When the Euro was introduced as the common currency of 19 European Union member states in 1999, the political expectation was that national market infrastructures within the eurozone would consolidate. This was the expectation across all financial markets – in trading and post-trade. Consumers in the 19 countries would no longer treat the other member countries as “foreign”. It would behave like a domestic single market.
Twenty years later, more than 10 years after the financial crisis and five years since the launch of Target2 Securities the trade association ECSDA has more than 30 members. Some EU member states have two CSD’s – even tiny Luxembourg has a duopoly. Bosnia Herzegovina, which unlike Luxembourg is not a centre for international capital markets, also has two. The hugely detailed list provided on the ESMA website, documenting all licensed CSD’s that operate in the EU, runs to 79 pages. In the past 20 years the number of CSDs has actually increased.
What seems to have eluded the policy makers is commercial reality. CSDs operate a variety of commercial models – some are state-owned, some are market utilities owned by their users and others are wholly commercial. What they share is a business-like approach. They are not motivated by politics or altruism.
So why haven’t they consolidated? I suggest there are three reasons.
- You First – even if you think a trend is positive it doesn’t automatically mean you have to join in. Regarding CSDs this translates into the attitude that I’m willing to think about merging with or acquiring another CSD, but only on my terms. I do not want to be the junior partner.
- Flag Carrier – CSDs, like airlines, have historically been part of a country’s national infrastructure. Alongside central banks and payment systems it appears that governments and policy makers are very reluctant to give up a component of their domestic financial architecture. The parallels with airlines are clear: the EU single market has created some big trans-national entities (Air France-KLM, Lufthansa Group, IAG) plus several new entrants. In the background their operations are consolidated but they retain local brand names. Consumer costs are reduced. When T2S was launched this model was thought to be a viable option for market infrastructures – especially the smaller ones. Shared technology platforms would save a lot of money but don’t require a unified brand. National pride can be satisfied by using a national brand name and retaining local legal entities. Euroclear operates this model – a large group with some consolidated IT platforms but seven legally separate CSD’s). The model does work – but it appears that policy-makers want to keep their flag carriers.
- T2S scope – when T2S was in the pre-launch phase many custodians and clearing brokers looked at whether it was truly transformational. I recall attending a meeting held by a large custodian bank to give an external viewpoint on the potential opportunities. Their fundamental question was: does T2S allow us to build a pan European securities services platform? Will it allow us to break out of the national silos? My answer was: no. The reason is its limited scope. T2S is not a CSD – it’s a settlement system. Whilst it has introduced a highly efficient settlement process for the Eurozone markets it doesn’t perform the associated asset servicing functions. This is because asset servicing is extremely complicated. The Giovannini Group identified the barriers preventing the creation of a pan-European market between 2001 and 2003. Many of those barriers still exist – and they are almost entirely public sector. Significant differences in fiscal and tax rules make the segment very local. Despite a long-standing initiative at the EU there are also fundamental legal issues to address: contract law significantly affects the transfer of ownership of securities. The 19 Eurozone countries still have 19 different legal systems.
Given these issues it’s hardly surprising that consolidation hasn’t happened. And there is no sign of progress.
Another possible way for consolidation to happen is for non-European entities to enter the market. Markets like India, China, Brazil, Hong Kong and the US have highly efficient settlement infrastructures. They all have a single CSD in their markets. So why don’t they see Europe as an opportunity? There are two answers.
Firstly, scale. The biggest European markets are already in the hands of the big European players: Clearstream and Euroclear. The remaining markets aren’t big enough to be attractive to external players. None of them are going to move the needle.
Secondly, politics. European policy makers have long memories. When they recall the fate of Euronext and Nasdaq they shudder. These so-called “mergers” were widely viewed as disguised takeovers by US firms. It was commonly expressed in Brussels that the local European management team had been completely hollowed out. All senior executive decision making was done in the US. It may have been naïve for people to believe the “merger of equals” concept but it appears they did.
The impact is that the political desire for Europe to have its own local providers outweighs almost all other considerations. DTCC discovered this when it tried to engineer a three-way triangular merger with Euroclear and LCH Clearnet. The industrial logic was sound, the potential cost and operational benefits were obvious. All three were user owned and governed. But it became very clear that European policy makers would not green light the deal. Another US “takeover” was not going to be allowed.
Twelve years later not much has changed. The European settlement landscape remains hugely fragmented. The single market is only part built. The big European players aren’t big relative to their global peer group. T2S and CSDR have not created the hoped-for consolidation.
Very few markets remain in stasis for this length of time. Something will happen – but when or how is unclear.