Preparing for a continental shift
Today’s issuers, investors and intermediaries face enormous challenges, as do the European capital market utilities that support them. The current trends are complex.
The euro, the passport and a raft of directives have paved the way for a fundamental change in European and, indeed, world markets.
Europe is fragmented but market users must build confidence in Europe. To be successful, market users, issuers, investors and intermediaries, must work together to create new added-value products and streamlined services and processes; they need to partner new solutions.
Today’s capital markets are evolving quickly as innovation and consolidation conspire to create new challenges for all. Market utilities, exchanges, clearers and CSDs are co-operating and merging. This however, is a long-term process. As is increasing capital-market efficiency through the harmonisation of the different issuance and investment-related processes.
Europe requires a new mechanism for wealth creation. It needs the bringing together of issuers, investors and buyers and sellers of securities, the primary role of capital markets. However, the changes faced are so extreme that no one organisation can be expected to reengineer the process. Capital market users must work together and partner new ways of creating wealth and adding value. However, with so many traditional players and so many new entrants, organisations must seek out partners they can trust.
There may well be a single currency in Europe but the issuance, investment, trading and settlement processes remain fragmented.
There is widespread agreement among market users that post-trade consolidation is necessary because of the creation of the Euro-zone. This will allow service providers to take full advantage of the economies of scale inherent in the clearing, central counterparty (CCP) and settlement business. Further, legal harmonisation at the European level, and technological developments are also increasing consolidation. However, the European consolidation process is moving in two directions.
Vertical consolidation is the process by which the utilities in charge of securities trading, clearing, settlement and custody become increasingly integrated, The new entity provides a single system for debt and equities traded on the spot and derivatives markets.
Any development in horizontal or vertical consolidation can be viewed as being positive for Europe. Vertical consolidation allows for full integration of the key processes of the investment cycle, while horizontal consolidation provides for economies of scale in separate market-owned utilities.
However, in terms of confidence in Europe, vertical consolidation at the national level makes horizontal consolidation progressively more difficult. This is because it fully exposes the many market practice, regulatory and legal differences between countries across the entire spectrum of the investment cycle. Therefore, in an organisation and system covering the whole trading, clearing, settlement and custody chain, its integration with another organisation and system located in a different country becomes more complicated. In addition, vertically integrated national capital market utilities have become more autonomous and the investments in integrated technological platforms regarded as more costly.
Europe may be fragmented when compared to the US market but it has great potential to adapt and grow. European mutual funds are forecast to grow significantly as a result of the easing and simplification of European regulatory restrictions; the marketing capabilities of the large European and US financial institutions; and the growth in websites dedicated to investor communication.
There remains a great deal to do to harmonise processes like settlement, or the tax, regulatory or legal regimes. In polarising markets, the investment life cycle will change, requiring substantial reengineering, new products and services and the rebalancing of fixed and variable costs.
There are positive initiatives, contributing to confidence in Europe and negative forces, spinning Europe in the wrong direction. These fall into four categories: market users, suppliers, the competitive environment, and the regulatory environment.
Market users must take an active interest in European markets and the forces, both positive and negative, impacting on confidence. On the
positive side, issuance and investment in the euro-currency markets will increase; a rapidly emerging corporate debt market and growth in mutual funds are just two examples. Europe will expand; again creating more opportunity. In deregulating markets, new products and services are created and innovation is freer and faster. Market consolidation will provide for economies of scale, resulting in lower costs and lower risks – all contributing to confidence in Europe. On the negative side, market users are concerned that the European markets are fragmented, and will remain so for some time. National politics and the baggage of history are delaying the benefits of deregulation. European markets are still very different with market practices, laws and regulation all in need of further harmonisation. And, while consolidation brings economies of scale, it also requires significant investment in resources (finance, systems and people).
On the supplier side, a number of positive efficiency initiatives are under way, for example, Global Straight-through Processing. There is a great deal of innovation and many new business entrants, Electronic Communications Networks (ECNs) and Automated Trading Systems (ATSs), and new processes like B2B (Business to Business) making a major move. In the post-trade environment, there is a major push to consolidate clearing and CCP services into a single governance structure and process, to improve market risk management and collateral management for asset optimisation. Further, alliances and mergers between exchanges, CSDs and International Central Securities Depositories (ICSDs) will create positive benefits and with many new innovative suppliers coming on stream, like fast cruisers challenging the super tankers. That said, the markets face a number of challenges.
When it comes to standards and harmonisation, there are competing initiatives and this is creating confusion. The national market utilities have been slow to respond to the challenge of fast moving ECNs and ATSs and in terms of clearing and CCP many countries do not have a capability. Indeed, many may be reluctant to accept a pan-European approach or give up what they already have. When it comes to the merger of exchanges and CSDs, there are competing initiatives, duplicated investments. Europe is not seeing any benefit.
The European regulatory environment represents a major challenge. On the positive side, the finality directive sets new benchmarks for the management of risk and the credit institutions directive will go a long way to providing a more level playing field, complementing the European Passport.
On the negative side, it is recognised that every new directive takes up a significant amount of resource, both people and money. Further, many of the directives are complex, even cumbersome; they will take time to achieve their end goals.
It is essential to build confidence in Europe and market users at large must be able to identify with the benefits and work together to achieve them.
The market at large will benefit from the new business arising from adverse demographics, from issuance and from innovation. There are many initiatives aimed at making Europe a truly regional market, liquid, transparent, efficient and safe.
On the negative side, there is continuing concern about fragmented European markets, the negative impact on liquidity, rising costs and high investments in infrastructure. National pride, protectionism, conflicts of law and regulation; these are all detracting from confidence in Europe.
Market users, issuers, investors and intermediaries all benefit from rebuilding European markets. They all need to co-operate towards the aim of making the markets efficient and successful; everyone benefits from a rapidly growing euro-currency market.
We have adopted a partnering approach as a fundamental component of its strategy. With so much innovation and consolidation taking place, there is a need to seek out the right partners.
Partnering solutions will combine the best of local on the spot expertise with a regional and international capability. Excellent customer support, appropriate to cultural needs and combined with multi-lingual, multi-cultural capabilities, is also essential. In progressively re-engineered European markets, partnering requires innovation and easy to use, cost effective products and services. This is a ‘partner-centric’ approach.
Jacques-Philippe Marson is head of BNP Paribas Securities Services. The above is based on a speech given at the SIBOS Securities Conference