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Dematerialisation is essential to keep Irish trading practices in line with best international practice Back  
An extensive consultation carried out by the Irish Stock Exchange in 2004 with Irish and UK market participants established that dematerialisation, which would lead to a paperless market, should be pursued as a matter of priority by the Irish equity market, so that practices are in line with best international practice. Failure to progress this issue will be a significant competitive disadvantage to the Irish market, says Brian Healy
DDriven by globalisation, increasing trading volumes and technological innovation, securities markets worldwide are undergoing significant changes to the manner in which transactions are processed. Consolidation among participants in securities markets, by (i) market operators such as stock exchanges, (ii) clearing and settlement providers and (iii) securities traders gives an even greater impetus to this drive to deliver more efficient and harmonised processing of securities transactions. In Europe, the European Commission’s Financial Services Action Plan (FSAP) is the legislative backdrop to much of this change. One of the core themes of the next phase of the European Commission’s policy drive is clearing and settlement.

Corporate activity among key players is moving in parallel with this harmonisation and reengineering process. Deutsche Borse and Euronext are vying to acquire the London Stock Exchange (LSE) and the different clearing and settlement structures of both the UK and German markets have become a critical issue in this bid. Europe, and in particular London, is at a crossroads and now has to take decisions that will be vital in determining the future landscape of securities trading, clearing and settlement right across Europe.

CRESTCo, the central securities depository for Irish and UK equities, has provided a world-class settlement infrastructure and has given both efficient and cost effective service to the Irish equities market since it was established in 1996. On merging with Euroclear in 2002, CRESTCo positioned itself for integration into a far wider offering across five European jurisdictions, at present: France, Belgium, Netherlands, UK and Ireland – with the prospect of more to follow.

It is therefore timely to look at some of the main challenges facing the Irish securities market in the context of this global and European change.

Harmonisation of settlement
Both Irish and UK equities are settled in the CREST system while Irish Government bonds are settled at Euroclear Bank in Brussels. Many Irish financial institutions use both systems. The merger of CRESTCo and Euroclear, effective from September 2002, created Europe’s largest settlement services provider, operating under the Euroclear brand name. Euroclear is now moving to create a ‘domestic settlement market’ comprising the French, Dutch, Belgian, UK and Irish markets. In the initial phase of the Euroclear plan a Single Settlement Engine(SSE) is to be delivered by 2006. The SSE will form the core of the new settlement infrastructure with the second phase of this project being further integration and the replacement of the various interfaces between the different national markets with a single common interface.

The expectation is that the implementation of the SSE will lead to economies of scale and a reduction in infrastructure costs thus leading to a marked reduction in the cost of settling cross-border transactions. It should also be possible for participants to cut their own back office costs as far more standardised procedures will apply in clearing and settling across the above five markets. This will benefit the investor as cost reductions should ultimately pass to the end-investor and it will increase investor choice since it should be easier and cheaper to hold a broader portfolio of European securities.

In order to enhance delivery of this radically altered infrastructure solution, Euroclear has commenced a process of analysis and consultation on the current operation of settlement practices across the five markets prior to harmonising them. It is of considerable advantage to the Irish market to be a participant in the largest European settlement grouping, one that is firmly at the vanguard of European developments in post-trade processing. However the Exchange was concerned that there was a risk that the interests of, or the particular issues faced by, the Irish market could lose out to the combined mass of the other four markets (including three that already fall within the Euronext trading infrastructure). To address these concerns, and to ensure that the Irish market is fully represented in this highly significant phase of securities market development, the Exchange lobbied Euroclear for and successfully achieved the setting up of an Irish Market Advisory Committee (MAC). The role of the MAC is recognised within the corporate governance structure of Euroclear.
It was established in November 2002, and is a market user forum with the principal purpose of monitoring developments, identifying settlement and post-trade processing issues concerning the Irish equity and government bond markets and then representing and pursuing these at Group level in Euroclear.

Dematerialisation of Irish equities
One of the main challenges to the Irish and UK markets identified by comparative analysis done by the Exchange against other well developed capital markets, as supported strongly by the deliberations of the Irish MAC, is the growing need for the Irish equities market to dematerialise. Dematerialisation has now become a benchmark for efficient and successful capital markets worldwide. For the purposes of this discussion by dematerialisation I mean the removal of paper certificates from the issuance, securities trading and post trade processing cycles of securities admitted to trading on the Irish Stock Exchange. Dematerialisation has either been implemented already in other EU jurisdictions or is currently the subject of attention. A similar analysis is relevant for the UK equities market.

The current position in the Irish market is that settlement of Irish Government bonds is entirely dematerialised while for Irish equities it is still possible to obtain share certificates for Irish equities. An extensive consultation carried out by the Exchange in 2004 with Irish and UK market participants established that the market consensus is that dematerialisation, should be pursued as a matter of priority by the Irish equity market. Only CREST participants such as stockbrokers and some other institutions can avail of dematerialisation at present. Currently if a private individual sells a certificated shareholding, the client selling the shares must complete and sign a stock transfer form and send it to his stockbroker together with the relevant share certificates, which are then lodged with CREST and ultimately are reflected on the issuer’s register. The disadvantages of the current system are mainly the inefficiencies and costs associated with the cumbersome process of managing paper-based transactions and the risks of fraud from misplaced and stolen share certificates.

The most developed securities markets worldwide have or are in the process of implementing increased levels of straight through processing with the aim of streamlining the processing of transactions and reducing settlement times. As one key element in achieving this goal, various markets have effected full dematerialisation in recent years including Australia and New Zealand. These countries meet the highest international benchmarks for efficiency in settlement, which benefits both market participants and investors. The Exchange and our colleagues in the market generally are keen to ensure that Ireland responds appropriately and immediately so that Irish market practices are in line with best international practice; failure to progress this issue will be a significant competitive disadvantage to the Irish market.

The Irish market has brought this issue to the attention of relevant government departments and has highlighted what we believe to be the optimal way to achieve the necessary legislative change. The Irish proposal for dematerialisation was also made available to certain participants and operators in the UK which galvanised an immediate response from the City. The UK is now on track to remove paper from the system as the market has obtained full government support for this issue. A report issued by the European Securities Forum (ESF) in December 2004 entitled, ‘Better, Quicker and More Efficient Investment Arrangements for the Individual Investor’, specifically dealing with dematerialisation, was issued by a broad array of UK market participants. Its analysis and conclusion was supported by the relevant Minister of the Department of Trade and Industry (DTI) in mid January. Significantly, the Minister also indicated that the DTI would take practical steps to implement dematerialisation as legislative changes would be incorporated in the UK’s Company Law Reform Bill this year.

Where does this leave the Irish market?
The Irish MAC strongly supports the removal of physical share certificates from the Irish equity market. The market is very aware of the concerns of investors who may have a preference for holding shares via a share certificate and who may be concerned at their removal. This concern will have to be and can be fully addressed. The full details of the proposal for the dematerialisation of Irish listed securities have yet to be finalised but the intention is that as well as the contract note provided to investors after every transaction by their stockbroker, there will be an additional safeguard of the independent provision of a statement by the registrar directly to the investor after every movement on an investor’s account. This will mitigate the risk of fraud as any potential fraudster will be aware that investors will receive independent third party statements triggered by any transactions on their account. Registrars and issuers will no longer provide physical share certificates to investors but instead will provide a statement of holdings, similar to a bank statement. The investor’s name will appear on the register as the holder of the shares and this should be achievable with no additional costs to investors from the provision of these statements or from the fact that the investor’s shares will be held electronically. As is the case today, the shareholder will still have the option of holding his/her shares in own name on the register or through a stockbroker’s nominee company.

A bespoke working group, known as the Dematerialisation Implementation Group, has recently been constituted with the sole focus of achieving dematerialisation of Irish listed equities on as timely a basis as possible. It comprises representatives of all key market constituencies, legal expertise and soon it should also incorporate representatives of the relevant government department and of the regulatory authority.

This issue of dematerialisation has become more urgent due to the recent UK developments as the consequences for the Irish market of negatively differentiating itself from the UK, as well as from other European markets, are likely to include an escalation of costs and damage to the reputation of Irish securities internationally. A timely and co-ordinated response by the Irish market is essential. Similarly, full engagement by all affected participants in the market with Euroclear’s initiative to create a ‘domestic market for Europe’ needs to be a priority in 2005 and beyond.

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