities, such as OFZ, they can put these on the collateral management list. That does not mean that systems such as Euroclear and Clearstream will draw all liquidity in Russian securities trading. On the other hand, custodians present in Russia are doing exactly the same, they settle trades internally.

- Will some liquidity drain abroad?

- Some will go, some will come. It will go back and forth. Speaking of OFZs, key investors here will remain Russian banks. These are Central Bank Lombard List securities, they are used by banks to attract liquidity. A working tool, these securities are in demand with Russian investors, which guarantees that they will not go into one Euroclear account to be traded abroad exclusively. Active trading is unlikely there, it’s more for buy-and-hold investors, so the liquidity will stay here, in Russia. Even hypothetically, the market can only go abroad if and when demand from Russian investors vanishes completely. This is not going to happen, since this is, once again, a working liquidity management tool.

- What will happen to liquidity when Euroclear and Clearstream gain access to shares?

- I don’t see why they should not get access to shares whatsoever. Both Euroclear and Clearstream were created to service bonds and are traditionally targeted at that market. Servicing shares is a more complicated process, it is harder to make it uniform, since there are so many types of corporate actions for shares. Hence, the risks of concentration and drain of share trading abroad through these links are very questionable.

- Have security owners started transferring their assets to NSD?

- In the past eight months we have received RUB 600bn worth of shares. This flow will increase. Since we filed for the status of Central Depositary with FFMS, market players have started actively transferring into out accounts. I think receiving this status will prove a massive boost.

- How much more will you receive?

- We will transfer all the DCC assets to NSD by the end-year, some RUB 3 trillion. Generally speaking, if the Russian market is worth a trillion dollars or RUB 30 trillion, in the coming months we are looking to receive up to 10 trillion roubles more. Even today we hold a total of 9.5 trillion roubles worth of securities.

- Do these transfers come mostly from Russian investors?

- Both Russian and foreign, the latter are less active. Their risk management policy sees accreditation as critical. Russian investors are more flexible in this regard.

- You have planned earlier to introduce special discount fees for share transfers to NSD. Have you?

- Special terms apply to transfers from DCC to NSD, we take no fees from investors. In the near future we will discuss discount fees for transfers to NSD accounts at registrars in the transition period.

- Have you sent central depositary fees to FFMS?

- We did so to get accreditation, but a new plan will be introduced. We have basically laid down the new fees draft and approved it with major market participants. Instead of raising fees we propose lowering them - safekeeping fees will go down 15% to 50% depending on client category.

- Will core clients get lower fees?

- Yes, just as in most safekeeping systems throughout the world. All in all, the fees issue is slightly blown out of proportion. From investor’s point of view these fees are incomparable with broker or custodian fees. What really causes some concern is registrars’ fees in the transition period. There are indications that part of them are looking to raise the fees many times for asset transfers to the central depositary. To the best of my knowledge, FFMS is considering a ban on such actions. It will be the right thing to do as far as we are concerned, to limit client expenses in transition.

- What is your headcount so far?

- Together with DCC and RTS Settlement House we have a staff of 555.

- Will you hire more after you become central depositary?

- We will fire, bringing the headcount down to 500 by the year-end.

- Is it necessary to hire foreign professionals to work with foreign clients?

- We already have them on the payroll. For instance, our Advisor to CEO is a former top manager of Clearstream Luxembourg Alain Meyers. NSD strategy and corporate management consultant is ex-CEO at Euroclear Group Pierre Francotte. It is a matter of prime importance for us to keep in direct contact with international investors. For this purpose, NSD has established an International Consulting Committee, to draft proposals and recommendations for Russian financial market post-trading infrastructure development. The committee includes top-ranking representatives of major global institutions such as JP Morgan Chase, UBS Investment Bank, BNP Paribas Securities Services, Nomura Securities, SEB, Bank of New York Mellon (Brussels), KBC Securities, Pictet & CIE. We are in touch on a regular basis, we met in Moscow this April and have a meeting scheduled in London by the end of this year. We plan to discuss nominee accounts, taxation of transactions, unification of depositary corporate actions procedures, DVP-1,2,3 settlement.

- Will you add more people to the Board?

- We plan to. According to our shareholders agreement, the NSD Board may have up to five members. Today, we have three, that leaves two positions open, to be filled in the near future. I can’t disclose the names yet.

- What will the new Directors be responsible for?

- No one represents Operations, Product Development, Client Relations and Risk Management on the Board so far. Incidentally, Pierre Francotte helped us implement best central depositary practices in the NSD corporate management, specifically the division of functions between the Advisory Board and the Board of Directors, Board member qualification requirements, a balanced structure of company representatives in the Advisory Board and the committees.

- This year five more shareholders joined NSD with one share each. All of the new shareholders are registrars. Which business will the next five come from?

- In the near future we will welcome another shareholder – Zerich Bank, who we bought their DCC stake from. The other four are still undecided.

- What are NSD investment priorities?

- Risk management, data security, IT, human resources and new products. We must maintain business continuity at the Central Depositary, on one hand, and support a competitive product line versus global players on the other hand. We have replaced our two base platforms: depositary and clearing, by Oracle. We have implemented a brand new multi-purpose monitoring system, also by Oracle. Based on external audit results of our operations, IT and risk management, we have drafted development plans and are financing them accordingly. We have established a business continuity service and radically modernized all back-up depositary systems. We have run a series of tests of the disaster recovery site with clients and external monitors. We have started a total IT stress test program. By the end of the year, we promised our shareholders and the market two new products: collateral management system for Bank of Russia repo trades and a trade repository. All in all, we are simultaneously solving three key issues this year: NSD acquiring Central Depositary status, NSD-DCC-RTS integration and new product rollout. This is what we invest in.

- How much do you invest in NSD?

- A lot. On average, NSD spends at least 80-85% of its annual budget on human resources, IT and new products. We invest a lot in our staff, our management team, and I believe that NSD needs loyal dedicated professionals to be effective, people who see that the declared corporate values are put into practice. In August, we welcomed Nikolay Degtyarev from the Central Bank to the NSD Board. He will cover IT development and tech support. In December he will report to the Advisory Board on the principles and strategy of NSD IT. In October we launched a year-long leadership and management change program for department heads.

- You have mentioned earlier that NSD plans to become a repository. Have you made progress in that?

- We have conducted a client seminar on how the repository will work. We have signed first repository contracts with clients and begun testing. On 3 December, we plan to go into production on two instruments – OTC repo and OTC currency swaps. We will launch other instruments later on.

- Will you only provide trade information storage as a repository?

- A repository’s primary function is trade registration and reporting to the regulator along with trade registration confirmations to the counterparties. A proper repository also offers client services such as keeping open OTC positions. We also plan to do that, but in 2014-2015.

- One legal entity will accumulate the risks of central depositary and repositary. Could it be more feasible to register the repository as a separate entity?

- We are discussing the separation of the repository. One of the possible ways is delegating this function to DCC, which will soon become service-free. We have already transferred the bulk of DCC services to NSD, and twill transfer the remainder by the year-end. This way we will end up with a clean-slate company that has depositary and clearing licenses.

- Who will head DCC?

- At the moment, DCC President is Maria Krasnova. Her main task is integrating NSD-DCC in accordance with the concept passed by the Integration Management Committee in 2011. She is doing a great job, but we want her to come back to NSD eventually and be on the Board. That is why we debate the next DCC president.

- After FFMS has accredited NSD as central depositary, another year will be given for opening accounts in the transition period. When will we see a fully operational central depositary?

- We are interested in expediting the process, however, two factors affect the timing and we have to put up with them. One is clients’ readiness to start transferring securities en masse, especially foreigners. They are very slow in deciding, and need to have risks assessed first, which will take months. Another factor is registrars readiness to process massive flows (tens of thousands) of transfers from their accounts to CD nominee accounts. Since these mass asset flows never happened and was not foreseen in pre-CD times, registrars software was designed for other, smaller volumes and less intense processes. As a result, they will now have to upgrade their software. We are currently drafting a roadmap for CD account opening in registrars and asset transfer in close cooperation with our clients and registrars. I think in November thus roadmap, detailing the process as much as possible, will be made public.

- Early this year, Thomas Murray agency rated NSD "A+" as a central depositary, while the preceding rating was "АА-". Do you plan to initiate a rating review?

- We are expecting Thomas Murray experts in November. Don’t forget that the previous rating was lowered due to the merger between NSD and MICEX Clearing House, which hypothetically increased risks. Today, we have audited our risk management and are pleased with the results. Of course, we hope for a higher rating, but frankly, I don’t see that much difference.

- Should we expect a revision of Russian risks by foreign institutions? Will we comply with conservative investors’ requirements, for instance, American?

- I would understate it and say that the CD has at the very least brought this out into the spotlight. Risk review is not only about SEC Rule 17F-7, that you probably refer to, it is also a matter of supranational institutions, the key of which is the Global Custodians Association of 11 major custodian banks, including J.P. Morgan, Citibank and others. They provide information to investment funds. And there is no consensus, each custodian decides whether the CD is compliant or not, whether our system is eligible. Then the custodian shares his opinion with the clients, investment funds. The Association is now in debate on the Russian central depositary. As far as I know, several major funds are conducting due diligence of the new Russian safekeeping system.

- What is your outlook? Will they deem our system eligible?

- We are certain that our new system is fully eligible. To back our own view with a credible independent opinion, we have turned to experts from Мorgan Lewis and K&L Gates, renowned American legal firms, serving the leading U.S. investment companies, for a compliance assessment of our Central Depositary Act. Their verdict is yes, it does.

- You have mentioned a risk management system. Registrars have repeatedly stated that the procedure of final settlement, or proof of title to securities, as per the Central Depositary Act, is flawed.

- Final means that all entries made by the Central Depositary are the only correct ones and no further proof is required from the registrar.

- What if the registrar and the Central Depositary show a different share amount, and the discrepancy turns out to be the depositary’s fault, who will be held responsible by investors?

- If it is the Central Depositary’s fault, the discrepancy will be covered by the CD. NSD’s capital is roughly RUB 6bn. We are also insured by Ingosstrakh for $65mn. We do not plan any special reserves.

- Will you increase your capital?

- We have looked into the concept of recommended capital amount for a Central Depositary. There is no evidence of it anywhere in the world. What do you need capital for? Mostly for managing credit risks, and the Central Depositary has none.

- When MICEX bought into RTS, the exchange lowered your capital by paying a dividend of RUB 4,4bn. Have you and your majority shareholder, the Moscow Exchange, agreed on a dividend limit?

- According to the shareholder agreement, NSD pays out a 100% net profit dividend unless otherwise agreed by the shareholders. This year we have paid a dividend of RUB 1,2bn, with net RAS profit of RUB 2,3nm in the previous year. The dividend decision is taken by the GSM in April-May, and by that time the Depositary development budget is approved, funds allocated. In this regard, there are no risks of underfinancing.

- What is your estimated net profit this year?

- This year we have set a mark of RUB 2,7bn, but we have already surpassed that amount.

- Which is your most income generating line of business?

- There are two sources of income. One is the settlement and depositary business per se: safekeeping, cash and share settlement, S.W.I.F.T. access. Of these, safekeeping fees account for some 60% of our income. We have checked and found out that this is in line with other CD’s elsewhere. The other source is placement of temporarily disposable cash resources, the scope of which is limited for us as a non-profit organization, so we invest in low risk, low yield assets, such as Central Bank deposits and OFZs.

- Does that mean less income when NSD lowers its safekeeping fees next year?

- We expect depositary safekeeping income to remain at least the same, since the asset volume will increase, giving us a scaling effect.

- Since 15 October, NSD has become the owner of the DCC DVP service. Do you plan further development of this product?

- DVP will initially be the total equivalent of the former DCC service. Market participants demanded this, since their back office is compatible with this service. We plan to improve the product in the future, including e-workflow. We also want to introduce priorities for client instructions (instructions queue management). This is an in-demand service, we plan to introduce it next year.

- Will these be the only new DVP features?

- We also plan DVP in “Central Bank money’, when NSD handles security settlement and BESP processes cash settlement. This is the preferred DVP model for foreign clients.

- BESP fees are high…

- We are working with the Central Bank on cutting fees for this product.

- So DVP is the cornerstone of competition versus major foreign depositaries?

- Fees, DVP and collateral management. In general, key depositary services are safekeeping, corporate actions, settlement (DVP or free delivery) plus collateral management, the latter considered a key strategic product by central depositaries… and also our competitors, global custodians.

- When do you plan to introduce this?

- We plan to offer collateral management in test mode to our clients in December for Central Bank repo trades with a securities basket.

- What changes do you see in the Russian stock market with the coming of the Central Depositary? Will volumes rise or drop?

- Euroclear and Clearstream will partially draw the Russian market liquidity, however, on the other hand, dealing in Russian assets will become less risky, meaning that major foreign investors, primarily funds, will be able to increase investment limits for Russia. Therefore, liquidity will come to Russia and volumes will rise. This will drive the sovereign debt market, the OFZs, as Russian and possibly CIS company IPOs will become possible in Russia.

- What could be the estimated cash inflow?

- I think in retrospect the share of foreigners in the sovereign debt market could reach 35%. Today this share is 3-4%. In absolute figures we are talking tens of billions USD for the sovereign debt market. As for the corporate sector, there is no telling how much money can arrive there.

- Will NSD see the OFZ beneficiaries?

- This issue is currently debated with the regulator. We will probably request beneficiary information for corporate actions: coupon payments or bonds redemption.

- And for shares?

- I think we will adjust this procedure according to the bonds experience. We will have time to do so, because initially Euroclear and Clearstream will have direct access to the bonds market only, and to the shares market in mid-2014.

- How will interaction with registrars be structured?

- We have agreed on data exchange formats, including e-workflow. For instance, securities will be debited and credited by matching instructions to the CD from the registrar and the client. This will improve safety and keep the central depositary and registrar balances in sync.

- If there is a discrepancy, will you be able to check the matching instructions to find the error?

- Yes. Besides, all matching instructions will be electronic, making the process easier.

- How many registrars have you set up an e-workflow with?

- Practically all of them. But having an agreement with registrars is not enough, the issuer must allow the registrar to send electronic instructions for its shares. Issuers still who have not allowed this exist in the Russian market, however e-instructions become mandatory by law starting 1 January.

- The Moscow Exchange has changed its company name and plans a rebranding. Will NSD perform a rebranding after it acquires a new status?

- According to our shareholder agreement, rebranding is a group issue. We do not act as a separate entity in this case.

- The exchange has planned to roll out a service that allows share and DR trading in one Open Book. Do you take part in the development of this technology?

- Yes, we are working on this one Open Book share and DR trading scheme with a global custodian. Today, share/DR conversion takes roughly three days, we want to convert in one.

- How do foreign investors react to the fact that the country’s central depositary is owned by the exchange?

- They are okay with this. Depositaries are owned by exchanges in many countries. Apart from the exchange, NSD is owned by 37 shareholders, including all the leading national banks. There is also the Central Depositary Act that regulates this entity.

Trading infrastructureProject Group №1Eddie Astanin