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August 31, 2003

Europe on the Cheap

By Peter Gaffney

U.S. trading costs are much cheaper than Europe's. That's because the U.S. has a more consolidated and efficient clearance and settlement system.

It all began in the U.S. in 1976. That year, the National Securities and Clearance Corporation (NSCC) was launched to provide clearing and settlement for the New York Stock Exchange, the American Stock Exchange and Nasdaq. The NSCC now offers it services for all equity and corporate and

municipal bond transactions in the U.S. Its systems and services are integrated with the Depositary Trust Company, the world's largest securities depositary.

Today, all securities traded on U.S. exchanges are cleared by the same consolidated counterparty, namely the NSCC. Europe, by comparison, does not have a central clearing and settlement organization like the NSCC. Europe uses both clearing institutions and custody banks, such as BNP, the Bank of New York and Citibank. European trading firms also employ groups such as Clearnet, the London Clearing House and Euroclear. There is only one rule of law, corresponding regulatory infrastructure and government in the U.S. The markets in Europe, however, are fragmented - even politically and monetarily - generating costs and tensions in the marketplace.

This needs to change. To reduce the overall cost structure of post-execution services in Europe, more competition and greater cross-border harmonization are needed. Nevertheless, a single point of entry into the clearing and settlement houses for the entire continent isn't realistic. It isn't realistic across Europe where there are monopolies, unresolved cross-border political issues and multiple currencies, the Euro notwithstanding.

A better approach is to increase competition between all of the clearing and settlement institutions, which indeed have had very limited reach. (That reach is normally only in specific local markets.)

Large clearing and custody banks have begun building cross-border clearing and settlement services. But the overall cost structure is generally prohibitive because of the limited number of players offering services across several markets.

To break down the existing monopolies in local markets - and to open up the cross-border market to competition - regulatory pressure needs to be exerted by the European Union (EU). By fostering competition among post-execution vendors and financial institutions across all of the markets, the existing monopolies that have created a barrier to growth will dissappear. This would produce new solutions and technologies options, driving down total costs.

The EU must promote more harmonization. This would ease cross-border trading and result in cost ratios similar to those in the U.S. In its second report on European clearance and settlement, the Giovannini Group underlined this when it stated, "Building integrated and efficient clearing and settlement arrangements is urgent and functional to other initiatives to strengthen the EU financial system. A project of such importance requires - and deserves - strong political support."

The U.S. and Europe are responsible for nearly 90 percent of the global equity market capitalization. With a better system for clearing and settlement that puts European exchanges closer to parity with U.S. exchanges, the two markets could offer a considerably greater supply of capital. And for traders across the globe, more efficient clearance and settlement would offer an enormous new source of liquidity and investment opportunities.

So it's time for the European markets to put aside political, currency and other differences. A competitive environment for post-execution services in Europe, supported by the EU, would open new pools of equity, increase flows of investment into the European markets, and offer a more efficient global source of capital for corporations.

Peter Gaffney is president of U.S. operations at NeoNet, a provider of real-time equity trading services for institutional investors and prime brokers.