European banks and clearing organizations worked so hard to cope with the stock market boom of the late 1990s -- not to mention Y2K, the arrival of the euro and the rise of cross-border trading -- that they neglected a critical infrastructure problem: the need for a common clearing and settlement framework. In that respect, securities markets in Europe remain almost laughably less efficient than those in the U.S.
What makes the U.S. different -- and a possible role model for fragmented European market structures -- is Depository Trust & Clearing Corp., the country's single, central counterparty that tracks and guarantees the transfers of securities and related payments.
The New York-based utility estimated last year that a European transaction settlement costs 50 cents on average, versus 3 cents in the States. Convinced that European exchanges and clearinghouses would rush to its proven trade-processing and risk management model, DTCC opened a subsidiary, European Central Counterparty, in late 2001. The initiative failed miserably.
EuroCCP had only one customer, Nasdaq Europe, which, in the midst of dismal markets, couldn't generate enough volume to justify DTCC's overhead costs. In September the subsidiary closed.
But DTCC hasn't given up on Europe. Although the company recalled four people from London to New York, DTCC's five-member U.K. staff, supplemented by U.S. counterparts, including international services division head Jeffrey Smith, continues to manage trading systems for emerging-markets debt and commercial paper. And it has a new marketing priority: mutual fund services.
"For some time we have been hearing from our clients that Europe could benefit from something that looks like Fund/Serv," says DTCC head of mutual funds Ann Bergin, referring to the standard U.S. system for transmitting transaction details between mutual fund families and distributors.
As EuroCCP demonstrated, however, a well-timed product and tech- nological proficiency don't guarantee market acceptance. Will DTCC fare any better this time around?
EuroCCP's failure had some mitigating factors -- notably, the struggles of Nasdaq Europe in a persistent bear market with no IPO activity -- but it ran into still more problems because of its U.S. roots and perceived high-handedness. Much of the European financial establishment viewed DTCC as an insensitive foreign behemoth trying to impose a system that could just as easily have been run by an indigenous organization like the London Clearing House. Many in the European securities-processing community also hadn't forgiven DTCC for teaming in 2000 with Boston's Thomson Financial to form Omgeo, a central matching utility designed to automate trades at their presettlement stage -- and to compete against a previously organized not-for-profit entity doing the same thing.
The not-for-profit start-up, the Global Straight Through Processing Association, disbanded in November, in a vindication of DTCC's for-profit strategy. But the rivalry left a bad political aftertaste.
Mindful of the criticism, DTCC protests that it merely seeks out opportunities to expand its franchise in accordance with the free market, which, in the case of EuroCCP, clearly ruled against it.
Even its supporters acknowledge that the huge U.S. counterparty arouses suspicions. "DTCC's involvement in Europe is an interesting issue," says board member Thomas Perna, head of the financial companies services sector at Bank of New York Co. "I think DTCC needs to be careful that it goes where it is wanted."
Is it wanted in the mutual fund market? European clearing and settlement may be inefficient, but they do get done; mutual fund transactions, however, are a disaster. The Society for Worldwide Interbank Financial Telecommunication, the international financial messaging network, estimates that more than 50 percent of European fund transactions are processed by fax and other error-prone manual methods, causing E1 billion ($1 billion) in excess costs annually. In contrast, the U.S. fund market is virtually standardized on Fund/Serv, a 16-year-old automated product from DTCC's National Securities Clearing Corp. subsidiary. Fund/Serv handles an average $6.2 billion a day in fund purchases, exchanges and redemption orders, as well as account registration information transmitted to and from fund companies and their distributors.
DTCC set the stage for its European initiative in July by publishing "Bridging the Funds Divide," a 48-page white paper it commissioned from Paris-based think tank Prométhée. The study's conclusion: No more than 20 percent of the E4.7 trillion in European funds is currently invested cross-border, and the infrastructure is not equipped to handle the inevitable increase in transnational investing.
The report does not explicitly promote DTCC, and it proposes an "open architecture" approach to international transaction processing, akin to the standards that enable mobile telephones to operate outside their countries of origin.
DTCC's Bergin doesn't deny that her company sees revenue opportunities in Europe, but she resists the hard sell. "We don't presuppose that the U.S. product can be wholly moved to Europe and result in the same efficiencies," she says. "There are specific dynamics in the European market."
Some of the problems are being at least partially addressed by Europe's international central securities depositories -- Euroclear, with its FundSettle system, and Clearstream International, with Vestima. These systems let fund distributors exchange messages with their transfer agents. The platforms are only two years old, have penetrated just a small fraction of transactions and do not interconnect.
Will these local programs best DTCC? Martine Dinne, an executive director of Brussels-based Euroclear, concedes that Fund/Serv is a formidable offering but argues that DTCC, if it has a role, should "add value by filling any gaps that may be in the market. We'd have to be convinced there is a missing piece."
DTCC shouldn't be pushing another product that complicates financial firms' decision making, Dinne believes, when they are loath to spend money on new technology.
Says BoNY's Perna: "Clearly, there is a need for something like Fund/Serv. Whether the European market wants to see DTCC running around over there is another story."
DTCC's Bergin explains that the Prométhée report was meant only to stimulate discussion on how to streamline European funds processing. But she also contends that the Continent needs a unified framework. "The solution would have to have the right functionality and understanding of the needs of the client," says Bergin. "DTCC could build such a solution, based on discussions in advisory groups that include representatives from both sides of the trade working together."
Giulio Di Cerbo, sales director in the financial intermediaries business of Citibank Global Securities Services, says that DTCC is more likely to succeed by cooperating with existing entities -- which appears to be its tack with mutual funds -- rather than steamrolling current players.
Then, if DTCC wants to go deeper into the European infrastructure, it has three options, Di Cerbo says: "First, DTCC could be appointed by an existing exchange or alternative exchange as a clearing or depository institution. Or it could tie up with another clearinghouse or depository to gain economies of scale. Finally, it could look at providing technology and risk management tools to up-and-coming or existing central counterparties in Europe, such as [Euronext exchange affiliate] Clearnet and [Deutsche Börse and Clearstream derivatives affiliate] Eurex."
The Citibank executive believes that, in view of the EuroCCP stumble, the last option is best: "DTCC would have a real role to play by providing its knowledge and know-how to the newer clearinghouses," he says.
Di Cerbo doubts that DTCC can depend on the major U.S. commercial and investment banks -- which are its owners as well as customers -- to build a global presence. "Most of its clients are the big broker-dealers and global investment banks, which, you could argue, are no longer just U.S. institutions," Di Cerbo notes. "As the traditional U.S. names have gone international, they have become direct members of exchanges and individual clearinghouses around the world."
One place DTCC will be welcome is the Central Securities Settlement Infrastructure, an initiative of Swiss central securities depository SIS Swiss Financial Services Group to create a common clearing gateway for all participating markets. SIS expects DTCC to be among several depositories signing on to CSSI by February. As envisioned, a firm in any country could effect cross-border settlements at domestic rates -- akin to dialing a local phone number for long-distance access.
CSSI is no EuroCCP; DTCC will be one among equals. But that may just make the American firm more palatable to European institutions as they reach for much-needed back-office efficiencies.
"A DTCC in Europe could make a huge difference for us," says Donald Brydon, chairman of Axa Investment Managers and founder of the European Asset Management Association. "We have to start thinking European and not national. Otherwise our cost base will be uncompetitive with the Americans'."
