Europe Awaits Competition

Will culture and regulation stop the American invasion?

U.S.-based companies are readying a full-frontal assault on the European clearing business. They believe that Europe is not only ripe for competition, but that overseas providers are inefficient and too expensive. American executives say they can dramatically reduce clearing costs, as they contend that Europe should welcome new players to enter their turf

and make trading less expensive. That’s the argument that Nasdaq and the Depository Trust & Clearing Corp. (DTCC) are separately making.

“Nasdaq is really trying to muscle into the clearing business,” points out Phillip Silitschanu, a senor analyst with the Aite Group.

Both Nasdaq and DTCC-unfriendly rivals looking at a relatively new market and offering different models-emphasize that European clearing is out of step with their more effective clearing methods.


DTCC says European clearers now charge too much through their various central counterparty clearinghouses, or CCPs, and central security depositories (CSDs). DTCC is in the process of trying to persuade European exchanges that they should farm out clearing to its EuroCCP subsidiary.

A DTCC study supports the conclusion that its subsidiary’s prices are cheaper. Its cost per side to clear a trade is about one-tenth of what European clearers are charging.

Many European exchanges, as now constituted, can’t effectively compete, DTCC argues. The study says that the only way a European CCP could now achieve its subsidiary’s price (0.003) would require huge investments, which “would negate the anticipated fall in prices.”

How would Americans deliver these cost savings for European markets? Firstly, big savings could come simply from unifying the dozens of marketplaces.

Nasdaq OMX and DTCC officials point to 27 European Union nations. Each has myriad different clearing laws and customs. That means the continent is a very expensive place to clear and process trades. Unlike the United States, there is no single central CCP.

This is the primary reason why clearing and settlement services are so expensive: There is a patchwork of disparate clearing and settlement practices across Europe. Almost any financial institution-from an exchange to a CSD, or even a bank, sometimes-can perform clearing when it internalizes a transaction.

Different Practices

Some markets function without a CCP. In Spain, for example, it is a CSD doing the clearing. And in some markets, such as Germany, France and Italy, extra precautions are taken. Transactions are run through a CCP prior to sending the transaction to a CSD. All these practices add to the clearing bill, observers say.

“In the case of some cross-border trades, it can be 20 times more expensive, compared with DTCC,” Aite’s Silitschanu says. Indeed, DTCC officials, in the study, claimed that Europeans buying equities overpaid by 350 million euros annually or about 60 to 70 percent more than what their subsidiary, EuroCCP would take for equivalent services.

Observers say Nasdaq OMX is already making inroads in Europe. It is a big player in the Northern European countries, including the Baltic states and Scandinavia. It is also looking to clearing both here and Europe as a profitable new line.

“We see great opportunity in clearing,” says Robert Greifeld, chairman of Nasdaq OMX, which is also planning on competing with DTCC for domestic clearing business. That would reopen a competition that ended in the U.S. in the 1990s. Consolidation left DTCC as the industry utility because U.S. exchanges conceded that it could perform clearing better than they.

DTCC, whose officials privately concede that they will be banging heads with Nasdaq here and abroad, is pushing for consolidation. Its EuroCCP was in about half of Europe, and it recently announced it was purchasing LCH Clearnet.

Nevertheless, even though the number of CCPs has been declining, dropping from 14 to nine between 1999 and 2007, the “space is still very fragmented and the situation is very different from the United States,” says Axel Pierron, an analyst with Celent, a division of the Oliver Wyman Group.

Indeed, EuroCCP argues that the ultimate savings would come if all the exchanges in the European Union opted for a continental DTCC.

Lower Costs

If a single CCP were used to clear trades from all exchanges, whichever CCP that was, market participants would face significantly lower costs of linking up with a single CCP, as compared with the many costs they currently incur as a result of having to link up with many CCPs,” the DTCC study says.

True, but that one market clearing utility or exchange isn’t coming anytime soon, Pierron predicts. He doesn’t doubt that the DTCC figures are right about potential savings or that a continent-wide clearer, the European equivalent of a DTCC, could deliver a more cost-effective product. However, he is skeptical that DTCC and Nasdaq will triumph in Europe. He warns that there are numerous regulatory and cultural issues that could prevent the American clearing operations from capturing the continent.

Pierron notes that there have been dozens of applications before the European Commission for clearing interoperability over the past few years. But only one has been approved.

“The reasons for failure have not been technical, but have to do with nonviable business models and resistance from incumbents,” he says.

Pierron says European exchanges are actually trying to protect their turf, but they don’t want to say so publicly. Therefore, they are making the case to the commission that there are a limited number of CCPs that can operate in any one trading venue.

There is also a cultural concern, Pierron adds. “There is a lot of concern about a consortium of American banks,” Pierron says. The issue, he says, is whether American bank officials will act in the best interests of European institutions.

EuroCCP officials dismiss this objection. They note that its board already has European representatives. Many European exchanges, they note, have officials from outside the country in which an exchange is domiciled. However, they concede there is another roadblock to one market.

The Silo

About 50 percent of exchange trades go through CCPs in which the exchange has what is commonly called “vertical silos,” says Diana Chan, EuroCCP chief executive. Other forms of less visible economic interest exist between a trading venue and the CCP it has chosen, such as reciprocity. Chan also explains that DTCC is a not-for-profit model, but many European exchanges are not. These European exchanges are making money from clearing even though it is hurting clients, she adds.

“This is due to the trading platforms whose economic interests are not aligned with the clearing firms that actually pay the bills of the CCP.” Firms trading on European exchanges are obliged to use the CCPs owned or chosen by the trading venues, even though less expensive clearing solutions exist, she adds.

It will take some time to convince these exchanges to give up their clearing operations because they have little incentive to give that business to anyone else, Chan says. Exchanges make money on the clearing operation even though it hurts the efficiency of the trading process. Until this disparity become huge, EuroCCP officials say, it will be difficult to sell exchanges on what is a more efficient model. It took decades to make the same case in the United States. Chan says it will probably be the same in Europe unless users succeed in convincing exchanges to allow them to use the CCP of their choice.

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