DG MARKT G1, European Commission, B-1049 Brussels Belgium 10 Paternoster Square London EC4M 7LS T +44 (0)20 7797 1000 www.londonstockexchange.com 30 July 2004 Dear Sir LONDON STOCK EXCHANGE RESPONSE TO THE COMMUNICATION ON CLEARING AND SETTLEMENT IN THE EUROPEAN UNION Thank you for the opportunity to comment on the Communication from the Commission to the Council and the European Parliament entitled Clearing and Settlement in the European Union - The way forward ( the Communication ). This letter constitutes the response by the London Stock Exchange ( the Exchange ). In determining its response, the Exchange has considered the Communication itself, the previous work done by the Exchange and others in this area, and the Exchange s own recent experience of increasing inter-exchange competition in Europe through EUROSETS - the Dutch Trading Service. The Commission s overarching objective of creating an efficient, safe and cost-effective European securities clearing and settlement system which ensures a level playing field among the different providers, is a commendable one. We agree that this is a crucial element in the framework needed to create an integrated and efficient European capital market - a goal that has already been progressed by the Commission s Financial Services Action Plan. Improving EU clearing and settlement arrangements should be seen as a further step towards enhancing the attractiveness of securities markets within the EU, improving the liquidity of the markets and reducing the cost of capital for EU companies. Clearly, an important attribute of a truly integrated market is the presence of crossborder activity. As the Communication highlights, clearing and settlement of domestic transactions across Europe is generally considered low cost and effective, whereas cross-border arrangements are currently complex and fragmented. London Stock Exchange plc Registered in England & Wales No 2075721. Registered office 10 Paternoster Square, London EC4M 7LS
This complexity and fragmentation leads to higher costs. This has been demonstrated in a number of studies, most recently in the NERA report 1 which finds that the back-office process of clearing and settlement costs between 0.35 and 0.80 for a typical domestic trade, whereas for non-domestic European trades this can cost up to 35 or more - this is in stark contrast to the US, where the cost is around 0.10. We believe that the removal of barriers that impair the functioning of cross-border clearing and settlement should reduce these costs and improve the prospects of a fully integrated EU financial services market. This can best be achieved through a effort by market participants, regulators and legislators. We are aware that the Communication should be viewed in conjunction with other initiatives in this area such as the two reports of the Giovannini Group, the work of the Group of Thirty and the CESR-ESCB's draft standards. We are fully supportive of these initiatives, and believe they are complementary to the work of the Commission. It is clear that the issues surrounding clearing and settlement in the EU are such that public policy intervention is required. We also note that the Commission s Securities Expert Group identified clearing and settlement as a key future priority, and this was a view shared by a number of market participants at the Commission s recent conference held to discuss the Group's report. We therefore support a Directive, as it is probable that a Directive will deliver benefits to businesses, most likely in the form of increased efficiency, reduced cost of cross-border transactions, and consequently lower costs of capital for EU companies. However, we believe that any Directive must be proportionate and balanced. Furthermore, it must reflect the Joint Initiative on Regulatory Reform proposed by the previous Irish Presidency. As such, we would expect the Commission to undertake a thorough Regulatory Impact Analysis, supported by a full cost benefit analysis. There should also be extensive consultation with industry and interested parties. Obtaining industry involvement and buy-in will not only enhance the Directive but will also, ultimately, expedite the process. We also believe that any Directive should have the minimum scope necessary and set out general principles only, following the Lamfalussy process. The general approach should be one which enables market participants and infrastructure providers to compete and grow their businesses, but not one which is overly prescriptive. 1 The Direct Costs of Clearing and Settlement: An EU-US Comparison - June 2004. By NERA Economic Consulting, published by the Corporation of London.
In the Communication, the Commission outlined the following objectives in order to achieve its overall goal: the continued application of competition policy; the liberalisation and integration of existing securities clearing and settlement systems; the adoption of a common regulatory and supervisory framework; and the implementation of appropriate governance arrangements. Competition Policy We agree that it is important to ensure the continued application of competition policy, so that anti-competitive practices - such as unfair denial of access or the imposition of excessive and/or discriminatory prices - cannot be adopted. If we look beyond the central providers, then - in the settlement and custody areas at least - competitive pressure is provided by agent banks. We believe that where competition exists, existing competition legislation and market forces can achieve the desired result. We therefore support the use of existing competition policy and do not think that these particular issues necessarily need to be addressed by a Directive. Liberalisation and Integration A necessary element for achieving the integration of clearing and settlement in the EU is the removal of the barriers identified in the Giovannini reports - namely technical or market practice barriers, barriers related to tax procedures and legal barriers. The Giovannini group suggests that the removal of these barriers should be effected through the combined efforts of the private and public sectors and according to an appropriate sequence. We support the suggestion in the Communication of establishing industry advisory and monitoring groups to assist this process and we believe it is important that they operate in an open and transparent manner. We are pleased to see that a list of the members of the group has now been published, in addition to a useful summary of the discussion held at the first meeting. We note that some of the legal barriers identified do not appear to prevent participants from operating cross-border, but may make the process less efficient. Clearly, a number of specific legal restrictions need to be addressed, mostly relating to access rather than fundamental security ownership law. However, it is not obvious that it is necessary to provide exact legal harmonisation in all areas, for example, in the range or approach to corporate events. There is a risk that harmonisation in this area will create additional costs of change for all, outweighing the savings that will accrue only to participants active in cross-border trading.
Furthermore, we do not feel that it is necessary to harmonise the standard settlement periods across markets (as recommended by the Giovannini group) - there seems to be no market pressure for this and the increasing use of central counterparties means that there is no material risk advantage to shortening the period. Our view is that the next change in standard settlement periods is likely to be a move to trade date settlement, but that this is many years away and would entail a considerable change to industry infrastructure. A FRAMEWORK DIRECTIVE We agree with the Communication that the removal of technical and market practice barriers, and the use of competition policy are necessary but not sufficient conditions for achieving a liberalised, integrated and competitive post-trading market in the EU. As such, we support the Commission s view that meeting the overall objective will require the adoption of a framework Directive. However, our views on the issues that the Directive should address differ from those outlined in the Communication, and are discussed below. In addition, there have been some suggestions that a Directive should not cover central counterparties. It is not clear why they should be excluded. However, it should be recognised (and this issue has also come up in the ESCB-CESR consultation on clearing and settlement) that central counterparties have a different role from other participants in the clearing and settlement process, and hence that the requirements to be placed upon them may be different. Ownership and governance The last few years have seen a number of changes in the provision of clearing and settlement services by central infrastructure providers (i.e. central counterparties and CSDs) in Europe, in particular: mergers between a number of providers, so that the providers are now multinational, for example Euroclear Group now owning a number of national CSDs or the merger of LCH and Clearnet to create LCH.Clearnet; the consequential move of some providers from an essentially mutual status to a for-profit status; and an increase in the number of cash equity markets using central counterparties. The resulting organisations demonstrate a variety of approaches to ownership and governance. We believe that the Commission should not attempt to impose specific ownership or governance structures. Furthermore, it is not obvious that some providers should be forced into different forms of accounting or pricing from others, especially when the division between different classes of providers (intermediaries and infrastructure providers) is likely to be somewhat arbitrary.
Comprehensive rights of access and choice The central infrastructure providers are no longer necessarily nationally-based, but it is still the case that in most cases there is a de facto central counterparty and CSD that the market chooses to use. However, there are examples where choice is available. Given that the availability of existing choices has come about largely through market forces, i.e. without needing the support of a Directive, we think that in this area the Directive should be limited to: ensuring that there are no particular barriers to a market participant using central infrastructure outside of its home state; and ensuring that central infrastructure providers can operate in any of the EU countries that they wish under their home state regulation, by providing them with a passport. It is not obvious that there is a need in a Directive to go beyond these general principles - as long as the principles are observed, it seems that the market is already capable of delivering solutions. However, the fact that there are no barriers to access, does not mean that it can be delivered on an identical basis in all cases, and it should be recognised that different participants may have different costs (e.g. for technical reasons) in different situations. The Directive should ensure that where identical access is not possible, that participants can achieve equivalent access, subject to a reasonableness test. For instance, it would be unreasonable to expect a central infrastructure provider to provide access in a particular way (e.g. using a technology approach that it does not currently use) just to support a particular participant and where the provider would have no reasonable business case for doing this. The Directive should also ensure that the scope of these access rights is limited to providers and participants within the EU and thus within the scope of relevant European Directives.
Common regulatory framework The Communication highlights that, as we move closer to a more integrated market, there will be increased demand for co-operation among national authorities to achieve effective cross-border regulation and supervision. It will be important to have clarity over the identity of the competent authority for the regulation and supervision of a particular set of cross-border clearing and settlement activities. Currently, in some jurisdictions at least, there are several possible ways that a central counterparty based in another member state could be regulated. For example, in the UK, an overseas central counterparty might be regulated as a Recognised Clearing House, a Recognised Overseas Clearing House, become authorised to perform the specific activities that they carry out, or benefit from the overseas persons exemption. The costs and implications of all these approaches vary and could potentially result in an organisation being regulated twice for essentially the same activity by two different national regulators. We agree with the observation within the Communication that the draft CESR-ESCB standards are a useful start in dividing responsibilities, but note the Commission's concern that they do not have the force of law. To this extent a framework Directive will be useful as it will introduce more legal certainty and support a level playing field. We believe that the introduction of a clear supervisory model based on home country control and supported by an EU passport would greatly assist the integration of the EU market. However, the Commission should also pay close attention to the principle of subsidiarity and avoid using the objective of a common regulatory framework to justify the introduction of excessive or unnecessary additional regulations. I hope our views are helpful to the Commission s work. Please do not hesitate to contact me if you wish to discuss any aspect of this letter. Yours faithfully Adam Kinsley Head of Regulatory Strategy London Stock Exchange Telephone +44 20 7797 1421