I visit Asia periodically to personally stay in touch with our Asian clients. A lot of things are happening in Europe right now and the way I see it, Europe tends to be a bit Euro-centric. The strength of Euroclear has always been its presence beyond Europe, in particular North America and Asia.
In fact, 20% of our client base is in Asia. We have a very high market share in Asia versus our competitors as a result of some very hard work. It’s critical for me to personally find out what’s happening in Asia and how our clients see their needs evolving over the next two to five years. That’s actually why I am here. This is the third time in 12 months I have been to Asia, and on this occasion I have been to Tokyo, Beijing and Hong Kong.
Q: You must spend a lot of time thinking about technology. How do you think technology will change your business?
Technology is revolutionizng our business. Obviously, we need the ‘most adequate’ platform for processing. Most adequate means the robustness to run something like $100 trillion of transactions per year for clients that use us as their primary entry point to Asia, North America and Europe. We need to have systems that are stable and reliable, so we have to invest in technology.
We also focus on technology for another reason. We must make communications to and from our clients easier. Historically, we have supported a proprietary communications channel. This means that our clients have had to adapt to our formats. We are now building the communications platform of tomorrow which will be based on internet technologies. We will, however, use a private IP network in order to maximize security and availability, while allowing clients to operate at their own speed. The real benefit for our clients is that they will use exactly the same formats to communicate with us as they already use in other parts of their business. If systems are built around the same logic, it makes for very significant savings for clients.
Q: What are the competitive threats that worry you? Can technology put you out of business? Can you see technology rendering your business obsolete?
There will always be a need for transaction settlement. We cover a wide range of securities and markets including bonds and equities from Europe, Asia, North America and Latin America. And, we have clients from close to 90 countries. So it’s difficult to imagine a technological innovation that will render us obsolete.
People sometimes wonder how our revenue is affected when there is a financial crisis. In fact, a crisis is good for us because people buy and sell securities that ultimately must be settled. We hit record peaks of Euroclear settlement volumes during the most recent Asian crisis. I’m not worried about our business shrinking, particularly as the securities business is booming. But the threats are always the same - to no longer be the best at what you do; to not focus on what your clients really need - it’s complacency that is our worst enemy. That’s the risk that every market leader always faces.
At the moment, we are at the heart of change in Europe. There are 25 central securities depositaries (CSDs) in Europe - there were more than 30 just a few years ago. We have just merged with the French CSD and expect to merge this year with the Belgian and Dutch CSDs. We have also become the CSD for Irish government bonds when the Central Bank of Ireland decided to outsource the CSD function to us for these securities. That’s four mergers in one year.
Another issue that poses a threat is resistance to change. In Europe, trades on many national stock exchanges are automatically sent to the local CSD for settlement. This practice made a lot of sense while Europe was a juxtaposition of 15 countries. However, traders in London, Frankfurt and Paris are no longer interested in trading just their national exchange-listed equities. They are now trading in pan-European sectors, for example, telecoms, rather than by countries. Instruments are now available that allow traders to do that.
As you can imagine, when they buy an index-based instrument that covers 10 markets, they expect to press a button and see their trades settle as quickly as when they trade national exchange-listed securities, for example, UK equities. However, that’s not the case today.
We currently have an infrastructure in Europe that requires these trades to be sent to 10 different CSDs for settlement. The costs for using 10 different settlement systems accumulate quickly and the time to settle at each CSD is different. So, the settlement process is not coherent, even though the instrument is. Clients would prefer to trade and settle in Europe the way they do in the US.
The next question is: if you have a single settlement process, do you need one depositary or can they all be linked to one another? We’ve looked at the options carefully. We think inter-linking is a useful step, but it is not the end-game. Indeed, inter-linking is much less efficient than placing all the business on the books of one depositary.
We will have to see if the same issues arise in Asia as the Asian markets become more homogeneous. In Europe, it is clear that a transaction within a single European country is probably as cheap as a transaction within the US. At the European level, it is probably about 10 times more expensive. When I say, at the ‘European level’, I mean someone trading a package of European securities, taking all of the costs that the intermediaries face from trading through settlement for the component parts of that package of securities.
Another consideration is that we have 25 CSDs for a market that is about the same size as the US, where you have only two CSDs. Someone has to pay for this fragmentation in Europe. The operating costs of these 25 CSDs is about 1.2 billion euros ($1.07 billion) annually. If we look at the US, their operating costs are about 500 million euros.
The major players who are active in the US, Europe and Asia all want to benefit from the synergies they see in each region, and they want the synergies to be replicated elsewhere. They don’t see it in Europe and they don’t see it in Asia - but the opportunity is not quite the same in Asia as in Europe. The single currency in Europe has opened the door for this to happen.
Reducing costs and integrating the financial markets are necessary steps, if Europe wants to be competitive with the US. Some people argue that Asia will only concentrate on liquidity if there is a single stock exchange. Then the question becomes: is there enough liquidity among the various stock exchanges, or is liquidity so fragmented that it needs to be in one place?
In Asia, there is no common currency, so what would be the drivers to move the market to consolidate, particularly as consolidation tends to be a very political issue?
The crisis has created a driver. Some countries are now irrelevant thanks to the MSCI index and that means the good companies in those countries are ignored. You almost need a super Asian exchange to allow those companies access to capital.
There may be a need for consolidation in Asia. But, what will be the glue in Asia? That’s why I think Asian pragmatism is so important. If some people think there are 15-20 companies that really matter here, then they may consider moving them onto one exchange.
The real pool of money is in Japan. Japan could create a lot of change in Asia. If it took an ‘ADR’ approach, that might be the first step towards an Asian exchange. But it would require a change of attitude in Japan.
It’s unclear to me whether Japan will change its attitude any time soon. On the settlement side in Japan, for example, there are several CSDs. For corporate bonds, there is no CSD, which is highly unusual for a sophisticated market. It has just been decided to migrate corporate bonds to Jasdec. So their own process of consolidation is taking place. The question is whether the Japanese would go into overdrive and try to make this happen for the whole region. I don’t expect this is going to happen anytime soon.
Q: You said Euroclear had merged with four CSDs in Europe. Would you do the same in Asia?
We have no intention of getting into a buying spree and merge with CSDs across the world. There have to be good reasons for mergers. The role of Euroclear in Asia is, first and foremost, to serve our Asian clients.
We have always said that we are happy to work with the CSDs in the region. In fact, we’ve been working to set up links that allow clients of CSDs in the region to access Euroclear counterparties. We have all the big, world-class clients on our books. It’s very efficient if a firm in Asia wants to trade with our clients by going through an intermediary that is linked to Euroclear. The CSDs in Asia bring their clients and we bring ours, so the links go both ways. That, in the short to medium term, is the most useful contribution Euroclear can make in Asia.
Our move to real time settlement has helped too. It used to be the case that Euroclear settled all client transactions in a batch process during the night in Brussels, which did not allow Asian clients to benefit from time zone overlaps. Now we are operating a real time settlement platform that is open during a large part of the Asian business day. Our systems are becoming increasingly seamless.
Q: What is the Euroclear position on expanding your business in China?
We are not in a position to offer our clients settlement or custody services in Chinese securities at this time. Why? The first condition for us to offer a service for any domestic security is for the currency of that country to be fully convertible. From a business standpoint, clients that use Euroclear tend to invest in markets that are open to foreign investment. As long as the local currency is not convertible, foreign investment in local securities tends to be small. We discuss this issue with our Chinese friends on a regular basis to try and understand when the local currency is expected to become convertible.
The Chinese have a CSD in Shanghai and in Shenzhen, and they have been busy setting up the appropriate infrastructure, which is another condition for us. They are moving very fast without having to consider a legacy system. They will have one single clearing and settlement system for bonds and equities. Countries that have the ability to bypass a legacy system can move very quickly. The same was true in Eastern Europe.
The third element that is important to us is a stable legal environment. As we are talking about holding assets for our clients in a specific environment, we need to understand local ownership laws in order to determine who is the rightful owner of securities held in the local market. Ownership rules are very important for all CSDs. It looks like China is taking this quite seriously and each piece of the puzzle is being put in place, one after the other. In contrast, we already provide our full range of services to top-name Chinese clients.
