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| The European clearing and settlement market has undergone huge changes over the past ten years. FINANCE speaks to Pierre Francotte, chief executive officer of international securities settlement giant Euroclear, to understand what lies behind its business strategy for delivering a ‘domestic settlement market for Europe’. |
1: What role does Euroclear play in the Irish capital market, and what benefits is it bringing to investors and issuers here?
If I may, I’d like to turn the clock back almost ten years. In 1996, the Irish Stock Exchange outsourced its settlement requirements to CRESTCo, the London-based central securities depository (CSD) that is now part of the Euroclear group. Ireland was essentially the first market to subscribe to what was a revolutionary idea at the time: a common settlement system for Europe, transcending national legal and fiscal regimes. Then, in late 2000, the settlement of Irish government bond activity was outsourced by the Central Bank and NTMA to Euroclear Bank in Brussels. This in itself was another significant accomplishment and a first insofar as a ‘foreign’ CSD was given settlement and safekeeping responsibilities for a nation’s sovereign debt. Looking back, both developments were in fact decisive steps on the road to reducing post-trade fragmentation in Europe’s financial markets.
Dublin is, of course, also a major centre for the administration of offshore funds. Today, Ireland services funds worth in excess of €880 billion and plays host to over 250 fund promoters. Serving their domestic and cross-border processing needs is FundSettle, our tailor-made platform for the order-routing, settlement and servicing of fund transactions.
The attraction of FundSettle lies in the fact that it removes the complexity and risk from what is still a very labour-intensive part of the business. It is not uncommon for fund distributors to have bilateral agreements with each of as many as 150 individual transfer agents. FundSettle is the only fully automated fund-processing solution in Europe that centralises relationships between all relevant parties – from fund sellers right through to buyers – and from a single location. As a result, those 150 individual relationships maintained by fund distributors have now been reduced to just one – with FundSettle.
Looking to the future, we are working closely with the ISE on some of its most significant processing enhancements. In partnership with the exchange and Eurex Clearing, CRESTCo will shortly launch a central counterparty for Irish equities, bringing the benefits of full counterparty anonymity and improved counterparty-risk protection to the Irish market for the first time. We are also an active participant in the recently announced initiative to dematerialise Irish equities.
2: Euroclear has merged with or acquired several national CSDs in recent years, starting with Sicovam (now Euroclear France) in 2001, as well as Necigef (now Euroclear Nederland) and CRESTCo in 2002. What lies behind this strategy?
As a user-owned, user-governed organisation, ours is very much a user-driven strategy. The advent of the euro has seen increased portfolio diversification and greater levels of cross-border investment, which in turn have served to highlight the inefficiencies and unnecessarily high costs of Europe’s fragmented infrastructure. This fragmentation is largely due to the historical evolution of Europe’s national markets, where each one generally had its own exchange and settlement provider. Although we often refer to a single capital market in Europe, the reality is that it is still very much a juxtaposition of 25 national markets.
Our main strategic objective is to reduce the cost and risk associated with cross-border securities settlement, particularly where equities are concerned. We aim to achieve this through the consolidation of national and international settlement platforms and the harmonisation of market practices and processes.
When we merged with CRESTCo in 2002, we laid out an elaborate, multi-year business model that will ultimately deliver a low-cost, uniform processing solution for all of the markets in the Euroclear group: Belgium, France, Ireland, the Netherlands and the United Kingdom. It is this foundation for a ‘domestic settlement market for Europe’ that we are now in the process of building.
3: Just how much more expensive is Europe’s current post-trade environment than it should be?
We estimate that about E1 billion of excess costs per year can be attributed to inefficiencies that the market could, and indeed should, address itself. While this is a sizeable amount even in absolute terms, the negative impact on Europe’s international competitiveness and the ability of European issuers to raise capital here is even more pronounced.
A practical illustration of this inefficiency was provided by one of our broker-dealer clients recently, who informed us that they can settle 2 million trades in the US for as much as it costs them to settle just 60,000 in Europe. Taking a local example, if an Irish broker wanted to buy shares on the Borsa Italiana (Milan Stock Exchange), they would have to pay as much as 25 euros to settle the transaction. A similar trade with an Irish counterparty would typically settle for less than one euro through CRESTCo.
What lies behind this? A large portion of the excess cost is attributable to the myriad of specialist expertise and multiple technology interfaces that are currently required in financial institutions’ back offices to cater for Europe’s divergent capital-market structures and practices. In addition, this excess includes the high cost of having to use chains of intermediaries – agents that charge fees to hold accounts and settle trades with foreign counterparties.
4. What form of savings can users expect to reap from the implementation of your business model?
By harmonising and consolidating, our aim is to remove E300 million annually from current costs. We believe that E240 million of this can be delivered by streamlining clients’ back offices, as well as through lower fees to intermediaries and settlement ‘internalisation’, meaning that trades from clients in the five Euroclear domestic markets, and those using Euroclear Bank’s cross-border services, will be settled as simple ‘book entries’ at domestic-level prices. Internal Euroclear savings should be about E60 million, as we will be running fewer systems and have simplified operational processes and, therefore, lower operational overheads.
If our solution was extended across all of Europe, it could generate annual savings of E700-800 million, eliminating up to 80 per cent of the total excess cost of E1 billion.
5. What progress has been made to date on the implementation of your business model?
Insofar as our market-practice harmonisation efforts are concerned, we have already inventoried the principle differences that exist across the Euroclear markets. Our focus is now on the uniform implementation of the various standards and processes that have been agreed across the markets, from the processing of corporate actions to settlement and transaction lifecycles.
Consultation with the market has been a key component of what we have achieved to date. We have consulted extensively with our clients and have attained very broad support to move forward in partnership with them. In terms of the Irish market specifically, the work done by our Market Advisory Committee (MAC) here has been excellent. Comprised of representatives of institutions such as AIB, Davy, Goodbody and the Irish Stock Exchange (ISE), the MAC has proven to be an effective and influential body in making sure that the views of the Irish market are taken into account in our broader strategy.
Turning to platform consolidation, we are less than a year away from a very important milestone. Our Single Settlement Engine (SSE) will be launched in 2006, laying the foundation for all further platform consolidation within the Euroclear group. Irish equity services are expected to move onto the SSE in July of next year, with Irish government bonds following in October.
Then, in 2007, we will launch a single processing and asset-servicing platform for the three Euronext markets in the group - Belgium, France and the Netherlands. We also expect that by 2007, these three markets will have agreed and implemented harmonised market rules and practices. The launch of this service – called ESES, for Euroclear Settlement of Euronext-zone Securities - will complement Euronext’s Single Order Book for these markets in the trading sphere.
The final phase, involving the remaining elements of what we call our ‘Single Platform’ will be implemented by service type during 2008 and 2009. First, all custody services across the Euroclear group will be migrated onto the Single Platform, followed by settlement and collateral management services across the group.
6. Some experts feel that Europe’s capital markets have been slow to embrace change, and usher in greater efficiencies and lower costs. What are your thoughts on this?
I would argue that the market has actually done quite a lot over the past couple of years. A certain momentum has been created and we are witnessing progress on removing all six of the barriers to efficient clearing and settlement that were identified by the Giovannini Group as being within the remit of the market to tackle.
For example, members of the European Central Securities Depositories Association (ECSDA) have agreed on common opening hours and days, and standards for settlement finality. There is already an 85 per cent compliance rate on these two measures, and ECSDA has received firm commitments and time-lines from those CSDs that are not yet fully compliant. Furthermore, it is widely perceived that Barrier 8, differences in issuance practice, has been addressed as there has been wide-scale acceptance of ISIN codes as the standard for identification of issued securities.
However, it is important to move from agreement to harmonise towards implementation of harmonisation. Here, our platform-consolidation efforts provide the opportunity to effect tangible change.
Other organisations pursuing the harmonisation agenda include SWIFT, the European Securities Forum, the European Banking Federation and the European Association of Listed Companies. Furthermore, my membership of the Commission’s advisory body on clearing and settlement, CESAME, also enables us to communicate what we are doing to a wider audience, and to understand their plans as well.
Of course, only six of the 15 Giovannini barriers have been placed at the door of the private sector. The removal of the remaining nine barriers lies in the hands of the public authorities, and we would like to see them bringing concrete proposals to the table as soon as possible.
7. Should clearing and settlement be subjected to an EU Directive?
The European Commission is currently conducting a regulatory impact assessment to determine whether or not a directive on cross-border clearing and settlement is required to accomplish its intended objective of making the industry more efficient. A decision is expected in the first half of 2006.
We do not believe that a measure focused on the activities of settlement systems will necessarily reduce cross-border settlement costs. The market is already making very good progress in removing its six Giovannini barriers. We are convinced that the work and momentum now in place across Europe to harmonise market rules and consolidate settlement infrastructures is by far the best way of achieving the Commission’s goals.
As I mentioned earlier, successful implementation of our strategy will save the market about €300 million per annum alone; other market-led initiatives, in the clearing area, for example, will add to that.
In addition, increased competition between Euroclear Bank and the agent banks has already driven down the latter’s fees significantly. Driven by strong user governance and user ownership, Euroclear too has reduced its fees - by more than 30 per cent over the past three years - and more can be expected in the coming months.
The private sector is investing a great deal of time, money and effort to deliver market-practice harmonisation and settlement infrastructure consolidation.
Misplaced or untimely intervention by Europe’s policy makers at this stage could slow or even stop that progress altogether.
We believe that the Commission’s role is to monitor the concrete progress being made by the market. Beyond that, its focus should be directed towards legislation that will reduce legal uncertainty and harmonise fiscal regulations, in line with the recommendations outlined by Dr Giovannini and his colleagues almost three years ago. |
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