In 4th quarter 2004 BTA Consulting conducted a series of unattributed, one-to-one, interviews with some 40 senior executives from across Europe, seeking their views and recommendations on the future of European Cross-border Clearing and Settlement with specific focus on the next three years, 2005-2007. They represented a range stakeholders: central banks, regulators, industry bodies, brokers, custodians, fund managers as well as central market organisations, exchanges, clearing and settlement organisations. This article features the key findings of this empirical research.
The years 2005-2007 are important for laying the foundations for the period beyond 2007. However interviewees did express concern that if their recommendations were not acted upon, there was a serious risk that ‘clearing and settlement may continue to adversely affect the cost of capital and market efficiency in Europe in the years 2005-2007’.
A uniform structural model for European cross-border clearing and settlement has yet to emerge. The European clearing and settlement model is driven by commercial providers and not mutually owned utilities, in contrast to other markets such as the USA. Europe is pioneering the use of the ‘for profit’ governance methodology. This ‘for profit’ model is not synonymous with low cost, efficient and competitive cross-border clearing and settlement. Financial institutions exercise their power as shareholders and investors in these clearing and settlement institutions. In some cases these are cash cows for the exchanges to which they are attached.
Perhaps one of the most revealing findings from this research is that contrary to expectations, market forces do not currently operate within the cross-border clearing and settlement business. Historically, transparent and open competition has not operated to provide low cost and efficient cross-border clearing and settlement because mutual or government-owned settlement or utility structures rendered competition unnecessary. Competition and market forces are critical success factors under the ‘for profit’ governance model.
Markets forces will be not able to operate in cross-border clearing and settlement for at least another five years, unless the EU adopts a new legislative approach. During this period it is anticipated that ‘consolidation would be the way forward, in response to shareholder demands’. It is anticipated that this will result in cross-border natural monopolies, which poses the risk of tariff increases, not decreases, unless there is some form of moderating force to oversee or regulate pricing of clearing and settlement.
Consolidation through interoperability between clearing and settlement systems is not expected to be a major contributor to consolidation, because interoperability lacks the required scale of cost benefits. Furthermore, it has inherent challenges in terms of transfer of risk between clearing and settlement enterprises and therefore is unlikely to be the model that drives competition into the cross-border clearing and settlement environment. Early adopters of the interoperability model validate this conclusion.
Full consolidation of cross-border clearing and settlement is not anticipated because ‘commercial interests stand in the way of full consolidation’. Regional clearing and settlement providers will continue to retain a domestic focus.
Looking forward, interviewees identified a number of critical success factors that need to be implemented in order to make European cross-border clearing and settlement cost effective. These include greater unanimity and co-operation, full support for legal reform via a European Union Directive or Convention, greater strategic direction and leadership as well as removal of the barriers associated with and beyond the so-called ‘Giovannini Barriers.’
Until these critical success factors are implemented consumers, in particular issuers and retail investors, will suffer. They are one step removed from the clearing and settlement processes and have no ability to reduce, influence or even identify transaction tariffs. They are obliged to absorb the costs, directly or indirectly, particularly in the absence of any tariff unbundling.
By contrast market intermediaries will continue to benefit over the next three years; they are the users of cross-border clearing and settlement systems and many buy side intermediaries are investors in the infrastructure organisations, which provide cross-border clearing and settlement services. Understandably, market intermediaries will be very reluctant to give up voluntarily any rights that their role gives them.
Those interviewed left a number of issues unanswered all of which are critical to the success of European cross-border clearing and settlement:
- Can improvement in the efficiency and cost of European cross-border clearing and settlement make an important contribution to achieving the objectives of the Lisbon Agenda which has a target completion date of 2010?
- Would delays in implementing cross-border clearing and settlement reform provide an unacceptable level of risk to the Lisbon Agenda?
- On the basis that the EU issues a clearing and settlement Directive or Convention to govern securities clearing and settlement within the EU, will it be possible to implement this in national legislation by 2010 under normal legislative processes? If not, can it be ‘fast tracked’ to derive lower costs and improved benefits from the legislation, thereby avoiding further post-FSAP regulatory fatigue?
- Can market forces be injected into cross-border clearing and settlement when ‘for profit’ clearing and settlement infrastructures are driven to deliver shareholder value?
- What will be the catalyst(s) to achieving low cost cross-border clearing and settlement?
- Will the 15 barriers to European cross-border clearing and settlement identified by the Giovannini Committee be dismantled, particularly those requiring public sector involvement?
A free executive summary of the report on which this article is based is available at http://www.btaconsulting.co.uk. A full copy of the report may be ordered through the website.
