Consolidation of European exchanges has led to reduced costs through scale. Now central securities depositories are facing similar challenges to increase efficiency in cross-border clearing and settlement.

Recent consolidation among European exchanges has been driven by increased competition as well as the need to reduce costs through scale and increase shareholder value through synergies. The net effect has been a reduction in the cost of crossborder trading, and that has given investors the incentive to trade more. The next task is to increase efficiency in cross-border clearing and settlement by consolidating the diverse European central securities depositories (CSDs). This, however, is easier said than done.

As costs have declined on the exchange side, more than 60 percent of the total trading cost now lies in the post-trade part of the value chain. Although most countries have merged local CSDs for equities and bonds, there are few examples of cross-border mergers. This has made it hard to reach real scale benefits.

For instance, the Swedish and Finnish CSDs are now part of the same legal entity, NCSD, but the actual systems consolidation still remains. On a larger scale, the Euroclear Group has brought together the CSDs of five European countries – Belgium, France, the Netherlands, UK and Ireland. They have developed a common cross-border business model based on a single technical platform. However, it is not expected to be fully implemented until 2010.

Undeniably, unifying CSDs into a common structure is no easy feat. CSDs settle trades executed on an exchange, but they also serve many other purposes. They act as the link between issuers and holders of securities. And in many countries, the CSD is the vehicle for the banking system to provide collateral to the central bank to support liquidity. In dematerialized markets, they act as the registrar and run accounts or investors.

Moreover, each CSD is deeply rooted in the legal and institutional framework of the country in which it is based. This has given rise to some debate over the pros and cons of the vertical and the horizontal model. In Germany, Italy and Spain, for example, the domestic stock exchange owns the CSD, whereas in most other countries the banks and other users own it.

Besides, it may not always be in the interests of all parties to rush into CSD integration. Many stakeholders generate revenue from managing the complexity of the international CSD landscape. If that were to change, all these organizations would need to understand the impact on their role.

Yet change is in the wind. Most recently, the European Central Bank (ECB) said it might set up a pan-European settlement facility for settlement in euros that would closely cooperate with the other services already offered by CSDs.

Industry observers question whether the ECB will be able to deal with settling transactions across euro zone and non-euro zone countries as the NCSD and Euroclear groups are doing. “At face value, it looks as if the ECB proposal would actually result in unwinding some of the [CSD] consolidation that’s under way at the moment,” notes Hugh Simpson, a consultant at Londonbased Bourse Consult.

Meanwhile, officials in the European Commission are waving a big stick at the industry to get its act together. Both Charlie McCreevy, EU Commissioner for the Internal Market and Services, and Neelie Kroes, Commissioner for Competition Policy, recently established clear deliverables that must be met in order to build a more efficient clearing and settlement infrastructure, the “Code of Conduct.”

The European Commission is not the only regulator breathing down the proverbial necks of clearing and settlement organizations. In a report published May 2006, the G30 Global Monitoring Committee (GMC) reiterated that facilitating clearing and settlement across different national and international systems is a priority. It also pointed out that despite greater adoption of uniform messaging standards and communications protocols, too many infrastructure providers continue to operate using proprietary standards.

We see this problem manifest itself as clearing and settlement organizations attempt to consolidate. “The coupling between CSDs and their members is much tighter than it is between the exchanges and their members,” says Anders Reveman, Senior Adviser to OMX and former President of VPC, the Swedish CSD. “Developments in CSDs can take many years because they have such a significant effect on the banks and brokers.”

CSDs are behind exchanges when it comes to consolidation, but they may be in the early stages of catching up. They have already taken the first steps through their efforts to increase harmonization, standardization and cooperation. The future may also bring legal and eventually IT consolidation.

By Sherree Decovny Illustration Måns Adolfsson

MarketView 2006:3