Custody banks forced to fight with CSDs

Never lauded for their clarity, the European Central Bank and the European Commission are set on reducing costs and increasing efficiency in the continent’s post-trade infrastructure, but some say they are pulling the industry in different directions. The ECB in particular has been accused of a contradictory approach, mixing utility with competition as its Target 2 Securities initiative looks to create a single securities settlement layer for Europe, removing a significant proportion of central securities depositories’ (CSDs) business and forcing them to compete with each other – and with custodian banks – on cross-border settlement.

“What’s going to happen with Target 2 Securities is that settlement and central bank money will be centralised on a single technical platform run by the ECB or the Eurosystem, so the CSDs in the Eurozone, those who are going to participate, will lose the settlement piece, will lose 30-50 per cent of their revenues, typically, associated to settlement. And in order to survive, they have to change their business model,” says Tomas Kindler, CEO of Link Up Markets, a new settlement joint venture between seven European central securities depositaries. “They have to become, basically, custodians, in the sense that they have to service foreign securities,” he says.

“And when you listen to the ECB, they specifically invite the CSDs to compete, to move up the value chain and to service whatever assets are in the scope of Target 2 Securities.” Link Up Markets is designed to facilitate this shift up the value chain. The project is a collaboration between Germany’s Clearstream, the Hellenic Exchanges Group of Greece, the Swiss group SIS, Denmark’s VP Securities Services, Norway’s VPS, OeKB of Austria and the Spanish company Iberclear to develop an ‘adaptor’ for the cross-border clearing links between the CSDs, so rather than maintaining six connections, one with each partner, they will have one, to the central translator, Link Up Markets. The eventual goal is that Spanish investors can access Danish securities through the Spanish infrastructure and vice versa. It is, Mr Kindler says, “a showcase for horizontal interoperability” that can deliver cost savings of up to 80 per cent for cross-border transactions.

Key elements missing This initiative, while lauded by the regulator, misses some key elements that the ECB would have liked to see. Notably, it does not include any agreement amongst the participants to join T2S. “Each individual CSD has its own positioning vis-à-vis the Target 2 Securities project and will decide on its own whether to join or not,” Mr Kindler says. “What Link-Up Markets is not is an agreement that we’re all going to join Target 2 Securities. That’s up to the individual CSDs.”

Also conspicuous by its absence is Clearstream’s rival on the ICSD stage, Euroclear, which operates CSDs in several of Europe’s key markets. Euroclear has its own initiative to increase interoperability between the CSDs under its umbrella, investing heavily in creating a single settlement platform. It is an approach that, while costly, offers more obvious cost savings. As Andrew Howieson, MD at Tabb Group, the consultancy, notes: “I’ve heard [Link Up] described as more of a routing initiative - allowing the different front end mechanisms to accept settlement instructions and pass them between the people who are participating in this initiative, instead of being a fundamental change in the platform or in the practices underlying the platform. And in that situation it’s hard to see how the fundamental cost structure can be addressed.”

It is a concern echoed by Euroclear’s spokesman, Denis Peters. “The goals of what appears to be an order-routing joint venture are to be applauded as we believe market-led efforts to reduce settlement costs in Europe are the best way forward. As we were not invit-ed to join Link Up Markets, we look forward to learning more about it.” “We are interested in understanding how much cross-border business flows between these CSDs, how this initiative compares with T2-S, how the joint venture will bring down the cost of cross-border settlement by 80 per cent, as stated in the announcement, without eliminating platforms or harmonising market rules and practices across these markets,” he says.

Link Up’s Mr Kindler is quick to address the issue. “Let’s be clear, of course what it doesn’t mean is that the prices for existing CSD links will go down by 80 per cent. I’m very confident that the fees for CSD links can be reduced with Link Up Markets,” he says. In the end, it will be up to the individual CSDs to address their individual price structures. And it is this, regardless of European politics or grand ideals of harmonisation or free market competition, that end users will be watching closely.