Euroclear is pursuing a strategy of collaboration with other market infrastructure utilities and agent banks. As a departure from several years ago, where the ICSD sought to expand its approach by acquiring other CSDs in Europe, the crisis and the need to reflect changes in the revenue base of its CSDs has forced a new approach.
Tim Howell, CEO of Euroclear, says the potential impact of initiatives such as TARGET-2 Securities (T2S) and regulations such as CSDR on CSD settlement revenues have been neutered to some extent because of regular CSD tariff reductions. Settlement-related revenues as a percentage of total CSD revenues have been declining for several years already.
While several Euroclear CSDs have signed the T2S framework agreement, the endgame is the same as it ever was, which is that if youre only relying on settlement income then life is going to become somewhat tortuous, says Howell. Saying that, I think T2S, which encourages CSDs to earn revenues from other sources (like asset servicing) and CSD Regulation, which proposes that CSDs cannot engage in some complementary businesses, are difficult to reconcile, but should emerge as something we can live with.
Euroclear and Clearstream have an advantage in that we have critical mass, so some of the costs of adapting to our new environment can be more readily absorbed.
Thankfully, there are opportunities emerging from the current economic environment, particularly with the decrease in unsecured lending and bank and sovereign downgrades, which has produced a requirement to collateralize transactions. Our objective is to help clients source and use good quality assets cash, government bonds or equities – as collateral for multiple purposes, says Howell. However, Europe has a shortage of quality collateral, as government bonds are not rated as highly here as they are elsewhere.
Euroclear, which holds 22 trillion of securities collateral for clients worldwide, is offering a Collateral Highway to source collateral wherever it may be located and transport it to wherever it may be needed, i.e. for securities finance transactions, central bank liquidity purposes, to cover derivatives trade exposures or for CCP margins. It is an open structure which agent banks and CSDs outside the Euroclear group can access to help their clients use the equities and debt held by them as collateral on the other side of Highway. Howell explains the rationale behind it: Life is pretty problematic for the collateral givers, particularly due to the collateral silos that have evolved by holding assets in various separate locations. There is a limit to what individual CSDs can do, as today they only have access to the assets they hold in custody.
The Collateral Highway also extends to agent banks whereby Euroclear can link up with these entities in order to offer clients a larger pool of collateral. Agent banks such as BNP Paribashave already partnered with Euroclear to make assets held by mutual clients available as collateral for triparty transactions managed by Euroclear Bank.
Commenting further on why collaboration makes more sense than acquiring CSDs, Howell observes that some firms have retreated to their home markets during the crisis, but still keep a foot in other parts of the world. They dont all have the financial capacity to reinvent their businesses internationally and so will partner with other companies in foreign markets in order to serve their clients. Collaboration can take many forms, but its all about realizing where you are in the value chain. Also, the bigger you are, the less you tend to collaborate. You end up trying to satisfy yourself that you can do something more efficiently yourself by using the same system in every country, which is becoming a harder business case to prove. There is no one entity I can name that provides the same level of service excellence across three or four different regions compared with four separate providers specialized by region. If you try to build that regional utility yourself and spend several hundred million on an IT system, you may find that someone else has built a bigger and better system than you have. So, we see more and more post-trade utilities operating with an open architecture model because clients and other organizations will want to use some, but not all, aspects of that utility.
Collaboration will be the way forward, particularly to meet the rising demand for collateral. Where I possibly disagree with Jeff (Tessler, Clearstream CEO) is that building one dominant utility is not the way forward; its more of a closed than open model. The plug and play approach, like our Collateral Highway, offers options and cost mutualization benefits that will be quite significant.
In addition to acknowledging that CSDs and other financial entities will find it increasingly difficult to help clients manage exposures with the right collateral, regulatory changes are something they will also have to live with. All (regulatory) change brings an element of angst and what we see coming from the regulators is heading us more towards angst rather than causing significant structural difficulties. People now expect that T2S wont save them money, so theres no point getting upset about it. Its better to take the position that the ECB is totally within its rights to pursue T2S; they know your view, but there is no point trying to have an intellectual battle about something that has already been decided.
As long as we set the company up in such a way that it evolves according to client needs, we feel Euroclear will remain successful. We cannot base the companys future on elements we cannot control, for example, net interest income. We know our business model makes sense even if interest rates are zero.
Euroclears most recent example of collaboration was announced at the end of April when the ICSD signed agreements with the Hong Kong Monetary Authority and Bank Negara Malaysia for a common platform for the settlement of Asian debt securities transactions. According to Howell, the platform was on the cards in Asia for some time and was discussed at the Association of Southeast Asian Nations Plus Three Summit in November 2007 with the intention of making the cross-border dimension of securities settlement cheaper. While Asean Plus Three provided a very good blueprint, that was about four years ago, says Howell. So, Euroclear Bank, HKMA and Bank Negara Malaysia decided they would put this blueprint into action.
An added value dimension we recently put in place with the HKMA is that instead of securities being parked and forgotten about, they can be used as collateral across borders, without the client losing its rights to benefit from corporate actions while the securities are being used as collateral. Its all about the efficient movement of collateral, while fulfilling asset-servicing responsibilities. The two dimensions are far more important now than they were a year ago. Its a reflection of the economic environment and the increasing demand for collateral, as a result of both regulation and bank credit rating downgrades.
The next chapter in Euroclears collaborative efforts is Russia, where the ICSD in March announced it has been planning a link with the National Settlement Depository (NSD) to provide cross-border services (settlement, custody and related services) for all classes of Russian domestic securities. Initially, there was a feeling by some that the Russian market was not ready for an ICSD to add another dimension to the cross-border business in Russia and might actually withdraw some liquidity, says Howell. “These concerns have since abated. It is very likely that Euroclear Bank will gain the necessary regulatory approvals to make Russian OFZs and other Russian debt securities euroclearable.
– Janet Du Chenne