Euroclear to ‘isolate’ settlement rivals

Europe’s financial services industry is agreed that something has to be done about current practices in trade clearing and settlement. But that is about as far as the agreement goes. The industry is sharply divided on the question of what exactly should be done. The key debate is over whether financial intermediaries offering settlement services – custodian banks – should be regulated in the same way as settlement infrastructure providers offering the same services.

The problem with Europe’s post-trade arena is that the infrastructure for clearing and settling cross-border trades is highly fragmented. This means processing cross-border trades is much more complicated than processing domestic transactions. But the demand for foreign investment has never been higher due to the euro’s introduction and the onset of the bear market, which has encouraged some to diversify their exposure among different markets.

The Giovannini Group, a cross-section of European financial industry professionals charged by the European Commission in 2001 with investigating fragmentation, has found 15 barriers to the efficient delivery of clearing and settlement services including:

• national differences in technical requirements and market practice;
• national differences in tax procedures; and

• issues relating to legal certainty.

  The group recommended that consolidation be brought about through structural changes such as mergers and acquisitions or through strategic moves, such as outsourcing, alliances or joint ventures.

  Two years on and the Giovannini barriers have not budged. However, during the summer a set of standards aimed at addressing Europe’s clearing and settlement issues were submitted by the European System of Central Banks (ESCB) and the Committee of European Securities Regulators (CESR).

  The standards have yet to be approved and they are currently open to industry comment.

Applying standards

The ESCB-CESR team suggests that its standards should be applied to certain custodians because some of them have clearing and settlement activities comparable to those of national CSDs (central securities depositories) in terms of volume and value.

The fact that they operate on this scale means that they could be open to significant risk when they loan cash or securities to customers that have not put up collateral.

The ESCB-CESR team says: “The level of systemic risk triggered by the largest custodians may affect the entire financial market of the EU. For this reason several standards are relevant for custodians that operate systemically important systems.”

The team defines companies as “systemically important” if they have a minimum of 5 per cent of EU market share or 25 per cent of domestic bond, equity and derivatives transactions.

Certain big custodians have met the ESCB-CESR suggestions with alarm. They appear to go directly against the efforts of Fair & Clear, the group of custodians led by BNP Paribas and Citigroup which has lobbied European regulators for the separation of the settlement and banking operations of International CSDs and in particular Euroclear.

Fair & Clear’s official response to ESCB-CESR was that while it “welcomed” the standards, “it believes that applying the standards to banks that are not merged with CSDs would impose unnecessary and unprecedented regulatory costs without providing new safeguards.”

‘People have no choice but to use central depositories therefore their governance and costs should be transparent’

Diana Chan, Citigroup Global

Transaction ServicesDiana Chan, global product manager and director at Citigroup Global Transaction Services, says: “We agree that risks need to be identified and reduced, but the cost should not be greater than the benefit.”

She says that Fair & Clear questions whether regulating banks is crucial to Europe’s infrastructure. “People have no choice but to use central depositories therefore their governance and costs should be transparent. Their structures are monopolies, they can’t be avoided. We banks, however, are competing with each other.

“ESCB-CESR focuses on risk, but it doesn’t see the need to look at cost and competition.”

She contrasts the ESCB-CESR process with that of the Giovannini Group. “Giovannini was a very open process. One hundred people from all parts of the industry were contacted and public meetings were held where anyone could talk to Mr Giovannini.

“The ESCB process was very closed. They nominated who would be in the working group, which was heavily weighted towards the regulators themselves and industry people could only take part if they were invited by domestic regulators.”

ESCB-CESR standards, argues Ms Chan, are misplaced. “EU-wide regulations exist for banks, but not for infrastructures. If banking regulations are seen as insufficient, then they should be reinforced. Carving out banks’ settlement services to be subject to the standards shouldn’t be necessary.”

Euroclear’s advance

Members of Fair & Clear, formed in 2001, and other custodians have for some time been concerned about one infrastructure provider in particular – Euroclear. They were unhappy when it began encroaching on their equity settlement businesses and have become even more wary since Euroclear started acquiring local CSDs and offering cheap settlement prices. Euroclear now owns the depositories of France, Ireland, the Netherlands and the UK. Fair & Clear fears that the organisation is using its status as a depository to advance its commercial banking activities.

Ms Chan says: “The problem with mixed-function systems, which combine infrastructures with intermediary banking business, is that they not only cause regulatory confusion, but can also distort competition and concentrate risk.

Fair & Clear’s gripe is that while Euroclear competes with other European banks, at the same time the banks need Euroclear. The agent banks say they want “a level playing field”. If they do not get one they will exit. Then Euroclear will have a monopoly and there will be huge liquidity problems.

Euroclear attempted to placate its critics last month, announcing its intention to restructure. Speaking exclusively to PWM at the Sibos conference in Singapore, chief executive Pierre Francotte, revealed that settlement operations would be handled by a separate new company, to be called Euroclear SA/NV. Meanwhile, Euroclear Bank, the international CSD, and each of the national CSDs – CrestCo, Euroclear France and Euroclear Netherlands – would become sister subsidiaries of Euroclear SA/NV. Mr Francotte said he expected “a large number of people in the market to react positively” to the move. In which case, he said, “Fair & Clear will be more isolated in the comments they make”.

‘Fair & Clear is against European harmonisation as it would mean losing a lucrative business share – transaction processing is one of the few ways to make money’

Anso Thire, Euroclear

Anso Thire, Euroclear’s head of corporate strategy, says: “We are the first company to embark on a project to create a platform for a truly pan-European market.

“Fair & Clear is against harmonisation in Europe as it would mean giving up a lucrative business share. In current mar- ket conditions transaction processing is one of the few ways to make money.”

Mr Thire adds that Euroclear’s banking business is essential to its settlement activities as it provides the collateral necessary to settle cross-border and multi-currency trades efficiently.

The acquisitions are also central to its plans to “harmonise” Europe’s clearing and settlement operations. In those countries where Euroclear has not acquired the national CSD it is embarking on plans to improve links to the depository.

Monopoly defence

On the monopoly issue, Mr Thire says: “Monopolies are not illegal, unless you abuse them. Fair & Clear says we are abusing our position, but Euroclear does not have a different tariff for people outside the group. It also says we will gradually increase the price, but we committed to keeping prices stable when we did the mergers [with Crest etc] and we are setting up an external auditor to ensure that there are no cross-subsidies.”