Recent stock market mergers and the drive for straight through processing have produced their share of problems- not least from a regulatory perspective and from pressure on clearing and settlement organisations to co-operate. These were among the latest developments and challenges facing the securities services industry, John Gubert, told plan sponsors and other clients recently in London.
Gubert commented on the uncertainty over iX’s regulator, the initial structure of Euronext, the product of the Paris, Amsterdam and Brussels exchanges’ merger, and stressed the need for a central counterparty.
On iX he talked of a four tier system- a platform for new economy stocks, based in Germany; a market for blue chips, based in London; and markets for local German and UK stocks. Selecting a market regulator is unresolved and a source of anxiety. “There is a high risk of regulatory fragmentation and there’s a battle taking place,” he said. Both the Germans and the British want to regulate the market but investors prefer the idea of home country regulation. Whatever the outcome it’s essential to get coherent regulations. He also touched on discrepancies between trading processes. Germany uses T+2, the UK T+5, moving to T+3. “There is no way that overnight a new rulebook is going to be written…there is complexity in amalgamating the trading processes and the general rules,” he said.
There’s also a need for guidance on a central counterparty. The London Stock Exchange is developing a central counterparty using the London Clearing Houses Risk Engine and CREST settlement systems. Deutsche Börse, through its contact with Clearstream, has proposed a central counterparty using the German/Swiss Eurex derivative CCP system. This is bad news according to Gubert: “the last thing you want is two central counterparties”. There’s also uncertainty on settlement and custody. Deutsche Börse has Clearstream; LSE is linked to the CREST settlement system. “Somehow these two processes have got to be bought together.” Merging the two isn’t necessary, just whatever produces a seamless interface enabling them to support iX. Clearer statements are apparently due later this year.
Gubert criticised Euronext and its three-tier structure- blue chips in Paris, small companies in Brussels and stock derivatives in Amsterdam. “It’s absolutely crazy. Logically you would bring everything into one market.” Taking out the infrastructure in Belgium and the Netherlands would produce job losses but he is convinced reason will prevail. “The good news for Euronext is that it looks as if logic is prevailing in the post trade environment even if it’s not in the trading environment,” he said. It appears Euroclear and Clearnet will oversee clearing and settlement.
Next up for review were netting and matching systems that Gubert says are changing at a fierce pace. The Global Straight Through Processing Association (GSTPA) recently raised $130m to build a global trade matching facility. America’s Depository Trust and Clearing Corporation (DTCC) and Thompson are bringing their matching systems together. According to Gubert, the GSTPA’s system will provide an interactive matching process bringing investors, brokers and custodians together. Underlying the system is the intention investors, custodians and brokers will agree trades on a real time basis. Gubert said the launch target is early next year and the system should be fully operational by the end of 2001.
The DTCC and TFS intend to join their matching structures and Gubert believes the product will be a rebadging rather than a new system. Emphasis will be on T+1 settlement and, unlike the bilateral, interactive service proposed by the GSTPA, it will be conversational, sending and receiving messages. “Architecturally and conceptually they are very different,” said Gubert. Competition will exist between the two systems and the key is whether the two are interoperable. “One being a messaging system and the other being an interactive system, it isn’t easy to create interoperability.” On top of this, major changes will be required if the market moves to a real time, interactive model. “It’s a very, very different structure to the one we know today.”
He also spoke of the proposed joint venture between France’s Clearnet and the London Clearing House, details of which are apparently lacking. Equally pressing is getting them to join forces with the German/Swiss Eurex system. This is a key target of the European Securities Forum, of which HSBC is a member. “For the UK it’s an incredibly important decision because with iX we have one part dealing with Eurex and potentially we have another side dealing with the London Clearing House and Clearnet,” he said. If the two are brought together it will resolve one of the problems facing iX. Brokers and dealers want a unified netting system as it will reduce both the costs and risks. It will also allow them to operate with a single pot of capital which will be cheaper to manage. Less wastage means they will need less capital to trade and a single system would mean one set of regulations as well.
Driving the changes is a desire to cut the trade cycle. Gubert is concerned the shift to T+1 may potentially increase operational risk and CRESTco has demonstrated its scepticism. It will move to T+3 in the first quarter of 2001 but says it’ll only adopt T+1 after the US has shown it viable. Given the US has recently postponed the introduction, hardly a resounding endorsement. Shorter settlement cycles have prerequisites complicating the matter. Same day matching or fault-free straight through processing; interactive and real time settlement systems; T+1 compatible forex and T=0 spot cash markets for efficient cash management are all needed.
Gubert finished on the viability of a T+0 environment, “a regulator’s nirvana” and something he was willing to bet against, at least until his retirement. He predicted consolidation of the different trading platforms, not least because history has shown linking platforms is more complicated in practice than in theory. He also predicted if more matching systems become interactive, technically they will be more interoperable and that pressure to form a European central counterparty will eventually pay off. Rounding up, Gubert’s message was simple. “We work to three objectives. First we want to see a reduction in the overall risk of markets, secondly we want to see an improvement in efficiency and thirdly we want to see the overall cost of doing business reduced.”
Hugh Gibson, head of specialised services at HSBC’s Global Investor Services, shared the platform with John Gubert and spoke predominantly about risk reduction in UK markets, including delivery versus payment (DVP). “Everybody claims DVP and STP but it’s terribly important to understand real DVP,” he said. CREST, the UK settlement system provides simultaneous exchange of stock and payment but this payment is only assured by a settlement bank and is only finalised at the end of the day. Gibson says while this may be of little concern to most legislation from the European Central Bank makes a new system, DVP Model 1, compulsory from 1 January 2002.
According to Gibson, under the new system, when securities move against payment they will be paid for by central bank money, or guaranteed by the Bank of England. He said there is comfort in that risk will be taken away from the settlement banks and that the chance of systemic failure is reduced. One of the major issues facing DVP though is the generation of liquidity. In the past, CHAPS payments have been in central bank money and this has been achieved by settlement banks putting up collateral with the Bank of England. Adding securities settlement systems will virtually double the existing £300bn (e492bn) daily turnover of CHAPS. While CHAPS payments can be spread throughout the day, the movements of overnight collateral cause major peaks at the beginning and end of the day. Increasing repo trading, together with a forecast 25% year on rear growth in securities activity will exacerbate these peaks.
According to Gibson there is concern that settlement banks will not have enough collateral of their own. He talked of the proposal to introduce self-collateralising repos, whereby securities will be repoed to the Bank of England during settlement, satisfying any potential need for security. Credit management is also vital and HSBC’s main concern is the ability to unwind all the repos at the end of the day. Gibson said it’s going to be crucial that settlement banks can swap liquidity between the different pots they put up for collateral. “It is absolutely essential that in bringing in risk reduction methods you do not impinge on settlement.” IPE