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GLOBAL SECURITIES SERVICES - Fueling the Flow of Capital

Custodians sense opportunity as China loosens its capital controls.

On July 5, chinese regulattors further relaxed the country’s qualified domestic institutional investor rules, enabling local securities firms and investment managers, for the first time, to apply for approval to invest outside of China on behalf of their clients. The move comes on the heels of an announcement in May by the State Administration of Foreign Exchange that it would raise the limit on total foreign investment in China from $10 billion to $30 billion. As authorities gradually ease these and other controls, in part to reduce pressure on local stock markets, big global custodians — many of which have been investing in China for years — are ever more optimistic about the moneymaking potential.

“This is the beginning of the great opportunity that everybody has been talking about,” says Kevin Tan, the Beijing-based chief representative in China for Chicago-based Northern Trust Corp. “The doors are starting to open.”

Custodians provide a wide array of services in China. These may include helping global investors navigate the local regulatory landscape — for example, by facilitating applications for qualified foreign institutional investor status with the China Securities Regulatory Commission and for investment quotas from the State Administration of Foreign Exchange. Custodians may also help investors set up their investment infrastructure and resolve problems with brokerage firms.

Today just a handful of foreign banks, including Citi, Deutsche Bank, HSBC, Standard Chartered Bank and Singapore’s DBS Bank, are approved by Chinese regulators to provide direct custody services for the domestic market. But other custodians are tapping into China by cutting deals with local firms. Northern Trust, for instance, has a partnership with Shanghai-based Bank of Communications, one of China’s top commercial banks, which had 1.72 trillion yuan ($226 billion) in assets at year-end 2006.

“We provide them with a global custody capability, and they provide us with domestic custody,” says Northern’s Tan, who declined to comment on the amount of his firm’s assets under administration in China.

Size and market-share statistics for China’s custody market are hard to come by. But Chee-Ping Yap, China securities country manager for Citi’s Global Transaction Services division, says that his bank has $4 billion under administration in China and, together with HSBC, controls more than 40 percent of the domestic Chinese custody market for foreign companies investing there.

Providing custody to the increasing number of Chinese institutions that are expected to begin investing abroad presents different challenges. Under Chinese regulations, domestic institutional investors must seek custody services through a local bank, which can then contract with a global custodian. The top players see a rich opportunity because Chinese banks have little, if any, experience providing the core custody services necessary for foreign investing, such as recordkeeping, performance reporting, risk management and proxy voting. Some global firms hope that winning custody business in China will enable them to cross-sell their money management services.

Many firms are still pouring resources into building global custody offerings for Chinese clients — but have yet to see a profit, largely because the overall market is still small. Citi’s Yap says his bank has a big cut of this business because it was early to the market, launching its global custody offering about two years ago. Citi expects the business to be profitable in three to five years.

Another big player with deep roots in China’s nascent custody business is the newly merged Bank of New York Mellon Corp. The legacy Mellon operation had a comparatively small China presence, but Bank of New York Corp. established its custody beachhead in the Chinese market in 1997 through a local partner and enjoys added visibility thanks to its position as a top American depositary receipt bank for Chinese shares.

Kenneth Lopian, a BoNY Mellon senior vice president who runs international client management, says his firm is turning a profit providing custody services to the domestic market as well as a global offering for Chinese institutions investing abroad. He plans to add staff and make additional investments in the country. Lopian says that BoNY Mellon is also eyeing securities lending opportunities. As Chinese firms invest abroad, he adds, that capital will constitute a new pool of assets that can be loaned to investors.

Global custodians are heartened by China’s moves to relax capital controls — but chastened by the country’s deliberate pace of reform. “It took the Chinese 2,000 years to build the Great Wall,” says Northern Trust’s Tan. “They have patience, so ‘soon’ is a relative term.”