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What is meant in the Communication by "clearing and settlement"?
Clearing and settlement takes place after trading, that is after two parties have agreed to transfer securities (e.g. in a stock exchange or over the counter). It comprises several key steps, not all of which will necessarily apply to every transaction, and its objective is to enable the final transfer of ownership of the securities from the seller to the buyer and the corresponding transfer of cash from the buyer to the seller. The term is constructed broadly, since it also covers custody.
Clearing and settlement is therefore synonymous with another frequently used term - "post-trading activities".
What is the Commission's overall objective in the field of clearing and settlement?
The Commission's overarching objective is to make sure that EU securities clearing and settlement systems are efficient, safe and ensure a level playing field among the different market players.
Why is EU intervention necessary in this area?
Without efficient cross-border clearing and settlement arrangements in the EU, the ability and willingness of participants to trade in EU securities will be sub-optimal, the liquidity of financial markets will be adversely affected and the cost of capital will be higher than it need be.
The two reports issued by the Giovannini Group of experts identified 15 barriers as the main causes of fragmentation and inefficiencies. The Group divided them into technical or market practice barriers, barriers related to tax procedures and legal barriers. The reports concluded that until these barriers are eliminated by private and public sector bodies, the EU clearing and settlement environment will remain a juxtaposition of domestic, non-integrated markets. An additional problem in the EU is the absence of a common regulatory/supervisory framework for clearing and settlement. This not only acts as an impediment to cross-border activity but also makes cross-border clearing and settlement potentially less safe.
All these barriers have to be dismantled and a common legislative framework established. This project will be a lengthy and complex one requiring the combined efforts of market infrastructures, market participants, regulators and legislators. The Commission considers that in order to move forward in a structured and coherent way it is necessary, first of all, to ensure that the political impetus is maintained, that action by private and public sector bodies is co-ordinated and that the appropriate specific legislative measures are adopted. This can best be achieved at EU level.
What measures is the Commission proposing to increase the efficiency of clearing and settlement?
The Commission considers that in order to increase efficiency, it is necessary to liberalise and to integrate existing securities clearing and settlement systems. The aim is for the EU to have an environment where all possible options for the clearing and settlement of cross-border securities transactions are available to investors and to the intermediaries acting on their behalf. In such an environment, decisions on which cross-border channel to use should be based on the quality and cost of the services offered; they should no longer be hindered by artificial barriers preventing the creation of a genuine internal market for clearing and settlement services. This will be achieved through the introduction, by means of framework legislation, of comprehensive rights of access at all levels of the clearing and settlement chain - thus complementing the legal framework provided for in the new Investment Services Directive - and the removal of the other barriers identified by the Giovannini group of experts.
The liberalisation of access and the elimination/reduction of the current complexities in cross-border clearing and settlement through the removal of the Giovannini barriers are intended to increase competition among the different cross-border channels for clearing and settlement.
The efficiency of the systems will also be ensured through the continued application of competition policy to address any restrictive practices that market operators might be tempted to adopt and to monitor further industry consolidation and react as necessary.
How does the Commission propose to increase the safety of clearing and settlement?
The Commission believes that in order to increase safety a common regulatory and supervisory framework that ensures financial stability and investor protection needs to be adopted. It does not consider that the safety of the systems will require legislative intervention in the way market participants are structured. The Commission currently takes the view that other less radical measures such as capital adequacy rules, the adoption of appropriate risk mitigation techniques, governance rules and appropriate regulatory supervision could make sure that systems are safe. However, proposing further prudential requirements is at this stage not excluded.
The Commission is closely following the discussions taking place between the European System of Central Banks (ESCB) and EU Securities Regulators in the context of the ESCB/CESR working group developing non-mandatory standards for clearing and settlement. These standards primarily address risk issues and are being taken into account by the Commission in the development of its policy.
What is the Commission's current approach to regulation?
The Commission proposes that any future Directive on clearing and settlement should be based upon functional definitions. In other words, regulation should cover functions performed by the various institutions active in clearing and settlement. This approach has been adopted by the CPSS-IOSCO (the Committee on Payment and Settlement Systems and the International Organisation of Securities Commissions) and ESCB/CESR in their drafting of relevant recommendations and standards.
The Commission's Communication, however, does not attempt to introduce specific definitions of functions. At this stage, it is more appropriate to put in place the right framework for EU action than to provide detailed definitions. Nevertheless, the Communication gives broad definitions of functions plus further indications on how more detailed definitions should be developed.
Why does the Commission refrain from taking a position on the future model for clearing and settlement in the EU?
The starting point of the Commission's approach is the current, inefficient situation in the securities clearing and settlement market. Its primary objective, at this stage, is therefore to ensure that cross-border barriers to clearing and settlement are lifted and that markets function under a legislative framework which ensures that the systems are safe and efficient. Starting from the current situation, it is not easy or possible to predict how markets will develop. For this reason, the Commission does not feel that it would be sensible to take a firm position and to propose the imposition of specific market structures.
Nevertheless, the Commission will continue monitoring market developments closely and may adapt its approach, if necessary.
Does the Communication distinguish between infrastructures and intermediaries and if so, why?
Yes. The Communication distinguishes between securities settlement systems, central counterparties, custodians and clearing members.
Securities settlement systems and central counterparties are considered as infrastructures, based on the fact that they enjoy a monopoly situation towards their participants. For instance, settlement of a transaction basically means exchange of securities for cash. In order to achieve this, the parties to a trade need to have direct or indirect access to the issuer securities settlement system. This means that they need to have accounts with the issuer security settlement system (direct access) or with intermediaries having accounts with that security settlement system (indirect access).
Custodians and clearing members, meanwhile, are intermediaries that do not have a monopoly position. Custodians provide intermediary services for settlement, while clearing members provide intermediary services for clearing.
However, when it comes to defining functions the Communication clearly states that definitions "should be based on appropriate segments of the value chain, not on the 'intermediary' or 'infrastructure' status of the service provider, even though such a dichotomy may still be relevant for the sake of deriving the level of risk associated with the different functions." The Communication also addresses the issue of the governance arrangements to be applied to both infrastructures and intermediaries.
How does this Communication fit in with the competition law investigations initiated by the Commission in that sector?
The Commission Communication on Clearing and Settlement is an important consultative document which proposes a number of initiatives to ensure that this sector will become more efficient and secure in a fully functioning internal market. It is very wide in scope and is forward looking.
The competition law investigation currently under way (IP/03/462) addresses a specific series of events at a specific moment in time and assesses them under competition rules. It does not prescribe a proposed regulatory environment or standards for the sector.
Nevertheless, the Communication stresses the Commission's intention to monitor further industry consolidation and the importance of ensuring an appropriate balance between ex ante legislation and ex post intervention of the competition authorities to address any restrictive practices that market operators might be tempted to adopt.
Why did it take so long for the Communication to be adopted?
The complexity of the issues required sufficient time for the Commission to develop its view as to the way forward. The Commission is confident that the period it spent doing this enabled it to present a coherent view of the measures that are needed if progress is to be made in achieving efficient and safe cross-border securities clearing and settlement.
