Few custodians would argue that Europe is the place to be. Yet, at the same time, talk of a European marketplace is something of a misnomer. “The trigger for_harmonisation was supposed to be the introduction of the euro, but while we hoped the next steps would follow quickly thereon in, the devil lies in the details of national vested interests, national legislation and regulatory structures,” says Joachim Sierig, head of business strategy at Deutsche Bank Global Securities Services (GSS).
The failure of the proposed London-Frankfurt exchange merger was a sobering wake-up call: “Early on, there was a strong belief that significant progress could be made just be merging trading platforms or stock exchanges,” Sierig says. “However, one reason for the failure of the merger talks was that the participants came to realise there was much more required if they were to realise the synergies. Who was aware before those talks that 75% of the synergies actually lie in the post-trade part of the value chain?”
Adds Tom Zeeb, managing director and head of sales for Europe at The Bank of New York: “All over Europe we are seeing a lot of talk about harmonisation of regulations and of retirement savings vehicles in one form or another, but the reality is that – in the short to medium term at least – that is not going to happen. There are still so many market-specific factors from a settlement perspective – there are still different deadlines, different information flows from the exchange to the stock exchange, different tax regimes and so forth.”
Certainly, the sophistication of investors, and hence their investment behaviour, is far from homogenous. Broadly speaking, three ‘sub-regions’ can be seen to co-exist within the EU: the UK and the Low Countries, where there already exists a large asset pool; Germany and France, where a huge amount of growth is still to come, but which equally pose difficulties (in terms of regulations and local competition) to non-indigenous custodian banks); and Italy and Iberia, which are already seeing significant growth but, again, are overbanked and subject to regulatory restrictions.
“There is a big difference between the Anglo-Saxon European markets – the UK and the Netherlands – which have embraced pension reform and privately-funded retirement provision and the rest of Continental Europe,” says Stefan Gmuer, head of customer management – EMEA at Deutsche Bank GSS. “While the shift towards more international investment patterns presents a huge opportunity on the one hand, at the same time the non-uniform nature of regulations with the EU puts a premium on local knowledge and delivery capabilities. For instance, in Spain and Italy there are local regulatory requirements which simply do not allow you to offer a full-blown global custody service out of a single hub.”
The speedy dissemination of information – which lies at the very heart of the custody offering – across the different European markets is a key challenge facing custodians. “The consolidation amongst big institutional investors, and the various cross-border mergers they have themselves undertaken, means there is an ever greater desire to have a clear understanding at the group head office level of their exposure to a certain market or region,” says Zeeb. He cites the example of a large insurance company with subsidiaries scattered throughout the various European markets: “Those subsidiaries have either been bought as part of mergers or set up as separate entities to meet local regulatory requirements, and in most cases they are required to use a locally registered bank as a depository. Also, in most cases they will have some sort of distribution arrangement with that local bank for the funds which that insurance company holds. So you at present you won’t get a company like that to commit lock stock and barrel to one provider for its global custody services.”
However, if a hub approach is not presently viable in respect of custody services within Europe, that is not necessarily the case when it comes to clearing, Zeeb argues. “European financial institutions have generally run activities through their universal banks, whose back offices were essentially one big black box regardless of whether deals came through from the branch retail network or the institutional side or from the proprietary side, everything was thrown into the same back office,” he says. “What we are seeing – and this is a contributing factor in terms of the uptake of outsourcing – is that these big universal banks are starting to split up their own internal information and deal flows on the basis of where that business is coming from.
“For instance, if you have internet brokerage business coming through from a retail client, does that really belong in a custody environment? The answer in most cases will be no, because the business activities such as day trading they will be doing will never be competitive if you are applying a custody rate card to it along with full tax reporting and so on. So we run it through the clearance side – the clearance engine can accommodate that kind of high volume, low value transaction very competitively, whereas a global custody operation centre is geared up for servicing a portfolio as opposed to merely grinding through transactions.” However, as Zeeb is quick to point out, “there are few global custodians who are also global clearers such as us – the systems are very different, it is not just a matter of doing custody faster”.
The advent of central counterparty (CCP) services for securities around the region will – in theory at least – go some way to bypassing some of the outstanding issues relating to the fragmentation of the post-trade landscape within Europe, notes Sierig. By using netting to reduce the volume of trades that actually need to be settled, CCPs should also help reduce costs. “The problem the whole industry faces at the moment is how to efficiently service the individual investor who wants to buy a few hundred IBM shares for a few thousand dollars,” adds Zeeb. “The infrastructure isn’t yet geared up to do that.”
In Europe, as elsewhere, the barriers to entry within the custody business remain intimidating in the extreme. Given the levels of investment required – particularly in the technology sphere where, despite the internet-led shift to more open architectures, the burden of staying at the bleeding edge remains onerous – critical mass remains vital, as does the ability to offer a broad range of services above and beyond the traditional core competencies of safekeeping and settlement, such as securities lending and performance analytics, which allow client assets to be exploited to the full. “Aside from a lack of a proven track record, gaining that critical mass would be the challenge for potential new entrants,” says Sierig. “The only way to achieve that is to utilise an existing client base, and from that perspective there are only a few banks left who are not as yet involved in the business capable of leveraging such a client base.”
One possible scenario is the emergence of entities capable of allying a powerful, if narrowly focused, processing solution with economies of scale, thus undercutting custodians in the core areas of safekeeping and settlement. It has long been debated whether Europe’s central securities depositories (CSDs) will in time seize this mantle. Certainly, recent consolidation in this sector – which has seen the two international depositories (ICSDs), Euroclear and Clearstream merge respectively with Sicovam, the French CSD, and Deutsche Börse Clearing – while predicated on enhancing efficiency and cutting costs at the national level, has brought such a scenario a step closer to reality. Furthermore, it is expected that the Dutch and Belgium depositories will soon amalgamate with Euroclear/ Sicovam in the wake of the Euronext exchange venture, while Clearstream recently acquired a stake in Monte Titoli, the Italian CSD. However, the decision by CRESTCo in the UK and SegaInterSettle, the Swiss CSD, to eschew partnership or merger with either of the ICSDs in favour of establishing the separate Settlement Network grouping (although they will be working with Euroclear to service the new virt-x exchange) means a unified European Clearing House along the lines of the Depository Trust & Clearing Corp in the US is still some considerable way off.
Given the grandiose scope not just of the model itself but also the egos involved, the concept of a single pan-European depository remains mired in controversy. The European Securities Forum, a pressure group formed by the largest institutions involved in the sector, has voiced its support for a single clearing entity, while at Clearstream the view was that a unified structure bringing together not only pan-European settlement but also trading was crucial if international capital flows were not to flee the Continent.
However, other figures within the industry, such as Charles Cock, head of multi-direct clearing and custody at BNP Paribas Securities Services, warn against adopting an ‘oversimplified’ approach to post-trade processing within Europe. While Cock recently acknowledged that cross-border processing for equities remains “the ultimate challenge”, he also warned that “the process will not simplify overnight and consolidation in the market utilities will not produce some magical quick fix”. “We must be careful that in finding a solution to Europe’s inefficient investment, trading and settlement environment, we do not create an alternative monster,” he commented. Furthermore, Cock added, it is important the industry avoids a scenario where “consolidation brings concentration of risk, and with that excessive regulation due to the fear of problems arising within this pan-European monopolistic utility”.
Indeed, the news that the Giovanni Group, which advises the European Commission (EC) on financial services, already plans to investigate cross-border securities clearing and settlement with the EU will do little to allay Cock’s fears. Certainly, the EC’s involvement looks guaranteed to turn up the gas beneath what is already a simmering pot. While the Giovanni Group’s intentions are, at first glance, eminently reasonable – ensuring lower costs and improved quality of service to users along with adequate investor protection – closer inspection reveals it also proposes to investigate competition (or, more specifically, a potential lack of it) in this sector. For the EC, competition equals efficiency equals a good thing; unfortunately, as intimated earlier, a good many participants in the post-trade arena see fragmentation, and by extension competition, as the very devil that must be vanquished; they would further argue that a central utility owned by the industry would in fact put everyone on an equal footing, even though it would putatively qualify as a monopoly. If the EC fails to grasp this distinction, then the harmonisation of Europe’s post-trade infrastructure will remain nothing but a pipedream for some time to come.