Competition at the front end has not, so far, been matched in the post-trade arena, and that is hampering many firms’ abilities to actually trade on the venues they may wish to.
When the Markets in Financial Instruments Directive (MiFID) was unleashed by the European Commission back in November 2007, one of its main aims was to increase competition across the European Economic Area financial markets. While there has been a migration of some traditional cash equities business from exchanges to the new multilateral trading facilities (MTFs) as a consequence, there remain a number of separate national clearing houses and settlement depositories across Europe.
Why this is the case was discussed by a panel moderated by Bob Currie, editorial director at Financial Services Research. Industry experts considered what major changes have been seen from a post-trade perspective and the main issues that are arising. They began by considering what and who was driving the movement of liquidity from exchanges to MTFs.
Trevor Gatfield, head of securities operations at Investec, thought this migration was broker-led rather than client driven, as the former were striving to access all pools of liquidity in order to offer best execution. The panel noted one of the unintended consequences is that many clients cannot afford to develop the IT required to connect directly to all the pools of liquidity now. As a result, they need to partner with an IT routing specialist instead, and as Philippe Ruault, head of financial intermediary solutions at BNP Paribas Securities Services, pointed out, over the last two years there have been many new developments to assist connections to MTFs as well as cover new investment products.
Fragmented and shallow, not integrated and liquid
Lauren Vis, managing director at Kas Bank, reminded the audience the Lisbon Summit in 2000 proposed European market efficiencies, calling for financial markets to be deeper and more integrated, and set 2010 as the target to achieve that. Somewhat disappointedly, here we are in 2009, still striving for this goal, with the liquidity pools in Europe, “now more fragmented than ever”.
Though there was not much surprise expressed about this fragmentation, Trevor Spanner chief operating officer at EuroCCP, said he felt the various central counterparties (CCPs) had a clear role to play in reducing back-end clearing costs. Gareth Bevan of SunGard stated his belief that this interim fragmentation will eventually stop and there would be consolidation. But for the moment, the ongoing front office innovations had not abated. Indeed, “the back office needs to enable that [innovation], not stop it,” said Bevan.
Gatfield talked about the small impact MTFs have had on Investec so far. He believes the biggest current impact on costs is the reduced size of trades. “Doing more trades for less value needs increased automation to cover that cost gap,” he pointed out.
Ruault felt that many of the leading counterparties were going global using MTFs. Vis said this would not necessarily continue, as switching flow to an MTF had to be viable on a cost ground. He noted that the clearing and settlement for MTFs is still done by the major central depositories, which presents absolutely no economies of scale for the back office. Vis thought this was a key point, as direct trading costs now represented only about 10% of expenses, whereas margin management, post-trade settlements, regulatory and client reporting accounted for the remaining 90% of the costs.
Spanner thought the developed US model was an interesting comparison: trading activity had shifted to MTFs, but there was still only one CCP, which helps to reduce risks and costs. Vis thought the European post-trade model could benefit from similar competition, but that smart order routing needs to be extended to cover post-trade work. As the exchanges are unlikely to develop such links themselves,Vis believes it is still up to the exchanges to open up their IT connections to competent technology providers.
The interoperability dream
This led the discussion into the desire for interoperability. Ruault mentioned that a code of conduct for CCP interoperability is in place, but he questioned whether CCPs would really work together for the benefit of their clients. Gatfield felt that more competition between CCPs had perversely introduced more cost for the clients and brokers: even though trade unit costs are down, connectivity costs had gone up. Spanner thought some European CCPs were in favour of interoperability, and it could break through the barriers to access currently ‘closed shop’ markets as such as France and Germany. But he went on to caution that not all CCPs were keen to foster interoperations. For instance, he claimed, LCH.Clearnet would be ‘mad’ to embrace interoperability, because it charges about five times the rates of its European equivalents.
Vis picked up on this theme. In Europe, “there are still seven exchanges and seven CCPs now …if CCPs embrace interoperability, some of them will lose their business,” he stated.
A question from the floor was asked whether the European Central Bank’s (ECB) Target 2-Securities (T2S) initiative would influence the CCP landscape at all. Ruault answered with a flat no, as T2S is aimed at simplifying European settlements rather than clearing. But Spanner felt that directly navigating the 15 European markets was already very difficult and required an effective “agent bank” model – whereas T2S will promote direct access, and increasing investment opportunities. He did, however, acknowledge this was a ECB project in development with a future timeline for completion – maybe 2012 – with no certainty of adoption, rather than currently available. Vis also expressed some scepticism, saying he believed that T2S is a complex and expensive answer to cross-border settlement costs. He thinks it could only work under the auspices of a pan-European securities law that would allow securities firms to continue to legally reside in their home territory.
Change is not cheap
Currie rounded off the session by asking the panel their primary desires for immediate future clearing and settlement developments. Ruault requested more CCP interoperability, and clearer rules for firms to act as CCPs across Europe. Vis wanted to see the exchanges open up to multiple CCPs first, and also for margin processing to be standardised between the CCPs to avoid the current arbitrage possibilities.
Spanner thought that the high back office costs had now been fully exposed by lowering trading costs, with particularly more attention on clearing and settlement costs – and that true competition between the exchanges and CCPs was required to drive these costs down. Bevan said that, from a technology perspective, it was crucial to design systems that have the agility to accept market developments built in, and provide good operations accounting functions.
Finally, Gatfield cautioned that any major developments cost money – and questioned whether the many mooted changes would actually benefit clients, who would effectively have to foot the bill. However, he agreed that there is currently a window of opportunity to make major changes in the European securities back office landscape, before the markets get back to normal levels of business.
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