Volker Potthoff, managing director, banking and custody business at Clearstream, tells The Banker about Clearstream’s strategy and the challenges it faces in differentiating itself from the competition.
Q: What are the main elements of Clearstream’s strategy?
A: Some clear trends are developing towards a greater need for collateral management and for improved levels of risk management across the whole of our industry. I see these factors growing in importance – and this is connected to Clearstream’s core strengths in the fixed income sector. Therefore our strategy is focused on this and our proven ability to deliver value-added services in the custody sector. Looking at inefficiencies in the industry, we see the main causes of concern arise in the custody arena, where costs are still too high due to fragmentation and different regulatory environments.
Clearstream’s traditional strengths and comparative advantage lie in the European over-the-counter (OTC) fixed-income sector. This area represents around 80% of our revenues and we have proven over many years that this is where we can offer superior quality services to our customer base in more than 90 countries. The industry trends and our core strengths are closely connected and we are therefore concentrating on our customers’ needs in those areas because they need a committed and efficient infrastructure partner: that is what we are.
Joining Deutsche Börse Group has widened the portfolio of services that we can offer and, more importantly, created the opportunity for us to cross-sell to a wider audience. The market is telling us that cross-border settlement is not where the biggest inefficiencies lie; they are in the areas of custody and collateral management in particular. There is more to be done.
For us, the cross-border equities sector represents less than one third of our business and is already well-served by local agent banks. Factors such as central counterparty netting have reduced the need for settlement, so we see that clearly focusing on our core capabilities to deliver efficiencies in the areas of biggest cost will differentiate our business.
Does this mean you are not focusing on equities any more, or as much as Euroclear is?
Clearstream continues to offer a lower cost settlement service for equities than any other organisation in Europe and we will continue to seek further improvements. But Clearstream’s traditional customer base is in the OTC fixed-income sector and this is a key factor. We have set up a programme of key market deliverables over the next 15 months and we fully expect that plan to deliver real benefits to our customers. Our energy is devoted to delivering what the market needs now, not trying to create an idealistic solution seven or 10 years in the future.
The European Securities Forum, among others, still believes that clearing and settlement should be a utility. How does this sit with Clearstream’s plans?
When you talk, as I have done, to operations directors throughout Europe, you find that what they seek is efficient, low-cost and high-quality services. Remember, in no other industry has the utility model proven to deliver this; quite the reverse.
Our customers want a focused and committed service partner that works hard every day to deliver settlement efficiency. That is what we do. It is the competitive environment that drives us on and we do not believe that the utility model can do this for our customers.
Our business is to take away inefficiencies from markets. That means that international central securities depositories (ICSDs) and central securities depositories (CSDs) continually have to provide improved services. To ensure this, there will always be a need for competitive drive to lower prices and improve services.
In the markets covered by ICSDs, we therefore strongly believe in the competitive model rather than any utility model. Utilities have proven to be inefficient and, in some cases, have been seen to privilege certain market participants – as we have seen at the New York Stock Exchange and the Chicago Board of Trade.
Given the flurry of studies and reports, do you foresee some form of EU intervention in the clearing and settlement layer?
It is our view that the market should decide the shape of the industry; the authorities’ role is to maintain fair competition and prevent the build up of systemic risk. We have fully contributed this view to all of the important groups that have been studying our industry. We have also supported the findings of these reports, in particular the Giovannini Report, which shared our view that to raise the level of efficiency in clearing and settlement in the EU, regulatory barriers have to be dismantled and uniform standards developed.
We also support the call for the settlement systems to be opened up; we believe that Clearstream will continue to be the preferred settlement location for German securities due to its superior service offerings.
It is key for the market to evolve by itself, however, because there is a risk that the regulators are still learning about our industry and are as yet unclear about how to regulate the whole area of post-trade services. We think it is right that their role should be focused only on the areas of systemic risk and ensuring fair competition.
The Clearstream/Euroclear relationship has always been interesting. What is it like today?
We are tough competitors and the industry has benefited for more than 30 years from the results of that competition. However, we also co-operate with Euroclear on some important subjects.
The companies are interconnected by the electronic “bridge”, which delivers an important part of our industry’s infrastructure. On such issues, we co-operate fully because it is imperative that the highest standards of IT security and performance are implemented.
We have an electronic overnight bridge and a manual daytime bridge that act as a communication link between us. It allows counterparties that are trading securities with customers of one ICSD to settle the trades in the other.
Problems arise with the structure of the daytime bridge and it creates an unfair disadvantage to customers of Clearstream. However, the new level of interoperability that will come with the the automated daytime bridge due in November 2004 is key in removing that unfair situation. Customers of both Euroclear and Clearstream are demanding that this be addressed and, although it is a complex project, it will represent a big move forward for our sector.
Once automation is complete, customers will benefit from extended deadlines, same-day distribution of new issues and further cost and settlement efficiencies that deliver the true level of interoperability they demand.
We may see more co-operative or partnership initiatives as the industry continues to evolve.
In November 2003, Clearstream introduced a new settlement model in Germany. Are there plans to broaden this to other countries?
The success of the model has been outstanding. The smooth implementation and the immediate increase in settlement efficiency, plus the earlier finality in the process, have been well received. We have also developed the “guarantee concept” with the Bundesbank. This has been endorsed by the European Central Bank, and has been launched successfully with the central banks in Austria and the Netherlands. In effect, it links the central banks together by way of guarantees so that banks do not need to split their collateral across several CSDs. The initiative goes beyond the Giovannini Report and addresses the needs of the payments side of our industry.
Clearstream has announced a widening of its Vestima service to the investment funds industry. What does this mean?
We have been working closely with participants from across the European investment funds industry to understand the inefficiencies in the sector. We have concluded that no single solution can meet the differing needs of the main markets in Europe. Therefore we are launching a modular service that builds on our success of offering order-routing, settlement and custody services to the offshore market.
The new service will offer a low-cost service to the major European investment fund domestic markets, starting with France and Germany. This will bring new types of customers to Clearstream, such as asset managers and insurance companies, and it will enable them to benefit from our high straight-through processing rates, which average above 90%. The unique element of this service is that fund distributors may elect to choose their preferred lowest cost settlement and custody routes by using their own settlement processes and keep custody with the local CSD or to use the Clearstream settlement and custody facilities.
How many investment funds are making use of the Vestima service and what growth do you expect the new modular service to generate?
Rather than looking at the number of funds, a more illustrative figure of the service’s success is the fact that volume growth in terms of transactions settled increased by more than 220% in 2003.
We expect take-up to be strong. Early discussions with the larger players show that they wish to proceed as soon as possible, but exact figures are difficult to estimate. Today, the industry processes about 50 million transactions a year and 50% of those are said to be manual. It is in this area that real benefits and significant cost reductions can be achieved.
What do you see as the greatest challenges to Clearstream’s future?
Clearstream serves an industry that is consolidating. This is a real challenge because, as our market changes, we must be placed to service the consolidators, such as the global custodians and broker/dealer communities. We will continually have to find services to meet their ever-evolving needs – during a period in which we are all feeling the pressure on our margins.
We have to develop our positioning away from competitors and show the entire market where they need to come to receive the best services. Differentiating ourselves in our chosen sectors is the key – and we will do it.
