A clearer future for securities servicing

And the European Commission has begun to show more than a passing interest in the issue. Its role is not just about hum-drum regulation. There is also a need to adjudicate between warring parties and to keep the peace between competitors.

The commission’s publication of a list of action points which need to be followed in order to improve efficiency by removing the barriers for integration and consolidation previously highlighted in the Giovannini reports (See Table 1), has been largely welcomed by all parties, who recognise the efforts made by Brussels in understanding the complexity of the industry.

According to Fair & Clear, the association of custodian banks offering post-trade security services in Europe, the commission’s communication provides a balanced basis for a constructive dialogue. Fair & Clear welcomes the Commission’s recognition of the “systematic risk and competitive issues likely to occur during the process of achieving integration and consolidation in clearing and settlement services.”

This statement is significant, because competition and integration are the two key topics under discussion in the securities industry. For an industry with such a sober image, there is certainly no lack of controversy.

Early in June, the Commission made an announcement regarding Clearstream, saying the company infringed competition rules by refusing to supply Euroclear with cross-border security clearing and settlement services for registered shares issued under German law, and also by applying discriminatory prices between 1997 to 2002.

Although infringements came to an end and fines have not been imposed, competition commissioner Mario Monti said the Commission’s decision showed that “competition rules are being applied in the financial industry”.

“Smooth cross-border trade in securities requires functioning co-operation in clearing and settling of trades. This is in the interest of creating an integrated single capital market that will promote growth,” said Mr Monti.

The Commission has made it clear that its decision does by no means favour a particular business model, admitting both Euroclear and Clearstream’s parent Deutsche Borse, are working hard to improve the EU securities trading landscape.

Both Clearstream and Euroclear know better than anyone else that the only way forward in this complex environment is through collaboration. Both companies have recently announced the launch of the new Automated Daytime Bridge between the two securities depositories (ICSDs). The new ‘bridge’ will complement the existing electronic communications link, which operates during the night to facilitate the efficient settlement of securities transactions between counterparties in Clearstream Banking Luxembourg and Euroclear Bank.

Once fully implemented, the new system will allow customers to of both ICSDs to benefit from more flexibility to repair unmatched instructions and by automatically recycling failed trades in the daytime cycle. The phase one of the, two-stage project is to be implemented on June 28.

‘There are things that need to be changed and sometimes people are reluctant to change’ - Riccardo Gambineri, Clearstream

“It is a complex environment and we are working together for the interest of the customers of both parties and everything is going according to schedule,” says Riccardo Gambineri, head of product management for investment fund services at Clearstream.

Mr Gambineri describes improving the efficiency of the industry and bringing costs down as the major goals, adding there is still a lot to be done since many infrastructure providers “are still not focused”. “They are trying to do too many things and in our opinion there is a need for rationalising the back office,” says Mr Gambineri. “There are things that need to be changed and sometimes people are reluctant to change.”

For Mr Gambineri the fact that the industry is growing is good news, but the fast development of open architecture and third party distribution of funds makes the development of more efficient infrastructures crucial.

“Open architecture is here today. There are a lot of institutions that have opened up for private investors and private investors want to have a broader range of products,” he says. “The bad news is that process inefficiencies and lack of automation are also a reality and they are pushing up costs.”

“Compared with the US, the European fund industry is costly, fragmented and growing rapidly,” he says. “The US market is a big market with one currency and one regulation and in Europe there is a collection of domestic markets, still several currencies, different rules and different settlement systems.”

“We find a lot of indirect and hidden costs in the industry,” he says. “Many fund promoters have up to 500 external distribution agreements, with some strong brands easily going above 1,000 distribution contracts.”

With the typical fund distributor having agreements with 30 to 50 fund promoters, that could go up to hundreds when it comes to web-based distribution platforms, it is not difficult to understand how easily costs can escalate during the settlement process.

At Euroclear, head of investment fund product management Thierry Logier, says the fact that an important part of the ordering, settlement and custody processes is still being done manually and without following certain standards is unacceptable. “We believe that what the investment industry need is a pan-European processing infrastructure,” says Mr Logier. “We need this badly because the growth potential is enormous and third party funds are going to be distributed more and more not only offshore, but within the domestic markets.” He explains that the multiplication of operational risk in this very fragmented market and the lack of standards are being translated into high costs per transaction, very poor level of service and high operational risks.

Mr Logier describes three possible solutions for the problems faced by the industry. The first one would be to have a direct link between distributors and fund managers, but this would not be cost-effective, and probably the worst possible solution. The second option is creating a messaging infrastructure, but this would mean settlement, reconciliation and corporate action processes will still be very manual.

The last and most efficient option will be to use a fully integrated hub, such as Euroclear’s FundSettle or Clearstream’ s Vestima, with no operational relationships between fund buyers and fund suppliers. “Because there is no duplication of investments you can get economies of scale and substantial cost savings can be achieved,” says Mr Logier.

“FundSettle is currently used by 130 active intermediaries in 28 countries and has access to over 21,000 fund classes from 18 jurisdictions, including cross-border, domestic and offshore funds.

“Many clients share their figures with us, they are very open, and they tell us that their costs have been reduced between 35 and 55 per cent,” he says.

Vestima, on the other hand, has recently been enhanced with the launch of Vestima+. The three key improvements of the new platform is that is open to more customers than before, including asset managers and insurance companies, it covers all types of fund transactions and that there is an open settlement route. According to Mr Gambineri, the reaction from the industry has been “incredibly positive”. With more interest at the political level and better resources at market level, the clearing and settlement industry seems to be moving in the right direction towards a better integration. The question now is to find out whether integration will mean consolidation between the different players or more competition in the market.