Clearing and Settlement shows the way

It looks like Clearing and Settlement in the Euro zone is finally moving towards consolidation after decades of trying. How much of this is directly due to MiFID is doubtful as many plans for consolidation had already been made but it's fair to say that there has probably been some acceleration because of the directive.

It was always thought that consolidating Clearing and Settlement in Europe was more difficult than bringing the Stock Exchanges together but the merger of LCH Clearnet and the development of Euroclear in particular has already brought major benefits in cost reductions and increased operational efficiency. There is of course more to go to bring the European capital markets up to the same quality of the American markets, which still are the international benchmark for CSDs and Clearing Houses to achieve.

The European Stock Exchanges have proved most obstinate and difficult to consolidate with any number of variations being tried whether trying to merge or instigate a takeover, with most failing. It has been left to Euronext with its takeover by the NYSE to move ahead of the pack. The LSE still flounders and the Deutsche Börse is cornered with OM and most of the other Exchanges in numerous stages of developing partnerships. Any number of the Stock Exchanges could disappear into merged single exchanges or become part of any of the largest Exchanges in Europe. All this is work in progress and the only thing clear is the certainty that mass change is still on its way.

The Stock Exchanges probably see the intrusion of ECNs and other electronic trading venues since MiFID as looming like a hatchet over their necks! Furthering the view that Europe is on the precipice of a major Stock Exchange cull. Who survives? You decide!

Notably the new trading venues that are breaking up the Stock Exchange monopoly have gained hugely from the consolidation and the flexibility of financial services firms to chose the CSD or Clearing House suited to their business. It's early but the signs are that Europe is definitely achieving the aims set by Giovannini and others.

The old argument of dealing, clearing and settlement under a horizontal structure of choice against the vertical straightjacket of monopoly finally appears to have won. The horizontal structure has brought so much business to Euronext and the LSE and has scuppered the Deutsche Börse badly. Interestingly the Deutsche Börse are now looking to shift Clearstream out of their vertical monopoly and adopting a horizontal structure putting them in the same ballpark as Euronext and the LSE. The ability of the Exchange user to choose their preferred Clearing and Settlement organisation has proved a great boost for the Stock Exchanges and significantly also for the new electronic trading venues. This will make the restructuring of the order/execution and clearing and settlement picture under constant change for sometime yet.

There is no doubt that ISO15022 implementation has assisted the market to develop more efficient and cost effective operations in the cross-border business but again there is much more to come as the market structure and relationship between Custodians and their customers evolves. We can anticipate far more outsourcing by buy side firms and Broker/Dealers in the future.

The considerable benefits in the consolidation of the clearing and settlement functions have wagged the tail of all the trading venues and it is here that the battle is being won for Europe. Asset Management and some smaller Broker/Dealers have been slow to recognise the business opportunities that a Pan European portfolio offers but as the Euroclear harmonisation nears implementation it can only be a matter of time before an explosion of new cross border trading manifests itself. The point is that the new trading venues are not the determining factor but rather the less sexy functional operational capabilities created in CSDs and Clearing houses.

The work undertaken by Euroclear needs recognition as their developments are creating a central black hole for settlements pulling in more international users, more business and offering the new trading venues invaluable solutions for their own expansion.

Although Euroclear were late to the ISO15022 party their harmonisation project has formed a pivotal solution to the historical problems inherent in Europe for centuries. Euroclear has already brought considerable rewards to their users but will really pay off once their developments have been fully implemented. None of this I might add is because of MiFID but it is one of the greatest enablers of the European single market vision.

Other CSDs have also moved towards a more internationally competitive capability and although not to the extent of Euroclear they have created a technical capability that allows the potential for consolidation or at least close operational partnerships.

The success story is no less compelling in the Clearing Houses where interoperability is becoming a reality. Ok there have been some teething problems as noted in the media but these seem to be overcome now. It's almost inevitable that consolidation or collaboration will follow, like the CSDs.

The flexibility and choice which are becoming a reality in the clearing and settlement functions, now offer financial services firms the opportunity to choose their trading venue or venues and build a Pan European business that has less cost and risk than imagined a few short years ago. The future is still uncertain and is going to take much longer to settle down than many realise but the signs are excellent that a successful conclusion to the many problems in European capital markets is in sight. The amazing thing is that it is in the clearing and settlement functions where the battles are being won and not in the dealing rooms, who could have made that forecast ten years ago?