In addition to India and Russia, the survey identified a number of countries with significant operational problems affecting both investor and custodian. In this category, Pakistan was most frequently mentioned as a problematic securities marketplace.
Chile
Chile has an extremely complicated and lengthy application processes. "Clients don't want to decide which laws to use," says one custodian. There are many applications to various agencies which must be filed as well as numerous documents and statements required from the client taking months in the process. Depending on the selected method, clients commit to minimum investments and also, years during which principal invested can not be repatriated. Funds are required to be paid in advance, sometimes monthly. Specific taxes paid are credited toward annual overall taxes due, others are not. Monthly reporting to authorities, with accounting and tax preparations, and the initial investment authorization process may be deemed expensive by most investors.
Colombia
Colombia has very specific foreign investors' regulations. The application is extremely complicated and lengthy. One custodian "... provides very detailed procedures on completing an application, providing the forms on computer disc, offering to review the applications prior to submission and meeting with local regulatory authorities."
Hungary
A major difficulty in providing a custody service in this market is the existence of two forms of the local currency - convertible and non-convertible Hungarian forint. As the names suggest, only one form of the currency may be repatriated. The two currencies forms are reflected to the investor as a single balance, but the custodian maintains and reconciles the accounts separately. The Hungarian subcustodian is required to maintain accurate records to ensure that the investors assets are readily available in the base currency upon request.
Indonesia
Indonesia's physical securities and regulations contribute to abuses and inefficiencies in securities processing. Various industries and individual companies are "off-limits" to foreign investors or limited by percentage of foreign ownership. Occasionally an investor discovers - after the fact - that a stock purchase is disallowed.
For investors entering the Indonesia markets, on custodian advises:
Israel
Frequently mentioned difficulties are the short settlement period (trade date equals settlement date) and currency restrictions. One custodians recommends that investors negotiate a longer settlement period with local brokers. It is possible to extend settlement to T+1 or T+2 for OTC trades. The local subcustodian handles purchase/sale of currency and fund trades for this custodian.
Due to the tight TD settlement regime, the trade order includes settlement instructions. In Israel, a Glass-Steagall Act equivalent does not exist. Subsequently, banks may act as brokers. If a trade is executed through the brokerage arm of the subcustodian, a credit facility allows funding of a purchase on TD+2. If a third party broker is used, the credit facility is individually negotiated between the client and the broker. The credit facility arrangement is imperative as it is impossible to fund a purchase in time due to trade date equals settlement date.
One custodian advises, "...foreign investors should pay close attention to deadlines for trade instructions and funding of securities transactions. Once an order is executed, it cannot be canceled. It can be reversed by an additional order, but if the trade order was deemed legitimate, the potential loss resulting from price differential is the responsibility of the client."
We thank one custodian for providing an excellent description of the Tel Aviv Stock Exchange.
Pakistan
"We have noted inconsistencies in the adherence to policies and procedures as well as a discriminatory treatment towards foreign investors. Brokers, local custodians, registrars and the government operate with irregularity," complains one custodian. The high levels of political instability and the frequency of any action, forces frequent disruptions and eventually, closure of the securities market.
One custodian monitors local agents to ensure performance is in accordance with standards, referring to this feature as a risk management tool. Particular attention is given to the review and follow-up of failed trades, pending corporate events and shares out-for-registration.
Settlement is physical and the re-registration process is lengthy and inefficient - two major challenges in this marketplace. Given these circumstances, the processing of income and corporate actions is complex. Pakistan has no designated payment dates, thus, investors entitled to dividends are oft times uncertain of payment.
Poland
Poland requires every investor to establish separate letters of authority with each local broker used - a time consuming and onerous requirement. One custodian avoids this problem by operating via Creditanstalt, Vienna's omnibus account. For this custodian, several named London brokers take trade orders which are passed via Creditanstalt, Vienna. Contracts are issued in Austrian shillings.
Investors are forewarned - the buyer legally becomes the beneficial owner on T+1 but full settlement does not occur until T+3. For a sale, title to ownership is lost on T+1 but cash is not settled until T+3.
Taiwan
One of the major obstacles for foreign investors in Taiwan is the relatively short trade date-plus-one settlement period. Global custodians work with very short time frames to instruct local subcustodians to settle trades. Taiwan has a severe penalty - a three year trading prohibition - if trades are not settled timely. Also, the foreign investor application process is extremely complicated and time consuming.
Thailand
In the Thailand market, many foreign investors still purchase and hold "local" shares although technically illegal. A problem arises when corporate entitlements are declared as shareholders are not legally entitled to collect these distributions.
One custodian established procedures whereby clients use local brokers for entitlement collections. The client is then allowed to purchase shares in any company, even if the foreign ownership limit is exceeded.
Turkey
The Turkish securities market hosts an enormous interest rate, rapid depreciation, and difficulty in obtaining interest on local funds. The currency depreciation discourages investors from holding Turkish Lira for any period of time, resulting in only small pools of cash held in the custody accounts.
FX deals are struck for settlement on the anticipated settlement date of the associated security sale. Short cash positions are possible in the event of a trade fail. Since overdrafts are prohibited by law in Turkey, all settlements requiring a payment of cash out of the account are frozen. Funds are released once sufficient funds are credited to cover all payment obligations. The "domino effect" on fails creates compensation claims at rates between 70 percent and 80 percent for numerous failed trades as the result of only one or two failed credits of cash. The offsetting claim does not usually fully recompense the loss.
Direct interest paid is not available for Turkish call accounts. To obtain interest, the custodian enters the money market on a daily basis. However, given that a long fund position exists only as a result of fails, it is extremely risky to invest such funds in case the trade does settle while funds are on deposit creating a short fund position, frozen settlements, and multiple fails. "The custodian faces a classic Catch 22 and may decide the prudent course of action is to leave the funds passively in the account." mentions one custodian.
United Kingdom
UK market participants are managing the transition from a purely physical settlement environment to CREST, a book-based environment. During the nine-month conversion process, scheduled for completion in April 1997, securities will be migrating between the two settlement mechanisms. The issue of share availability is the major challenge facing custodians as each tranche of securities undergoes a four-week conversion cycle.
Venezuela
Venezuela was reported to have an excessively high fail rate - in excess of 90%!
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