A guiding light
Cross-border trading has been established in several regions, but in 2015 Europe will become unique in its use of a harmonised, cross-border settlement system and may even be in a position to sell its model to other regions.
Next June the first wave of central securities depositories (CSDs) will migrate their cross-border clearing activity to the Target2-Securities (T2S) platform, a pan-European system that will enable investment firms to settle trades made in any country on the continent through the CSD of their choosing, writes Dan Barnes .
First proposed in 2006, the project has been a long time coming and the negotiations have been arduous at times. Twenty-four CSDs have agreed to process their euro-denominated business via the T2S platform, a process which pits them as competitors while robbing them of a revenue stream.
Alan Cameron, head of relationship management for international banks and brokers at BNP Paribas Securities Services, says: “All of these independent CSDs, mainly privately owned, have, as one, outsourced a core part of their capability to a quasi-governmental body. There is nothing like this that has been tried in any industry, anywhere else in the world, anywhere before. It is a very unusual thing that can happen only thanks to the unique circumstances around Europe.”
The purpose of building T2S was the creation of a common market; having created a currency union for many European countries in 1999, uniting the capital markets was seen as a next step. Each function of capital markets that operated as a national monopoly – stock exchanges and securities depositories – would have its monopoly removed. A primary objective was the lowering of costs so that Europe could compete with large domestic markets such as the US. Introducing competition into these arenas was unpopular with the incumbent firms who had national, extra-national or multinational monopolies, but inevitable.
Private firms had already sought to benefit from cross-border operations. For example, Euronext became the single operating firm for the Amsterdam, Brussels and Paris bourses in 2000, expanding to take London’s derivatives market and Lisbon’s stock exchange in 2001-02. Post-trade service provider Euroclear, which has a partnership with Euronext, acquired the Anglo-Irish, Dutch and French CSDs between 2001-02 and the Belgian CSD in 2007.
The regulatory breakdown of national barriers undermined this process of corporate accumulation, as it allowed firms to operate across the continent from their domestic hub. The economist Alexandre Lamfalussy set out a bureaucratic process for building a single European market infrastructure in 2001. A task force of industry experts – the Giovannini Group – identified areas of market harmonisation that would reduce the national characteristics of Europe’s capital markets, producing reports on clearing and settlement in 2001-02. The Group concluded that “inefficiencies in clearing and settlement represent the most primitive and thus most important barrier to integrated financial markets in Europe”. This led to the European Central Bank proposal for T2S.
“Cross-border projects previously were just ‘talk shows’ really; they had no time frame and no real pressure,” says Jean-Michel Godeffroy, chairman of the T2S Board at the ECB.
National projects to deliver unified post-trade can be hard work – at the end of 2012 Russia consolidated record-keeping for stocks from more than 40 registrars to a single CSD. However there are other regional projects that seek to create a single market for trading across multiple countries, replicating the T2S challenge. The two most advanced of these are the Mercado Integrado Latinoamericano (Mila) launched in 2011 and the Association of Southeast Asian Nations (Asean) Link launched in 2012.
Mila connects the Bolsa de Valores de Colombia, Peru’s Bolsa de Valores de Lima and Chile’s Bolsa de Comercio Santiago Bolsa Mexicana de Valores is expected to connect by the end of the year.
The Asean Link, which connects Singapore Exchange (SGX), Bursa Malaysia and the Stock Exchange of Thailand, is expected to expand to the Philippines, Indonesia and Vietnam.
Godeffroy says the political and regulatory union that exists has enabled a development in Europe that other regions will find hard to follow.
“We have been able to develop our own platform for T2S because of the European integration,” he says. “In other regions, hosting market infrastructure outside of the national boundary would not be feasible. As far as I understand Japan does not intend to host its settlement processing in Korea, or vice versa, and that will be a stumbling block to a deal.”
Certainly the Mila and Asean Link projects are beset with difficulties. Local brokers report that Mila has not experienced the take-up expected. Its latest volume report from March 2014 indicated a turnover of $5.23 billion, still some way below its $7.5 billion monthly target, although a 14 per cent rise on February’s $4.56 billion. Settlement has remained siloed within the individual countries, meaning that while access to trading across borders can be facilitated by a local broker, there is no post-trade efficiency.
Rob Scott, head of custody and collateral solutions at Commerzbank says the Mila consolidation of exchanges in Peru, Colombia and Chile is not a move to standardise markets. Rather, it enables investors to have a choice of products across exchange traded funds, mutual funds and derivatives. “If you look at those markets in isolation they are heavily focused on areas like mining, service sectors and industrial. Mila is more of an access route than it is an attempt at harmonisation and industrialisation.”
The Asean Link has learned lessons from the pan-Asian exchange Chi-East, which was set up in November 2010 by SGX and Chi-X Global, but closed in May 2012 following a disappointing performance. Its principal challenge was an inefficient model of interacting with the Japanese, Hong Kong and Singapore post-trade infrastructures according to the security that had been traded.
As a result the Asean project is trying to tackle post-trade integration. In addition to delivering a trading link between markets based on SunGard Technology, in April it announced that Deutsche Bank would be providing brokers with a single point of connectivity for clearing and settlement services.
“Asean Link did set about to standardise, harmonise and mutualise regulation but it is very difficult to achieve because most markets in Asia operate very independently,” says Scott. “That is one of the reasons that Chi-East failed, despite the support of the Singapore Exchange. I do believe that in the mid- to long-term we will see a kind of T2S environment develop in Asia, it makes sense for some of the markets but at the moment I think that is a little way off.”
It is not the platform and connectivity that provides the greatest stumbling block to engagement with the platform, says Hans Sicat, chief executive of the Philippines Stock Exchange. He observes that a lack of harmonised regulatory framework can be a greater challenge..
“The easiest part is to turn on the computer link,” he says. “In the Philippines there is a regulation that says you cannot buy a financial services product which is not registered with our Securities and Exchange Commission. That restriction means that even in an age of cross-border internet access even if the Link was live, a Filipino investor could not buy overseas securities, but other investors could buy our securities. When the openness does come, it will be a net plus for the Philippine financial markets.”
Marc Robert-Nicoud, member of the Clearstream Executive Board responsible for strategy, believes that once these initiatives achieve the level of integration that they want in the trading business, they will look at harmonisation in post-trade. “There are different ways it can go; a larger domestic market may become a reference market; it could go in the direction of trading in an extra-national regional market as Europe did with the Eurobond market,” he says. “A good way to sidestep these political discussions is to support a model that has no nationality.”
As the Giovannini Group reported in 2002, “the distinctive feature of a cross-border settlement relative to a domestic settlement is that it involves gaining access to a settlement system in another country and/or the interaction of different settlement systems”.
Regulators want a certain amount of control over how infrastructure is set up. To be completely reliant on another country will not sit well with some of the regulators, for example it was the reason cited by Australian authorities when they vetoed a merger between the Australian Securities Exchange and SGX in 2011. In addition a process of harmonising procedures and rules must be in place, or the project risks simply placing that weight of the harmonisation on a single entity, as occurred with Chi-East. Negotiating where that control sits is difficult without a pan-regional authority as exists in Europe.
For the moment, the ECB is not publicly discussing the admission of non-European CSDs, as Godeffroy says it, “… would raise a lot of legal issues”. However there is no reason T2S cannot serve as a guide for other initiatives.
Hugh Palmer, head of T2S project at Societe Generale Securities Services says while T2S is one single technical platform, it is also a major achievement in terms of fixing standards, lifting the Giovannini barriers and in defining how the post-trade industry works. “So I would say other markets that want to replicate the initiative can at least have a starting point of a set of standards that will become more or less an industry norm.”
He cites the T+2 settlement cycle as an example, to which a number of markets outside of Europe are seeking to align. “I feel that that will be the case for a number of the other standards that T2S brings to successful implementation after many years of discussion,” he says.
There may even be a case for more technology-based support, says Godeffroy.
“Thinking out loud, it should be possible for [the ECB] to sell a licensed copy of the software to allow other regions to process their cross-border business, for a fraction of the cost to build a platform,” he says. “That could create a win-win situation which would improve our current cost model which is not bad, but is difficult.”
For now there is still much to be done in Europe. As the first wave goes live in June 2015, the market will see if T2S actually works and at that point, depending on the result, it could trigger renewed interest both from outside and inside Europe.
“The critical issue will be whether the central banks of the UK and Switzerland in particular agree to outsource settlement in their currency to T2S,” says Godeffroy. “I think that if we can prove that T2S is now part of the plumbing of the European capital markets and that political issues, which existed at the beginning when we announced the project, have disappeared then I think that they will be persuaded to use the European infrastructure rather than renewing their own infrastructure; it is an issue of timing.”
