Whatever the eventual outcome, it remains clear that Europe needs a further round of consolidation to improve market liquidity, efficiency, reduce costs for end users and compete with exchanges globally. The $64m question for the market and the regulators remains how implementation can best be achieved without upsetting competition.
Massimo Capuano, president and CEO of Borsa Italiana and president of the Federation of European Stock Exchanges (FESE), speaking at a recent convention in Brussels said: “Like a football pitch, Europe is a complicated place. Competition and the numerous alliances and other forms of cross-border cooperation between exchanges amply demonstrate that there are many valid business models trying to compete in the overall market.
“It should not matter to regulators and legislators whether integration is horizontal or vertical or diagonal like the Tower of Pisa, or whether exchanges specialise to a high degree. What matters is that priorities are set by the exchanges themselves in the context of the cold winds of competition and the disciplines of the market.”
Today, the patchwork quilt of Europe’s stock exchanges, clearing and settlement, and derivative bodies resembles more a printed electronic circuit board. According to FESE, the leading three exchanges in Europe accounted for a 70 per cent aggregate value share of equities traded in Europe in 2004, with the LSE accounting for 39 per cent, followed by Euronext with 19 per cent and DBAG at 12 per cent.
Following the admission of EU-accession countries into the fold, the picture has become slightly more muddied, with currently almost 30 central securities depositories (CSDs) plying their trade, while FESE counts 26 full members providing equity and derivatives trading services and central counterparty functions in 28 European countries (EU-25 plus Iceland, Norway and Switzerland).
This might well beg the question as to whether it would be better to consider consolidation of the post-trade infrastructure first, before engaging in any further exchange consolidation in Europe. After all, it seemed as if it was only until the latest bid for the LSE was bogged down in arguments over price and other matters that the debate finally shifted to consideration of the ‘plumbing’ - clearing and settlement.
Devil in the detail
Johannes Luef, president and CEO of VP Securities Services, the Danish CSD, concurs generally with the basic industrial premise of consolidating CSDs in terms of cost reduction and improved efficiencies. However, he acknowledges that the devil can sometimes be in the detail. “Some people think that there should be a parallel move between the stock exchanges and CSDs, but this is not necessarily so. If you look to Euroclear, for example, they have acquired CrestCo. from London, but as everyone knows Euronext does not own the LSE. On the other hand, Euronext owns the Portuguese stock exchange, but Euroclear does not control the Portuguese CSD, so there is not necessarily a 1:1 connection between the exchange and CSD world.
“And, in the case of the Danish market, we do not have much common business with the stock exchange, although of course all trades on the exchange are cleared and settled in VP, as more than 60 per cent of all trades today in Denmark are done outside the stock exchange.”
Jacques-Philippe Marson, CEO of BNP Paribas Securities Services, commenting on whether CSD consolidation should come before exchange consolidation, says: “You can convince yourself of the logic of not pursuing such consolidation as it potentially eliminates competition, but equally the same individual with the same brain can be completely schizophrenic about it because if you pursue consolidation you create a mega exchange and in theory eventually increase liquidity as you are putting more in one place, with all the economies of scale and efficiency this brings. Unlike the US, you still have borders in Europe, and on two sides of the border you still have different legal, regulatory and fiscal frameworks.”
Jacques-Philippe Marson, BNP Paribas
He adds: “In principle, there should be a European DTCC that should be user owned, user governed, user controlled and run for a little profit. The efficiency will come from having one instead of 20-30 CSDs today. Any future consolidation in whatever way it happens should quickly include Germany. But if you collapse the various CSDs into one legal structure and system, it is clear that Euroclear as an infrastructure provider should be segregated from Euroclear Bank as a competing user of the single platform.”
In the US, it should be recognised that the regional stock exchanges’ vertically-integrated CCPs and CSDs were gradually absorbed into the NSCC and DTC respectively, a 21-year process that started in 1976.
“While Euroclear and Clearstream could be the two owning 100 per cent of the infrastructure in Europe, they should not leverage on that position to eat up the corporate bond market and/or the equities market.
“A more sensitive issue relates to the privledged role the two ICSDs have gained at the inception of the euro, by being direct participants to the eurosystem. Similarly to the case in the US, where JPMorgan Chase and BNY jointly control 100 per cent of the government bond clearing business, Euroclear and Clearstream control 100 per cent of the eurobond clearing business. In both cases, they are duopolistic banks that need to access a market infrastructure to achieve finality,” Mr Marson adds.
In relation to the impact on clearing prices from a change in LSE ownership, the Office of Fair Trading noted in its decision to refer DBAG’s bid that, if successful, it would result in higher prices for UK clearing post merger. Even the annual report for Deutsche Boerse for the year ended 2004 revealed the explicit clearing costs for a sample order of €40,000 at €1.12 for Eurex Clearing compared to €0.35 for LCH. Clearnet - equivalent to some 320 per cent of the current cost in the UK.
The Euroclear group has been a key proponent of CSD consolidation under its umbrella in Western Europe and through the horizontal silo model. And, while their discussions back in April 2000 with Clearstream – then controlled 50/50 by Cedel and Deutsche Boerse – over a merger of the entities failed, today Euroclear’s top priority is ensuring that the first phase of its Single Settlement Engine (SSE), a consolidated platform for its five markets – France, Belgium, the Netherlands, the UK and Ireland – remains on target and on timetable for 2006.
When Euroclear announced their business model in July 2002 for the SSE, they invited all and any CSDs in Europe who shared their vision to come and talk to them, says a spokesman for the organisation in Brussels. While their first priority today is to deal with what they have already taken on, the organisation acknowledges that there are many CSDs in Europe who are looking with great interest to see if they can deliver. Successful completion of phase two of the SSE project, which is slated for 2008-2009, would probably herald a further spate consolidation in the European CSD land.
By then the grand design will have created a single settlement, custody and securities processing platform for the five Euroclear markets that the organisation currently covers, and will effectively be an internal settlement market. The cost of cross border settlement for a security transaction, which today can be anywhere between €10-€20, will be reduced to that of a cross border trade – around €1.
Euroclear estimates their efforts will lead to a reduction in the five Euroclear markets for their users of around €300m per annum, although the development costs associated with the project (c.€400m) must be counterbalanced against those envisaged cost savings. Should everything go to plan, there is also the corresponding reduction in the costs of operating the systems since the users are currently paying for five co-existing systems in five markets. In the future they will pay for just one – resulting in operational cost savings in addition to lower custody and settlement fees.
Consolidation has already taken place in the Nordic region with VPC AB, the Swedish CSD and its Finnish counterpart APK merging into a strong Nordic CSD (NCSD). While the Norwegian and Icelandic stock exchanges remain outside OMHEX stable (although there is overlap in the Norex alliance), one study has suggested the processing costs from a future integrated and single CSD platform for the region as a whole could be cut by 40-45 per cent compared to today (see page 40).
While the path to further CSD consolidation in Europe will not be easy, tie-ups are likely to occur over the next few years. In any event, it should be recognised that the ICSDs (Euroclear and Clearstream) are in a different situation from CSDs and from custodians, since they benefit from a CSD status and/or operate securities settlement systems, which benefit from the same network effects as CSDs, and bundle this network with custody and banking services. The trick will be to ensure users benefit through cost reduction and service levels, but sufficient competition remains and monopolistic pricing among the remaining CSDs does not arise.
The US DTCC: Thumbnail History
The US Depository Trust & Clearing Corporation (DTCC) in the US was established in 1999 and consists of the National Securities Clearing Corporation (NSCC), the Depository Trust Company (DTC) and the Fixed Income Clearing Corporation, with a government securities division and a mortgage-backed securities division.
Originally the NSCC and DTC were set up by the New York Stock Exchange (NYSE), the American Stock Exchange (ASE) and the National Association of Securities Dealers (NASD). In 1975 there were seven vertical silos operating across the US, but participants were generally in favour of consolidation of clearing and settlement, except the exchanges who were against this unless theirs was the surviving system. Other regional stock exchanges – such as those in Boston, Philadelphia and Chicago – each owned its respective clearing and settlement vehicles.
By 1976-77, about a year after the SEC released a report on the cost savings that central counterparty (CCP) consolidation would bring to the market, the NSCC was formed through the merger of the individual CCPs of the NYSE, the ASE and NASD. At around the same time all CSDs affiliated with the individual stock exchanges were interlinked to form a national system. Market participants could then trade the stock of a company on any exchange and hold their shares in their home CSD, by an arrangement called ‘one account settlement’.
