ECB opens exit from the ‘last-chance saloon’

EU policymakers have long complained that the inadequacies of Europe’s clearing and settlement structures are slowing down the integration of its financial markets.

According to a warning in November 2000 from the Commission-sponsored Lamfalussy committee, these inadequacies would leave the EU at a competitive disadvantage compared with the US, militate against the efficient allocation of capital and prevent the new single currency from fulfilling its potential as a vehicle for promoting economic growth.

Clearing and settlement institutions (post-trading activities) are the plumbing through which cash flows as part of the trading of securities such as shares and bonds. In the EU, national laws, regulations and institutions add to the costs of transacting cross-border securities business.

In March of last year Charlie McCreevy, the European commissioner for the internal market, warned in a speech in Paris that the clearing and settlement institutions were "drinking in the last-chance saloon" if they continued to prevaricate on accelerating the integration process.

In May 2006 the Commission’s competition department published an issues paper on the role of competition policy in securities trading and post-trading and, in an obviously co-ordinated initiative, the internal market department issued a draft working document on the subject.

One message both documents sent out was that, like the British competition commission, the European Commission was not going to let narrow national interests or the so-called vertical silos, such as Deutsche Börse, which integrate trading, clearing and settlement into a single opaque commercial operation, stand in the way of the desired changes. By last November, under intense pressure from McCreevy, representatives of the principal post-trade organisations had signed up to a voluntary code aimed at increasing efficiency and cross-border integration. Progress towards implementing the code has, however, been slow.

What has been moving forward swiftly has been flanking action from the European Central Bank (ECB). Last July the ECB shocked financial markets by announcing that it was examining whether or not to get into the settlement business itself. Not the whole business, but just the key link in the chain, the exchange of central bank cash for specific securities - equities, bonds and exchange-traded investment funds. After all, the ECB argues, other central banks, including America’s Federal Reserve Board, run a bond settlement business and, in the US, both clearing and settlement are carried out by the user-owned utility Depository Trust and Clearing Corporation which came into existence as a direct result of government pressure.

Within the next few weeks, the ECB initiative, Target 2 Securities (T2S), could get the go-ahead after detailed discussions between public and private sector representatives which have been intensifying in the past few weeks. It will need the approval of the European System of Central Banks and a nod from finance ministers in the Ecofin Council. Tacit Ecofin approval could come at the end of this month. Only the UK, Sweden, the Netherlands and Belgium are said to be signalling real scepticism about T2S. If the Ecofin does give the go-ahead, this would be followed by a decision to move to the next stage of development by the ECB Council in mid-March. The ECB understands that if delays ensue, it will strengthen the valid arguments of those institutions which claim they cannot press ahead with their own plans because of the uncertainty. T2S would take at least five years to come into operation.

Critics are saying that branching out into this business represents "mission creep" at the ECB. Some argue that it lacks the legitimacy and the depth of accountability, perhaps even the legal authority, to take a step which will further weaken the vertical silo and force adjustments on businesses such as Euroclear, a settlement operation owned by its user banks, which is in the middle of a €500 million, five-nation investment programme aimed at deepening cross border integration among these countries. Others worry that the ECB lacks the expertise and fear that it will not be responsive to the private sector’s needs. But privately, some of Europe’s biggest banks argue that if the ECB really can deliver a pan-European settlement structure, even one focused narrowly on the final cash for securities link in the trading chain, this is something they want and need.

EU policymakers have long complained that the inadequacies of Europe’s clearing and settlement structures are slowing down the integration of its financial markets.