Clients will demand greater efficiency on the part of service providers, warns Laurence Horobin of Deutsche Bank

By this time next year, the economies of Europe will be in the first phase of a planned transition to a single European currency. During the transition phase, which spans the period from January 1 1999 until the scheduled completion by the summer of 2002, clients will be free to make and receive payments in either euro or the national denominations of the single currency.

The speed and impact of the transition from national currencies to the euro will vary widely between broker-dealers and institutional investors. The custodian bank which wishes to succeed must understand the differing requirements of each, whilst providing the same, high standard of service to all participants.

The national stock exchanges and central securities depositories (CSD's) of the 11 participating countries have chosen to quote, trade and settle securities exclusively in euro from January 4 1999.

Broker-dealers must therefore be prepared to quote, trade and settle securities in euro from that date following their migration to the euro over the transitional (or Big Bang) weekend, which begins on December 31 1998 and ends on January 3 1999.

Institutional investors do not face such an aggressive timetable. Their custodian banks - and to a lesser extent their broker-dealers - can protect them from the initial impact of the euro. For institutional investors and companies issuing securities in the euro-zone, the choice to move to or even recognise the euro will follow the no compulsion, no prohibition" principle, and they will move at a time of their choosing during the next three years.

Redenomination: The different paces of migration to the euro are not just restricted to the participants in the market. Whilst all securities will trade in euro with effect from the January 4, the redenomination of the securities to reflect the new currency will be at varying paces.

Debt: For government debt, to demonstrate commitment to the single currency, participating countries have decided to redenominate over the first weekend, with an effective date of January 4 1999.

For corporate debt, redenomination of nominals will take place at any time during the three-year transition, at the discretion of the company or issuer.

Equities: Shares will be quoted, traded and settled exclusively in euro from January 1999 even if the nominal share capital of the company is not denominated in euro. Companies are not obliged to redenominate their shares before January 2002. The conversion of equities will be decided by the company rather than imposed by the regulatory bodies.

As Europe's largest custodian, Deutsche Bank expects to offer clients a service which will maximise their understanding and preparation for the process, as well as ensuring that we are able to process the event and advise clients of results quickly and with a minimum of human intervention. Redenomination will take place at a client level, thus ensuring that each client receives their exact entitlements. Each redenomination will be treated as a specific, new, corporate event. There are many benefits to this approach, not least because it enables the use of existing, proven functionality to provide detailed client advices in advance of the event as well as when it occurs. Full client service support will be available to clients through the course of the year, including "le weekend" and beyond, to assist with any client queries.

Transaction conversion and instruction

processing: Transaction conversion over the year end, and beyond, are key tasks to be carried out. Trades "pending" settlement at the time of the conversion will have to be converted to euro for settlement purposes. Should a customer not wish to, or be unable to convert to the euro on day one, we will be able to automatically convert instructions between legacy currency and euro and then back again for client reporting purposes. This flexibility recognises our home markets' needs and will enable the bank to interact with the market exclusively in euro, while protecting clients from a conversion to the euro at a time not of their choosing.

Custodian reports: Flexible reporting will be an important factor in the transition to the euro. Redenomination advices are vital to give clients an understanding of what the impact of the euro will be on their portfolios. The ability to provide reporting to clients in legacy currency or euro, or both, will be important, especially in the early days as clients familiarise themselves with the new currency and its value.

Cash management: Clearly, the euro has a major impact on cash services. A number of different payment channels can be used to move euros within a country as well as across national borders. Each of them provide facilities, at a variety of costs, to make payments in the new environment. Clearly, not all banks will be able to, nor wish to use, all of these methods. Only those with local market presence in all countries coupled with effective technology will be able to maximise the opportunities that the euro brings.

Custody services - securities settlement, income collection, corporate event processing and transaction and portfolio reporting - will be affected in a number of ways by the introduction of the euro. Understanding the conversion process and the transition period, and protecting clients from the difficulties they present, is the responsibility of the custodian banks.

It is imperative that custodian banks add automatic redenomination and reconventioning functionalities to their securities management and control systems. Auto-mation of this kind is vital to ensure that the necessary changes are made within the allotted timescale of the initial Big Bang conversion and the subsequent three-year transition of corporate debt and equities.

Ensuring that clients are informed quickly and accurately about the impact of the euro on their portfolios both before and at the point of redenomination will be crucial to the smooth introduction of the new currency. Custodian banks must ensure that clients have adequate information to make a sensible decision about the timing of their own conversion to the euro. Custodians must be prepared to accept instructions and provide reporting and accounting in national currency denominations well into the next millennium.

The euro is providing all custodian banks with a stern test of their capabilities. They will have to manage a significant number of changes; keep their clients fully informed with timely communications in their preferred format; and offer the maximum degree of flexibility in the products and services they provide.

The transition to the euro will see custodian banks being increasingly called upon to bridge the gap between wholesale market efficiency expectations and the underlying infrastructure, which are unlikely to change at the same pace as the cash market and investment strategies. This can only lead to far greater demands on the major custodians to increase efficiency and fully meet client expectations.

Once the euro is in place, technical competence will not be enough. Appreciation of the emergence of a single market, and above all the anticipation of its impact on the range of services clients now require, will determine the long term success of custodians.

The single market will open a very large client base to financial service providers. The removal of currency risk, as a direct consequence of the euro, will be a major factor in creating a large and liquid European securities market, rivalling the US and Japan in many respects.

As the market structure changes, the investment patterns of in-country investors will evolve. A gradual increase in the percentages of funds invested outside of national currencies will be coupled with higher volumes of transactions across national borders. The launch of new funds, the impact of the mounting pressure of pension fund obligations, combined with the need for improved returns, will additionally force European fund managers to invest greater amounts outside their own national borders. North American and Asian invest-ors will also take advantage of the single currency benefits to diversify their portfolios.

The increase in cross-border investments and differing levels of client preparedness for the single currency environment, will create demand for euro-zone product solutions. The potential lies equally for fund management, cash and securities processing, or any other financial service providers to capture greater market share in Europe and beyond.

However, to realise the opportunities presented by the euro, financial institutions must first overcome the hurdles presented by the transition phase. In summary, the operational and business issues that constitute the transition are:

l euro compliance of systems

l employee education

l impact on existing process flows

l development of new operational processes and procedures

l redenomination and reconventioning of securities

l Big Bang

l three-year transition

l transition of second wave of countries

l trade instruction conversion

l account denomination conversion

l client education and information

l flexibility of client reporting

l varying pace of migration by clients

While these are real challenges, they are of a short term, tactical nature. Indeed the considerable planning exercise and financial, technical and human investments required to successfully master the concurrent euro and Year 2000 implementations may distract from the fundamental choices with which the financial industry is confronted.

The real opportunities will be offered to those companies which have developed a clear business strategy beyond 2002 while managing their business through the transition. The creation of a single market will introduce irreversible trends of competitiveness and service pricing transparency. Financial institutions will be forced to concentrate on core competencies from which cost efficiencies and profit maximisation opportunities will arise.

A custodian's true commitment to its business will be tested to the full with the introduction of the single currency. As a key part of the financial services industry, custodians will need to address the long-term role that they want to play in an industry that is likely to see further consolidation in Eur-ope. The ability to maintain and increase the financial, technological and human investments paramount to offering clients a truly flexible and comprehensive service range, while margins further decrease, will reveal a custodian's long-term business strategy and its proficiency to derive additional revenue from new products.

Custody clients will benefit from improved quality services provided by stable providers which have understood the changes brought by the single currency as well as the impact on customers.

Ultimately, the real challenge for the securities services buyers is to select the right custodians, which will enable them to meet their own clients strategic objectives and maximise their opportunities through the custodians' services and products, while being able to focus on what they have defined to be their core business.

Laurence Horobin is associate director, custody services, global product development at Deutsche Bank in London"

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