As mentioned, last week was a clearing and settlement week, with lots of discussions about the issues of clearing in Europe. You would think if it was clearing, it should be clear … but it's a real mess of complexity and confusion if we're honest.
In Europe, part of the issue comes down to the European Commission focusing upon this area after MiFID rather than before.
MiFID you see, focused upon pre-trade equities investments in Europe. The aim was to get rid of the national exchange focused schemes, known as concentration rules, which meant that you had to invest on the national exchange of the country where the stock was listed.
The Commission wanted this to be open to new pan-European services but it has failed because pre-trade is only half the equation. Without post-trade clearing being addressed, where the trades are settled and paid, you cannot have an open and seamless market.
Therefore, MiFID led to a whole raft of issues as the explosion of new MTFs – exchanges like Chi-X, Burgundy, Turquoise, NASDAQ OMX and Equiduct – spawned a range of new and competing clearing systems, including SIX x-clear, EuroCCP and the EMCF.
MiFID also saw a dramatic rise in the use of dark pools, where trading blocks of orders is hidden from public view. These dark pools include systems run by the exchanges such as Baikal (London Stock Exchange) and Smartpool (Euronext), along with privately owned dark pools of market makers such as Goldman Sachs (SIGMA X) and UBS (Price Improvement Network), as well as those of the new MTF exchanges.
Then you have the new Electronic Liquidity Providers, such as GETCO, who create even more off exchange auto trading.
A mass of new trading venues and systems leading to the fragmentation of pricing and risk, and potentially making the markets more risk oriented due to the competitive nature of the brokers, exchanges and clearers involved.
This risk issue is demonstrated by the arguments EuroCCP are making over risk management, where their CEO has asked for an agreed convention in this space. Equally, reports of Goldman Sachs market manipulating doesn’t help.
These are the laws of unintended consequences, and they are all putting pressure upon creating a MiFID II to answer key questions around a consolidated pricing system, transparency in dark pools, the real definition of 'best execution' and how to create pan-European clearing systems that are truly comparable.
These are all questions challenging the Committee of European Securities Regulators (CESR), soon to become the European Securities Authority, who published a report on these issues back in June.
A core question in all of this relates to clearing and settlement.
Clearing and settlement was just plain missed when the European Commission began their lawmaking processes; and the problem with clearing and settlement is that traditional exchanges, protected by their concentration rules before MiFID, have raised barriers to pan-European trading due to the nature of their silo structures, where the clearing systems are integrated with the national exchanges.
Where the clearing and settlement systems are exchange owned and operated, the incumbents can lock-in and force buyers to trade and clear through the exchange, as they can’t get access to go anywhere else.
Some of these things are changing but the change is so slow that, by comparison, watching paint dry or grass grow or snails race is invigorating.
Now, thanks to the frustration of the new players, especially EuroCCP (owned by America’s DTCC) and EMCF (operated by Fortis and changing to new owners post the crash of Fortis), things may change.
These new players believe they can offer clearing at a fraction of the cost of the vertically integrated groups, but they are unable to access the markets. This is due to the barriers to trade and interoperability. In fact, it is pretty much impossible to even compare products and services across these markets that lock them out.
Change we can believe in
Where is the change coming from?
Well, it began back in 2001 with the Giovannini Committee chaired by Alberto Giovannini.
This Group analysed the issues to clearing and settlement across Europe and released a report in 2003 outlining 15 barriers to trade.
Most of these are industry related – transparency and access issues – although the most important barriers relate to government policies as they focus upon taxation and company law.
In 2003, the Giovannini report reckoned we could get rid of these barriers by 2006.
Therefore, in order to try to resolve such issues, the European Commission implemented a Code of Conduct for Clearing and Settlement in 2006.
The Code of Conduct came into force in January 2008 and has had sign-up from most clearers across Europe to resolve the issues of interoperability, whilst bringing in pricing transparency and unbundled products such that they could be more comparable.
It hasn’t worked however.
The Code of Conduct has reduced some barriers, but not much.
You still cannot compare products between CCPs across markets.
You therefore still cannot get a clear pricing structure or comparison.
And, no matter how hard you try, you still cannot see true interoperability across markets.
If you could, you wouldn’t need the creation of Trade2Clear, a working group comprising most of the new clearing systems announced on July 2nd.
In fact, you have three clear groups of clearers: the challengers, the incumbents and the gorilla.
The challengers are in the Trade2Clear camp which are the exchanges of Chi-X Europe, London Stock Exchange, Turquoise, Burgundy, Nasdaq OMX Europe and Equiduct; along with their clearers – LCH.Clearnet, SIX x-clear, EMCF, Monte Titoli and EuroCCP.
Then there is a second group of incumbents led by Clearstream, who have created a thing called the Linkup Markets alliance.
The Linkup Markets crowd covers key securities depositories from Clearstream Banking AG Frankfurt in Germany through CSE, Cyprus; the Hellenic Exchanges S.A., Greece; IBERCLEAR of Spain; Oesterreichische Kontrollbank AG from Austria; SIX SIS AG of Switzerland (those Swiss get everywhere don’t they?); and VP SECURITIES, Denmark along with VPS of Norway.
The final bit is the single platform developments of Euroclear, who cover the rest of Europe. Their focus is to create a massive single platform for European clearing.
These three camps are vying for supremacy and standards, access and transparency, and clear pricing with comparability.
But it’s not happening.
More change to come
This discussion thus far does not even mention the impact of other new things, such as TARGET2 for Securities (T2S), the ECB’s settlement service that combines collateral management (CCBM2) with settlement services.
T2S aims to get rid of most national Securities Settlement Systems and, as one person commented last week, “what incentive is there to get rid of 40% of your reason for existence?” This is in reference to the fact that most national Central Securities Depositories (CSDs) have half their business processing settlements … and that’s the half they’re now being forced to give up if it transitions to T2S.
Nor does it mention the latest craze to develop a single repository – not depository – for OTC Derivatives, along with clearing and other requirements in this market.
Nor the latest announcements which build upon the Code of Conduct and bring together the cumulateive work of the European System of Central Banks (ESCB) and the Committee of European Securities Regulators (CESR). These were published in a report: “Recommendations for securities settlement systems and central counterparties in the European Union” in June.
These recommendations are based upon an eight-year gestation period (that’s longer than it takes to give birth to a nation!) from the draft recommendations for securities settlement systems that were proposed in November 2001; and the recommendations for CCPs issued by the Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (CPSS-IOSCO) back in November 2004 **.
What was I saying about paint drying being more exciting?
Nor does it mention the relationship between central clearing at a national versus regional versus global level. Bearing in mind that we are talking these days about global markets requiring global regulations and regulators, regional operations for such global markets may not make so much sense anymore?
Nevertheless, first things first, let’s get the EU act together and, to do this, it means that there is now a very strong justification for a dictate to get this thing done.
A dictate means a Directive.
A Clearing & Settlement Directive
The industry doesn’t want this because they don’t like prescriptive regulation. Therefore, the industry will say the Code of Conduct works and continue to try to pretend this is gaining traction.
The European Commission doesn’t want this, because it means encroaching on member state’s laws for tax and fiscal reporting. Half the activities of securities depositories for example are involved in corporate actions, the payments of dividend and the calculation of taxes. The Commission doesn’t want to get into a bun-fight with national governments to attack this stuff.
But you know what?
Without getting involved, this space will just languish as a mess of clearing.
And that’s the last thing we want in light of the recent crisis so guess what?
A Clearing & Settlement Directive for Europe is on its way.
Draft legislation for consultative purposes is probably going to be published within a year or so, and then transposition in 2012.
This is pure supposition on my part but I just don’t see any other way around this.
Meanwhile, this is very challenging and specialist dialogue which I don’t normally report here … but, after a week of discussions about all of this, I thought a few of you might be interested to see what’s going on.
If you want to learn more, here’s some useful links (along with all those embedded in this report):
- Post-trade services come into their own, report from the Financial Times from February 2009 (six page pdf)
- Geithner Outlines Reform Proposals For OTC Derivative Market
- EU Seeks Use of Clearinghouses for OTC Derivatives
- Commission outlines ways to strengthen the safety of derivatives markets
- Plumbers and Visionaries, Book by Peter Norman
Although eight years in the pipeline, the CESR-ESCB
Recommendations were frozen under political guidance in 2004. As CESR's Post Trading
Expert Group state:
"Between 2002 and 2005, a joint CESR/ESCB working group
developed Standards for Clearing and Settlement systems in Europe. Following
other emerging initiatives in the area of post-trading, activities of the group
were disrupted after that period … In 2007, the CESR Members decided to
establish a group of CESR experts only, the Post-Trading Expert Group