European clearing and settlement: The American dream

Date: 12/04/03

Muddled plans to lower the cost of cross-border securities deals

THERE are, according to a report published in 2001, no fewer than 15 barriers to the efficient clearing and settling of securities across national boundaries in the European Union. That makes cross-border dealing in the EU expensive, and frustrates the dream of a pan-European capital market to rival America's.

European lawmakers are mulling new proposals from the Giovannini committee, which totted up those 15 barriers, to eliminate them over the next three years. This is ambitious stuff, because the barriers include mismatches in corporate law, taxes and information-technology platforms, as well as straight protection. To add to the complications, ten new EU members will join the fray next year.

The European Commission is expected to respond to the proposals in June. It may even issue a special clearing-and-settlement directive. Market practitioners are understandably sceptical about the likelihood of progress. Yet there is a chance, at least, of a shift in the polarised attitudes on opposing sides in a complex, distorted yet fiercely contested business.

Clearing and settlement is the unglamorous bit after equities or bonds are traded on an exchange. A clearing house ensures that buyer and seller have the cash and securities to do the deal; a securities depository settles the trade by moving the securities from one account to another. This may sound dull, but it is the stuff of monopoly.

Exchanges want to funnel as many trades as possible through their domestic clearing house and securities depositories - especially if they own them, as do the main stock exchanges in Germany, Italy and Spain. But they are being forced, by various regulatory threats, to provide more open access - so that, in theory, a securities trade in one EU country can be cleared in another and settled in a third at no greater cost to the customer than a domestically cleared and settled trade.

Last month the European Commission fingered Clearstream Banking Frankfurt, a settlement subsidiary of Deutsche Börse, which runs the Frankfurt stockmarket, for apparently discriminating against Euroclear, a Brussels-based, not-for-profit, securities depository, in settling registered equity trades. It seems that Clearstream's charges to Euroclear were on the high side.

Euroclear itself is under attack by a group of banks, which accuses it of competing unfairly for cross-border securities services. One of the banks, BNP Paribas, protests that its own dominant position in settling cross-border trades in French equities is being undercut by a cross-subsidised unit of Euroclear. This is forcing Euroclear to be more transparent about its intra-group business.

Deutsche Börse is a target because it has built a profitable domestic clearing-and-settlement “silo”. German securities traded on German exchanges must, by a quirk of German law, be settled in Germany. This may be beyond Deutsche Börse's control, but its record is still not good. Last year virt-x, a small London-based electronic exchange which trades Swiss and other European stocks, was refused access to Clearstream.

The (new) Giovannini report does not dare to join the debate over whether national silos are better or worse than the “horizontal” model favoured by the London Stock Exchange (LSE). In this system the exchange, clearing house and depository are separately owned. Preferably, the clearing house and depository are owned mutually by their users too. The debate is somewhat redundant, although long-frustrated merger talks between anti-silo London Clearing House and Paris-based Clearnet may hinge on whether Clearnet ceases to be part of a continental silo.

The Giovannini group recommends a mixture of market forces and regulation to create open access - whether to silos or horizontal systems. “It's a business plan, not a blueprint,” comments one analyst. But the timetable is unrealistic. Bear markets have driven investors back to home-based securities anyway. In such conditions, domestic silos are probably more efficient. Moreover, today's shrinking information-technology budgets will not stretch to developing pan-European compatibility.

Real savings, on the other hand, are being achieved by exchanges offering access to a central counterparty (CCP). The LSE has done this since 2001. Deutsche Börse started last month. Others will follow. CCPs allow trading houses to net all their trades in one place, reducing counterparty risk and the use of regulatory capital.

The dream of a pan-European CCP and settlement system, modelled on America's Depositary Trust and Clearing Corporation, is remote. But it is espoused by the LSE and by the European Parliament's Economic and Monetary Affairs Committee. This body has urged the commission to study the American example - imposed by regulators - to see whether “such an architecture could be set up in Europe.”

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