All together now

Europe’s securities depositories are trying gamely to harmonize. But not everyone is singing in the same key.

Twelve years after the European Union formally adopted its single-market framework and nearly three years after 12 countries joined in a historic unification of their currencies, the Continent’s capital markets remain highly fragmented. European financial institutions and securities exchanges continue to operate under a patchwork of national legal codes, market customs and taxation systems. Progress toward consolidation in these areas is proceeding -- but at a painfully slow pace.

No one disputes the need to harmonize market infrastructure. The alternative -- the status quo -- is hugely expensive. Germany’s Deutsche Börse estimates that inefficiencies caused by inconsistent market practices, excess capacity and different regulatory frameworks, currencies and languages cost financial institutions in Europe a collective E4.3 billion ($5.3 billion) a year.

Overcoming centuries-old legal and cultural conflicts isn’t easy, but there’s no mystery about how best to streamline securities clearing and settlement. The 21 central securities depositories -- 19 domestic and two pan-European -- are at least 19 too many to serve a region that is supposed to be moving toward unification.

“In the ideal model for Europe, there would be only one CSD,” declares Edward Neeck, head of custody and network product management at J.P. Morgan Chase & Co.'s investor services unit in New York and part of a team working on clearing and settlement recommendations for the Group of 30, an influential global policy forum on banking and payments. Neeck is used to the U.S. system, in which the markets depend on a single industry-owned utility, the Depository Trust & Clearing Corp., to perform the accounting, custody and recordkeeping functions of a CSD to ensure that securities trades are accurately completed. He believes that his European counterparts, as they deal with increasing cross-border transaction flows, will inevitably move toward a more centralized, DTCC-

like approach.

National CSDs, such as Portugal’s Interbolsa and Spain’s Iberclear, have loyal, long-term owners and customers who may understandably resist closing up shop and laying off faithful employees. But even they are facing reality. Licinio Manuel Marcos Moreira da Silva, director of Interbolsa, agrees that settlement operations can readily be merged. Local CSDs, however, will have to hold on to “custody services, such as corporate actions processing, because the different country regulations and laws [make them] more difficult to harmonize,” says Moreira da Silva, stressing that his opinion is his own and not officially that of Interbolsa’s parent, Euronext Lisbon.

Clearly, then, the single-CSD vision -- or something close to it -- is carrying the day. Clearstream International and Euroclear Bank, the two powerful international depositories, or ICSDs, that bankers have relied on for years to smooth cross-border settlements, actively support the trend, and for good reason: They stand to gain more business as smaller operations consolidate.

Euroclear -- which J.P. Morgan Chase owned until 2001, when the clearinghouse was restructured and its shares were distributed among more than 200 market participants -- has been a unifying force. In recent years it has acquired the domestic CSDs serving Belgium, France, Ireland, the Netherlands and the U.K. “This has created a sense of momentum and progress within the European harmonization debate,” asserts Mark Kirby, head of Brussels-based Euroclear’s business model and harmonization division. “This has turned something that was until recently an academic exercise into something that is live.”

Clearstream, a Deutsche Börse subsidiary located in Luxembourg, cooperated with rival Euroclear to take a big step toward harmonization in June: They created an electronic bridge that enables trades to be transmitted from one network to the other during daytime hours. In the past such transfers could occur only overnight. The daytime bridge, designed to speed up the processing of transactions that fail to settle on the first attempt, enters its second phase this month, when same-day settlement of inter-ICSD trades becomes the norm.

“Between the two organizations there is a greater level of competition and interoperability that will enable service to be enhanced to levels not seen before,” says Deutsche Börse COO Matthias Ganz. “But there is still more to do.”

That there is, at least, general agreement on the route to reform is a tribute to the Giovannini Group, a committee of market participants formed by the European Commission in 1996 and led by Alberto Giovannini, the CEO of Italy’s Unifortune Asset Management. In 2001 the group published a survey of European clearing and settlement facilities and enumerated 15 barriers to a unified infrastructure, such as inconsistent operating hours and settlement deadlines.

Two years later a second Giovannini report recommended ways to remove those barriers and called on groups such as the European Central Securities Depositories Association to undertake two- to three-year projects to achieve those goals. The ECSDA -- representing Clearstream, Euroclear and the national CSDs -- has taken on several harmonization efforts, including those concerning hours of operation, settlement rules, corporate actions and custody.

J.P. Morgan Chase’s Neeck calls the second Giovannini report “the template for the successful harmonization of clearing and settlement in Europe.” He adds, “It covers not only financial sector players but also the public sector, and addresses the tax and legal issues.”

But those reports stated principles and set operational goals; they did not specify any particular market structure, preferring to leave that decision to free enterprise. “It is essential that any innovation in the marketplace be nondiscriminatory in its access policies,” says chairman Giovannini. That means, for example, that “the harmonization within the Euroclear group should not be incompatible with the CSDs that are not part of the group.”

Euroclear wants to help shape the industry’s post-Giovannini evolution through a series of consultation papers over the next few months. The first will deal with unifying its operating platforms in Belgium, France and the Netherlands -- the three largest countries on the Euronext exchange, the pan-European cash securities market that owns part of Euroclear.

“One of our worries was that there are so many different bodies interested in harmonization that groups might compete with each other on how the issues should be addressed,” says Euroclear’s Kirby. “As it happens, the process has been much more positive, and we have very close working relationships with the main harmonization bodies,” including the ECSDA, the European Banking Federation, the European Securities Forum and the Society for Worldwide Interbank Financial Telecommunication. “Generally, everyone is going in the same direction, which is a very good sign.”

But will this accommodating spirit fade once Clearstream and Euroclear, their owners and their trade associations confront the politically messy business of CSD consolidation? And if the European banks get serious about reducing the field to just one DTCC-like entity, what will happen to Clearstream or Euroclear? Will one disappear?

J.P. Morgan Chase’s Neeck is a Euroclear fan. “It has established control over clearing and settlement for the Euronext markets, which represent 60 percent of the equity volume within Europe,” he notes. “This is an effective way to achieve consolidation through market forces.”

Neeck concedes that a single depository “may look fine on paper, but forming a new utility would cost a great deal for market participants and European taxpayers.” At the other extreme, he adds, maintaining multiple CSDs, even if interlinked, would be less efficient. “The benefits [of consolidated settlement] would trickle down from the banks to their clients and on to the end investors,” he says. “And it would therefore make Europe a more attractive market in which to invest.”

Others support consolidation but don’t want to move too fast. Jon Lloyd, the product head of clearing, settlement and custody at BNP Paribas Securities Services in London, believes that CSD mergers will be too expensive to integrate -- unless operational harmonization is achieved first, through common standards.

Diana Chan, director of EMEA securities services at Citigroup Global Transaction Services in London, agrees. “CSDs are natural monopolies, and merging them will not create competition,” she argues. “Certain cost reductions can be achieved through merging, but there is no reason to do that when the two operational environments cannot be merged.”

Deutsche Börse’s Ganz says that the payback from consolidation may not be as great as some have suggested. He cites a report last year by Morgan Stanley and consulting firm Mercer Oliver Wyman that put the total annual cost to investors of European clearing and settlement services at E3.6 billion, but with only 9 percent of that going to depositories. (Custodians and other banks collect most of the rest.)

Giovannini believes the potential savings are significant enough to drive consolidation. “The whole spirit of our work is not to force participants into any specific market architecture,” he explains. He insists only that “whatever market structure emerges will deliver posttrade services that meet necessary standards of efficiency and soundness.”

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