Due to the financial crisis post-Lehman Brothers, there has been a lot of discussion about the issues of clearing in Europe. One would think it should be clear, but it is a real mess of complexity and confusion.
Part of the issue comes down to the European Commission focusing upon this area after the Markets in Financial Instruments Directive (MiFID) rather than before. MiFID was focused upon pre-trade equities investments in Europe. The aim was to get rid of the national exchange-focused schemes, known as concentration rules.
Clearing and settlement was completely missed when the European Commission began its law-making processes; and the problem with clearing and settlement is that because the traditional exchanges were protected by their concentration rules before MiFID, they continue to be protected by raising barriers to pan-European trading through their silo structures, where the clearing systems are integrated with the national exchanges.
Where the clearing and settlement systems are exchange-owned and operated, the incumbents can lock in and force buyers to trade and clear through the exchange, as they cannot get access to go anywhere else.
Slow-moving process
Some of these things are changing but the change is so slow that, by comparison, watching paint dry is invigorating.
Where is the change coming from? Well, it began back in 2001 with the Giovannini Committee, chaired by Alberto Giovannini. This group analysed the issues of clearing and settlement across Europe and released a report in 2003 outlining 15 barriers to trade. Most of these are industry related - transparency and access issues - although the most important barriers relate to government policies because they focus upon taxation and company law.
In 2003, the Giovannini report advocated that we could get rid of these barriers by 2006. Guess what? It didn't happen.
In order to try to resolve such issues, the European Commission implemented a Code of Conduct for Clearing and Settlement in 2006. The Code of Conduct came into force in January 2008 and has had sign-up from most clearers across Europe to resolve the issues of interoperability, while bringing in pricing transparency and unbundled products, such that they could be more comparable.
However, it has not worked. The Code of Conduct has reduced some barriers, but not many. It is still not possible to compare products between central counterparty clearing houses across markets. Therefore, it is still not possible to get a clear pricing structure or comparison. And, no matter how hard one tries, it is still not possible to see true interoperability across markets.
The result is that there is now a very strong justification for a dictate to facilitate this. A dictate means a directive. A clearing and settlement directive is needed.
Industry reaction
The industry does not want this because it does not like prescriptive regulation. Therefore, the industry will say that the Code of Conduct works and will continue trying to pretend it is gaining traction.
The European Commission does not want this because it means encroaching on member states' laws for tax and fiscal reporting. Half of the activities of securities depositories, for example, are involved in corporate actions, the payments of dividend and the calculation of taxes. The Commission does not want to get into a 'bun fight' with national governments to attack this.
But guess what? Without getting involved, this space will just languish as a mess of clearing.
That is the last thing we want in light of the recent crisis. In fact, the crisis has changed things fundamentally and with the focus upon over-the-counter (OTC) derivatives, a new European Securities Authority, liquidity risk and capital adequacy, it is quite clear that a clearing and settlement system which is transparent and comparable is now a requirement.
So what does this mean? A clearing and settlement directive for Europe is on its way. Draft legislation for consultative purposes is probably going to be published within a year or so, followed by transposition in 2012.
This is pure supposition on my part but I just do not see any other way around this. And, no matter how hard one tries, it is still not true interoperability across markets.
Under the spotlight
With Lehman's collapse last year, the spotlight has been cast even more firmly onto the clearing and settlement structures of Europe. These infrastructures managed well throughout the crisis, with LCH.Clearnet claiming to have netted most positions across the markets within days of the market implosion.
However, the whole off-exchange trading of complex derivatives is firmly in scope for the regulators because $60,000bn in OTC derivatives products is a fairly sizeable exposure.
Now there are industry initiatives working to resolve these matters, such as the Depository Trust and Clearing Corporation data repository for all OTC products in the US and the European Commission's recent announcements of OTC derivatives regulations.
What this does, combined with previous attempts to rationalise the post-trade market, is suggest that there is a very strong justification for a dictate.
Chris Skinner is an independent financial commentator and chairman of London-based The Financial Services club. Read his daily blog on banking at The Finanser: www.thefinanser.com
