Post-Trade Competition Stirs in Europe

Terry Flanagan

Competition in post-trade clearing and settlement services in Europe is beginning to emerge following years of false starts, as legislators and industry participants seek to harmonize a fractured landscape dotted with numerous national jurisdictions.

Operators of central securities depositories (CSDs) will be subject to a new regulatory framework under legislation that’s contemplated by the European Union.

CSD regulation, together with Markets in Financial Instruments Directive (MiFID) and European Markets Infrastructure Regulation (EMIR), form the triumvirate of legislative actions in Europe that will transform the functioning of the securities markets.

The CSD regulations are a long time coming. The Giovannini Group, in a 2001 report, had identified several barriers to efficient clearing and settlement systems, including national differences in settlement periods.

”The regulations on CSDs, which are due to be published this year, have been under discussion for years,” Tony Freeman, executive director of industry relations at Omgeo, a joint venture of Depository Trust & Clearing Corp. (DTCC) and Thomson Reuters, told Markets Media. “The financial crisis provided the EU with the impetus to replace patchwork national regulations with a pan-European approach.”

In the United States, National Securities Clearing Corp. (NSCC), a subsidiary of DTCC, functions as the central counterparty for the nation’s major exchanges and markets, clearing virtually all broker-to-broker equity, listed corporate and municipal bond trading in the U.S.

“DTCC is widely admired for cost effectiveness and scale,” said Freeman. “European regulators and legislators are seeking the same level of efficiency across 27 countries and 27 different legal systems.”

The European Central Bank’s Target2Securities (T2S), scheduled to go live in 2014, will house market participants’ central bank cash accounts and securities accounts in a single place, thus facilitating settlement in central bank money.

This differs from the current situation in which securities accounts are housed at CSDs and central bank cash accounts are housed at the ECB, which means that settlement requires the sending of messages to and from the CSD and the central bank to confirm the transfer of securities and the cash.

Once EMIR enters into force, all essential market infrastructures will be regulated at the European level: trading venues by MiFID and central counterparties (CCPs) and trade repositories by EMIR, with CSDs having their own regulatory framework.

As for clearing, a solution to high clearing costs in Europe in the form of interoperability between the various CCPs has been an objective of the EU for some time, and is starting to get some traction.

BATS Europe, for example, has launched a Preferred Interoperable Clearing Program to allow trading participants the choice of a preferred clearer from three interoperable clearers: LCH.Clearnet, SIX x-Clear, or EuroCCP, pending regulatory approval of interoperability arrangements between these three CCPs.

“BATs is one of the most forward-thinking market operators in Europe, and this will hopefully lead other exchanges and clearers to follow suit,” Steve Grob, director of strategy at Fidessa, told Markets Media.

However, potential conflicts of interest involving dual ownership of exchanges and CCPs threaten to undermine interoperability. “A lot of national exchanges have a virtual silo model, which means they own the entire process, including clearing,” Grob said. “That vertical model confers a lot of advantages on the national exchanges.”

MiFID states that investment firms should be able to choose the most appropriate clearing and settlement provider, independent of its locality or nationality. But it doesn’t stipulate how this should work in practice, leaving it to be frustrated by commercial interests; for example, if a CCP is owned by an exchange it may wish to prevent another trading venue having access.

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