HSBC Nearing Custody Breakthrough?

On June 20, AK News published a cryptic article entitled “Iraq backs global bank’s initiative to encourage investment in stock market.” (See this link.) The Executive Director of the Iraqi Securities Commission (ISC) Abdul Razzaq al-Saadi was reported as saying that the global bank, “HHPT,” had “done the necessary groundwork and pledged to put up the capital needed, in coordination with the securities market, to develop the market and raise the foreign commercial shares.”

This seems almost meaningless until you realize that HHPT must be a typo. The reporter most likely means HSBC. And the initiative in question must be HSBC’s plan to act as a custodian bank for ISX-listed shares, a plan market participants have been talking about for at least the last two years.

Custodian banks typically provide services for funds rather than individuals. They help to protect a fund’s clients from fraud on the part of the fund manager and also protect the fund from fraudulent trading by its brokers.

In a market with scriptless trading, the custodian does not actually hold any shares. In Iraq, these exist only as entries in the Iraq Depository Center’s (IDC) computers. The custodian does, however, have control over the shares in its clients’ accounts. This allows it to provide independent verification that the assets a fund claims it holds really exist.

The custodian also does not execute trades—this is the broker’s responsibility. The custodian’s job is to take care of settlement—to identify the counterparties to the client’s trades and receive or deliver whatever securities were purchased or sold. (With scriptless trading this is just a matter of moving shares electronically between depository center accounts.) This eliminates the possibility that brokers will trade for their own accounts with their clients’ shares.

Custodians also offer a variety of administrative services such as processing corporate actions (e.g. rights and bonus issues), providing daily and monthly reports, and assisting with annual audits.

If HSBC were really moving forward in this area it would be big news for the market. At the moment, no custodian banks are active in Iraq. While this doesn’t matter to most individuals, many funds’ mandates do not allow them to invest without proper custody. If HSBC began providing this service, a flood of new foreign institutional money could potentially flow into the market.

Support from the head of the ISC is certainly a good sign. But others must sign off as well—the IDC, for example. It would be premature to conclude that HSBC’s custody breakthrough is a done deal. But perhaps it is getting closer.

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