How does Euroclear keep capital markets safe while using its open architecture to link global players in an ecosystem that makes those markets more efficient for the public good? flow’s Janet Du Chenne looks at how far the financial market infrastructure has come

Before the creation of the Euroclear settlement system 49 years ago, the mechanics of settlement for the developing eurobond market remained complex, requiring the physical delivery of certificates and cash. Trading was hampered by long delays in the delivery of securities, the loss of certificates, and the consequential excessive counterparty and market risks. In some instances, lorries carrying physical certificates across borders broke down, delaying the completion of settlement transactions indefinitely. In others, underground vaults that housed physical securities certificates caught fire or flooded and the record of securities ownership was destroyed.

In the beginning

The Brussels office of Morgan Guaranty Trust decided to address these risks and inefficiencies by launching the Euroclear system in 1968. The system effectively automated securities settlement, so that trades executed between buyers and sellers would then settle delivery versus payment (DVP). DVP means that cash and securities are exchanged simultaneously, in book entry form, thereby minimising risk. With the growth of capital markets, the Euroclear system grew through the acquisition of other local securities settlement systems into the largest settlement engine in the world, not only for the settlement of Eurobonds, but also a wide range of asset classes, including equities, funds, derivatives and investment funds. Today, it is the central securities depository (CSD) for more than €28.4trn of securities listed on the Euronext-zone stock exchanges of France, Belgium, Finland and the Netherlands, as well as Swedish and Irish equities, and all UK securities. In addition, Euroclear provides custody services for securities all over the world.

In taking the systemically important financial market infrastructure (FMI) further, Chief Executive Officer Lieve Mostrey (pictured) highlights Euroclear’s strategy using three concentric circles (see Figure 1):

  1. Protect capital markets and keep them clean and safe;
  2. Use an open architecture model and scale to make capital markets more efficient by linking across market participants, facilitating the flow of collateral globally; and
  3. Explore adjacent business models and new technologies.

To help with these ambitions of protecting and expanding capital markets, in 2016 Deutsche Bank’s Market Advocacy team analysed how regulatory change would impact financial market infrastructures such as Euroclear. A conversation with the group’s Chief Business Development Officer, Frederic Hannequart, about this led to a mandate in December 2016 for a liquidity facility to help Euroclear meet its goals, while complying with liquidity requirements. Almost at the same time, TARGET2-Securities (T2S) i,  a European Central Bank (ECB) platform harmonising settlement for Eurozone securities, meant that the local Euroclear CSDs of France, Belgium, the Netherlands and Finland would be able to connect to the platform and offer clients single point of entry for settlement in Europe. Since some of these clients were also clients of Deutsche Bank, T2S gave Euroclear an opportunity to review its business model and offer those clients pan-European settlement services, while outsourcing its asset servicing to Deutsche Bank for all securities settled in Europe.

[CSDR] stands for a lot of things we stand for, including open models, low risks, the strengthening of CSDs through capital requirements, operational processes and risk management

Play it safe

In the first circle of its strategy, Euroclear aims to keep capital markets clean and protect and facilitate the flows through settlement, safekeeping and servicing of domestic and cross-border securities.

It connects more than 2,000 financial market participants – including global and local custodians, broker dealers, central banks, commercial and investment banks, investment managers, supranational organisations, a wide range of issuers and even retail investors who have direct accounts with Euroclear in markets such as Finland – and ensures securities transactions are processed safely and efficiently (see Figure 2). The system ensures that, following a trade, securities and cash are exchanged in the right accounts. As an infrastructure to which participants can connect in multiple ways, it helps clients reduce complexity, lower cost and mitigate operational risks with its risk management framework, and with operations teams across multiple locations and backup IT data centres.

Invisible connections

With a DNA that supports an open marketplace, Euroclear uses its architecture to link its users’ securities in a ‘collateral highway’. This collateral management infrastructure helps clients to be compliant with regulation such as the European Markets Infrastructure Regulation (EMIR) and the Dodd-Frank Act in the US, which require more collateral to be posted for activities in the capital markets, by sourcing, mobilising and optimising collateral across borders and time zones for clients’ use. The infrastructure posted total collateral outstanding, representing collateralised transactions processed, in excess of €1.1trn in June 2017, up 14% from the previous year, as well as strong growth in other areas (see Figure 3).

Euroclear maintains a wide network of links to capital markets, enabling it to link pools of collateral around the world and bring that collateral together in one place. Such links include those with the Depository Trust and Clearing Corporation (DTCC) in the US. In September 2014, the two FMIs built an infrastructure for global collateral processing. The joint venture, called DTCC-Euroclear GlobalCollateral Ltd, has a Margin Transit Utility and a Collateral Management Utility to offer derivatives and financial solutions, respectively.

In another offering, Euroclear’s Global Reach team works with growth markets beyond Europe to help strengthen their capital markets infrastructure and connect their issuers with international investors. In 2014, Euroclear was granted access to Russia’s central securities depository, the National Securities Depository (NSD), opening the way for a substantial step-up in foreign participation in the country’s domestic bond market. Using Euroclear Bank’s account with the NSD, it provides post-trade services for Russian corporate and municipal bonds. Via this account, all Euroclear Bank clients investing in corporate and municipal debt will be able to settle those trades and deposit their positions with Euroclear Bank. In 2014 it also launched a new offering allowing international investors to settle Taiwanese-issued RMB bonds in the Taiwan Depository & Clearing Corporation (TDCC). In 2017, international investors were able to gain direct access to the domestic Chilean and Peruvian capital markets, following cooperation between both markets and Euroclear to align post-trade processes with international standards.

Regulation resilience

Given its role in financial markets, Euroclear is impacted by regulatory and infrastructure changes designed to make these markets safer and more efficient. Among these changes is the European Regulation for CSDs (CSDR) ii,  which creates uniform standards (see box out on page 17) for CSDs in Europe, and has also standardised the settlement cycle for securities transactions to ‘trade date + two days’, or T+2. Mostrey believes the regulation should be welcomed, as it brings a level of standardisation in what these infrastructures should provide to financial markets. “It brings transparency and clarity, and it stands for a lot of things we stand for, including open models, low risks, the strengthening of CSDs through capital requirements, operational processes, and risk management,” she explains. “It will add extra resilience, reduce risks and add more transparency in the way ICSDs and the CSDs operate and thus provide users with a level of comfort.”

To help Euroclear comply with CSDR, Deutsche Bank provided liquidity facilities so that the FMI could meet the liquidity requirements of the regulation within a tight deadline. It needed to be able to access sources of liquidity, even in stressed markets. In December 2016, it mandated Deutsche Bank to provide these by the end of the first quarter of 2017. The bank supported Euroclear with FX, cash management and repo facilities that it could draw on worth multiple billions of euros. Specifically, Deutsche Bank proposed an integrated structure of facilities involving:

  • A committed intraday liquidity facility to help Euroclear demonstrate continued access to intraday liquidity to support its settlement obligations;
  • A combination of multi-currency committed FX and repo facilities to manage liquidity and currency exposures against high-quality collateral available to the client in a stressed market.

These facilities are structured to be efficient from a credit, liquidity and balance sheet perspective, ensuring the sustainability of the transaction.

CSDR provides the context for EU CSDs to join T2S, the platform that harmonises the settlement of securities in the Eurozone, and how they interact with each other within a T2S environment. The platform aims to facilitate more cross-border activity with markets joining T2S in several migration waves from 2015. These include the Euroclear CSDs of Belgium, France and the Netherlands, which migrated in September 2016. After the final migration wave, planned for September 2017, it is expected that T2S will also provide an opportunity for new business models. According to Mostrey, the adoption of these new models depends on where market participants are in their investment cycle and whether they realise the opportunities brought to the market with this new infrastructure as markets migrate. “We are at the beginning of that journey, but I believe that next year we will see global actors favouring different models,” she predicts. “The evolution of our offering will happen at the clients’ initiative. T2S has enabled foreign players to use Euroclear’s connectivity to access multiple European markets.”

>€1.1trn
The total collateralised transactions processed in June 2017 by Euroclear


World in harmony

With these harmonisation efforts, global players no longer have to have various points of access to each European market. T2S gives them the option to connect to those markets, either directly or via a third party provider for settlement and asset services. For example, global custodian Northern Trust reviewed the way it accesses European markets on behalf of investors as a result of T2S.
Since it is a client of both Euroclear and Deutsche Bank, this meant that both parties could support the client. Euroclear can provide Northern Trust with a single entry point for pan-European settlement using its investor CSD, while Deutsche Bank can provide asset services to them. “Where activities are commoditised and standardised, and they do not make a competitive difference, it is better to invest once to provide those services for the benefit of everybody,” Mostrey explains. “This is where our open architecture model with Deutsche Bank provides Northern Trust with European access and the global custodian can benefit from our collateral optimisation tools.”

A partnership between Euroclear and Deutsche Bank, formed in July 2014, helps clients consolidate, optimise and more efficiently assign their collateral inventory as part of T2S. The partnership provides clients with a single entry point from which they can reach the collateral pools and distribution channels used by all key institutional and market infrastructure firms. Euroclear’s collateral engine collects the collateral and puts it in place at the exact point of time when it is needed for a transaction, ensuring it is of a certain quality. The client can place most of the assets they have as collateral into one tool that optimises that collateral for all purposes. It then uses Euroclear to instruct all of the movements of that collateral to ensure it is used for the right purpose, at the right time and with just the necessary amount of quality to it. The opportunity to make better use of assets held domestically helps financial institutions to secure exposures and financing transactions in tri-party, while consolidating the view of inventory with their preferred provider.
The mobility of those eligible assets across borders using the asset services, including custody, provided by Deutsche Bank helps clients to benefit from a reduction of funding costs. 

In addition to partnering on behalf of clients, Euroclear has itself used Deutsche Bank for asset services to respond to regulatory and infrastructure change. For instance, in the German market, it uses the bank’s Asset Servicing Only model to hold the assets of Euroclear Bank in a dedicated CSD account in Euroclear’s name, while benefitting from corporate action services provided by Deutsche Bank. This modular approach, while envisaged as a result of T2S opportunities, was introduced in October 2016, prior to the migration of Germany to the T2S platform.

Exploring businesses

In the third strategic circle, regarding innovation, Euroclear is considering providing services to other asset classes as new ones emerge for institutional investors. These include trade finance loans, which banks package as securitisations. These securitisations are then distributed into the capital markets to enable banks to release regulatory capital. Euroclear will look at the possibility of supporting this securitised asset class with settlement and collateral management services. 

Euroclear’s Finland CSD is looking into processing housing company certificates in the future. In France, Euroclear is part of a consortium that is exploring how blockchain may be applied to help funding for small and medium-sized companies. The fintech start-up, Taskize, which is backed by Euroclear, is a problem-solving network for financial services firms to resolve operational issues efficiently. For the first time, banks have a standard mechanism to connect people in the processing chain to solve problems and fix failed trades.

True innovation lies at the intersection between what the technology can do, how business models can evolve and what the regulatory objectives are. These regulatory objectives are a non-negotiable space, reflects Mostrey. “Euroclear’s innovation strategy is taking a collaborative approach wherever possible, working with third-party innovators in ways that reward their innovation, while simultaneously giving us flexibility. Part of the learning about the innovation going forward, and in distinguishing blockchain as a disruptor or an enabler of more efficiency and evolution in the ecosystem, will be answered the day that experiments in the niche environments prove conclusive and scalable. Then we will start having the answers to the migration challenges from one environment to another.”

European Central Securities Depository Regulation

  • The Central Securities Depositories Regulation (CSDR) took effect in September 2014 to provide the rules framework for European CSDs
  • The regulation lays out that their main role is to maintain and protect the settlement process in an efficient and safe manner, to ensure the proper functioning of the capital markets
  • CSDR enables CSDs to outsource their settlement activity to the T2S platform
  • CSDR changes the way in which some CSDs are permitted to operate and in turn affects the services that they can supply to their clients
  • CSDR distinguishes between CSDs as operating a securities settlement infrastructure and their possible role as lenders
  • CSDs now have to fulfil significant additional requirements in order to provide banking services and to take risk through, for example, providing credit

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See http://bit.ly/2xSQ2H4 at db.com

ii See http://bit.ly/2vPXOnr at db.com

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