If Europe needs a single European CSD, who will build it?
- Future of Finance
- Mar 14, 2024
- 54 min read
Updated: Jul 23
A single European capital market – a Capital Markets Union (CMU) – could provide European business with a lower cost of capital through deeper liquidity, a greater variety of instruments, a reduced reliance on debt rather than equity finance and readier access to venture capital funds to support innovative investments. But the trade and post-trade infrastructure of stock exchanges, central counterparty clearing houses (CCPs) and central securities depositories (CSDs) continues to fragment the European capital markets, denying European businesses, workers and consumers the potential benefits. Efforts to rationalise the infrastructure date back to the introduction of the single currency at the turn of the century but have stalled in the face of persistent legal, regulatory and operational discrepancies at the national level. In some areas, such as clearing operational barriers and reducing settlement fails, the European post-trade infrastructure is actually regressing. It was in this context that Christine Lagarde, the President of the European Central Bank, argued in a speech in November 2023 that “a truly European capital market needs consolidated market infrastructures.” To assess whether she is right and, if so, what can be done to advance consolidation, Dominic Hobson, co-founder of Future of Finance, moderated a webinar-based discussion with Chris Richardson (CEO of Percival Software, sponsor of the webinar), Dirk Loscher (Head of Custody and Investor Solutions at Clearstream Banking in Frankfurt), Andrea Tranquillini (advisor to the CEO of the Securities Depository Centre Company in Riyadh), Bill Meenaghan (CEO of SSImple) and Martin Watkins (CEO of Montis Group Limited).
Key Insights
In a speech on 17 November 2023, Christine Lagarde, the President of the European Central Bank, reopened a long-running argument by suggesting that a European capital market fragmented by 36 stock exchanges, 22 central securities depositories (CSDs) and 18 central counterparty clearinghouses (CCPs) needs consolidation of its market infrastructures if it is to provide European business with the low-cost risk capital it needs to prosper.
Failed efforts to achieve consolidation date back more than 20 years and include official reports into barriers to integration (such as the Giovannini reports of 2001 and 2003), a Code of Conduct (2006), legislation to increase competition (the Markets in Financial Instruments Directive and the Central Securities Depositories Regulation) and Target2-Securities (T2S), a cross-border securities settlement utility operated by the European Central Bank (ECB).
A poll of registrants for the webinar on 22 February 2024 found that 64 per cent agreed that Europe needs consolidation of its market infrastructures, including more than half of registrants working at CCPs and CSDs, but there was no majority consensus on whether this is best achieved by technology, normal market forces, harmonisation of laws and regulations or direct action by the authorities (the full poll results can be found here).
Consolidation of European market infrastructures is complicated by persistent differences in national market practices, and especially between CSDs that operate indirect omnibus accounts and CSDs that operate direct beneficial owners accounts, with the custodian banks that act as gatekeepers to the CSDs insisting that omnibus accounts are more efficient and therefore cheaper for users.
In addition to account structures, European markets are further divided by legal, regulatory, regulatory authority, fiscal and registration process differences, which between them have made it impossible to transfer the operations of national CSDs on to a single platform, even where the CSDs concerned are part of the same business group (as in the six national CSDs owned by Euroclear).
T2S has failed to facilitate consolidation of market infrastructures because it is both expensive to access and use and useful to the major custodian banks and their globally minded institutional buy-side clients only and has not proved to be of any value to the purely domestic brokerage, asset and wealth management and direct retail clients whose needs national CSDs are primarily incentivised to meet.
The failure of T2S is evident in the low proportion of transactions it settles between national CSDs (1.15 per cent of total T2S settlement volumes in 2021-22), which reflects not just the domestic focus of most business, but the particular difficulties of settling dual-listed securities in T2S and the procedural bias written into settlement systems that even securities denominated in euro must settle in their national market of origin.
Despite the introduction of a settlement discipline regime, the proportion of transactions that fail to settle in T2S also increased in terms of both volume and value in each of the years between 2019 and 2022, and cash penalties for failed trades are now costing an estimated €1.75 billion a year, thanks to age-old problems such as late matching of trades and poor quality reference data – increasing the risk that buy-ins will be imposed.
One route to rationalisation of CSDs in Europe might be to consolidate the CSDs with similar modus operandi – such as beneficial owner accounts – to reduce the overall number of CSDs without attempting the difficult task of harmonising national market practices but creating the possibility for natural market forces to complete the process by enabling users to choose the most efficient operating model over time.
Another way of consolidating the CSDs of Europe might be to proceed on a regional basis, with sub-scale national CSDs becoming part of larger regional groupings which can cut the cost of providing domestic issuers and investors with access to a single European capital market infrastructure, in a gradual process analogous to the consolidation of European sub-custodian banks into a relatively small group of regional providers.
A third route to rationalisation of CSDs might lie in bypassing legacy systems by a standardised blockchain-based platform (in the poll, more registrants – 25.97 per cent – named introduction of a “single programmable platform” as the easiest path than any other option) but experience of blockchain investing by CSDs so far indicates clients must support the transition with investments too, and this is not always forthcoming.
Blockchain investments by CSDs in both Australia (ASX) and France (ID2S) were not crowned with success but the failures had less to do with the technology than the reluctance of users to invest in a new approach, the resistance of incumbent service providers, regulatory constraints (such as the insistence on settlement in T2S) and the difficulty of detaching enough issuers and investors to create growing, liquid markets.
The reluctance of users of CSD services to invest in connecting to new technology platforms, even if (as with smart contracts programmed into tokens and into the blockchain networks that host tokens) the investment is already capable of transforming post-trade costs such as asset servicing and meeting legal requirements (such as achieving settlement finality), is a constraint on the pace of the transition to digital assets.
Some observers argue that CSDs should explore the liquidity creation models pioneered by the automated market makers that support some Decentralised Finance (DeFi) protocols with a view to adapting their techniques to the regulated environment in which CSDs and their users must operate, thereby conferring a sufficient degree of respectability to attract more institutional brokers and investors.
However, a likelier path for the adoption of blockchain by the CSDs of Europe is an incremental and hybrid process, in which investment in improving the efficiency of the existing system (such as tokenising collateral movements, raising the quality of reference data, adapting SWIFT messages to digital assets and creating digital asset registers) proceeds alongside a gradual shift from analogue to digital securities and funds.
The European Union (EU) DLT Pilot Regime, which is intended to encourage experiments by CSDs in the application of blockchain technology to the issuance, trading and settlement of tokenised securities and funds without breaching regulatory obligations, is too constrained by low ceilings on the size of issuers and investors, but this has increased interest in a United Kingdom alternative which is expected to be less restrictive.
There are limits on the power of any technology to influence a rationalisation of the CSDs of Europe because (as the poll of registrants identified) legal and regulatory barriers such as the lack of harmonised laws, a single rulebook, a single regulator, a consolidated tape and standard market practices are the most important barriers to better integration of post-trade infrastructure, and technology cannot clear these unaided.
Governments are partly to blame for the fragmentation of the post-trade infrastructure of Europe because they have (largely) declined to follow the example of the Eurobond market in creating the two international central securities depositories (ICSDs) and issue debt securities regularly outside their home markets, which has enabled sub-scale national CSDs to survive in many European markets.
Corporate issuers will support a consolidated infrastructure once they can measure the efficiency gains in terms of a lower cost of capital but securing the gains depends on lowering the barriers (such as the outstanding Giovannini barriers) and the barriers to entry (such as insisting on the ISO 20022 standard to connect to T2S) and encouraging inter-operability between traditional and digital asset market infrastructures.
Transcript
00:19 Dominic Hobson: Hello, everybody. I’m Dominic Hobson, Co-founder at Future of Finance. Welcome to our webinar, “If Europe needs a single European central securities depository (CSD), who will build it?” Does Europe need a single European CSD? That’s our first question. One person who definitely says, “Yes, Europe does need a single European CSD,” is Christine Lagarde, the president of the European Central Bank. And her speech to a European banking conference back on 17 November last year certainly caught my eye. It was called a “Kantian shift for the capital markets union.” And she invoked Immanuel Kant because – at least I think this is what she meant, to say nothing of what the great philosopher himself might have meant, because he taught us that the world does not make us, but we make the world. Which puts all those practical men and women of business who for many years have been saying it’s far too difficult to transform the way the post-trade functions of the capital markets in Europe are done today … It puts them right back in their box. A truly European capital market, said Christine Lagarde, needs consolidated market infrastructures. So our second question is, who can meet that challenge? Who can actually do it? Who can make consolidation happen? Is it regulators, or, as Christine Lagarde seemed to argue, market forces? The answer to this question is far from obvious, as the history of attempts to answer it demonstrate. European regulators have argued for more than 20 years that the European capital markets need a single European CSD. That goal was set in the famous Lamfalussy report of February 2001, just two years after the euro was introduced. The barriers that need to be cleared before Europe could have a single CSD were itemised in the Giovannini reports of November 2001 and April 2003. Again, both reports were published more than 20 years ago. The first iteration of the Markets in Financial Instruments Directive (MifiD 1), which came into effect a mere 17 years ago back in 2007, was expected to drive consolidation of CSD in Europe by encouraging competition between CSDs. And to make that competition easier, the European Commission of the time orchestrated a Code of Conduct by which European CSDs agreed to publish their prices. To push things along a bit faster, the European Central Bank announced in July 2006 it was going to build a European cross-border settlement utility. Again, 17 years on, that project, T2S [Target2-Securities] has yet to pay for itself or even succeed in its goal of increasing cross-border transactions. The daily average volume of cross-CSD settlement transactions averaged just 1.15 per cent of total T2S settlement volumes in 2021-22. Worse still, the European Post Trade Forum (EPTF), has reported that two thirds of the Giovannini barriers are still in place more than 20 years later. Not only that, but the EPTF identified another eight entirely new barriers that had been erected. So here we are exactly 23 years on from the Lamfalussy report. The euro area alone has not one CSD, but 22. That’s actually two more than the number of countries using the euro. The European Central Securities Depositories Association (ECSDA) has 32 members, and between them they’re servicing equity markets that are half the size of those of the United States when you add them all up, and bond markets, when you add them all up, one third the size of the American equivalent, Butt then there are also 22 different stock exchange groups operating 36 different exchanges and 18 central counterparty clearinghouses (CCPs). So if Christine Lagarde is right, and a truly European capital market needs consolidated market infrastructures, that consolidation clearly has a very long way to go. But without consolidation, argued one think tank report, much referred to in that speech by Christine Lagarde, European capital markets are destined always to be, and also ran to the United States. Not just that, but it has negative implications for the funding, the profitability, the investment, and the innovativeness of European business, and therefore it will damage the standard of living of all Europeans. Yet it’s very hard to see how consolidation can actually happen, given the current starting point. But to help us try and work that out, we’re joined by five experts. Chris Richardson is CEO at Percival Software, a leading supplier of technology to market infrastructures including CSDs, and the sponsor of today’s webinar. Dirk Loscher is a member of the Executive Board at Clearstream Banking in Frankfurt, where he’s head of custody and investor solutions. Andrea Tranquillini is advisor to the CEO of the Securities Depository centre company in Riyadh, where he is able to draw on his experience of five conventional CSDs and the first blockchain-based CSD. Bill Meenaghan is CEO of SSImple, a blockchain-based database for the storage and sharing of standing settlement instructions (SSIs), which he founded after more than 20 years in securities services with State Street Global Advisors (SSgA), Omgeo, DTCC and IHS Markit. Martin Watkins is chief executive officer at Montis Group Limited, which is developing a cross-border CSD to support both native and non-native digital securities. As always, in addition to our panellists, we have you, our audience. Our panellists are eager to answer your questions as well as mine, and I encourage everybody watching or listening to submit questions and comments throughout this webinar by using the Q & A functionality at the bottom of your Zoom screens. I won’t be saving your questions and comments up to the end but will endeavour to get our panellists to address them as we go along, so you can be an integral part of this discussion right from the outset.
6.05: Dominic Hobson: Indeed, you have already been an integral part of this discussion, and that’s because we asked you to answer a handful of multiple-choice questions when you registered for our event today. I’d like to thank all of you for doing that, because it means we can start with the collective wisdom of 140-odd – the number has gone up since then – 140-odd individuals who registered for this webinar. Now, we asked three questions, and the first was whether Christine Lagarde, the president of the European Central Bank, is right to say that a truly European capital market needs consolidated market infrastructures. And this is the first chart here. Two thirds of you think she’s right. Only one in six of you think she’s wrong. But it’s interesting, I think, to dig a little deeper into that two thirds majority and see where it came from. Can we have the second chart, please? As you can see, if you look to the left there, it’s technology vendors and consultants that agree with Christine Lagarde most enthusiastically. Personally, I thought it was rather an odd finding. I expected vendors and consultants would think the more CSDs the better, since it means more clients to work with. But what’s really interesting about who said what is that people working at CSDs themselves think consolidation is necessary. 54 per cent of those working at CSDs and, less surprisingly, 63 per cent of those working at ICSDs, think that Europe needs a consolidated infrastructure. Now, of course, those individuals at those CSDs are not all working at CSDs in Europe, and so probably many of them have good operational reasons for finding the fragmentation of the European market infrastructure rather tiresome. And some are also working at CSDs owned by ICSDs. And it’s ICSDs, of course, which see themselves as the natural consolidators rather than consolidatees. If you look carefully at the results of the poll, those European CSDs that are attending today are, I’ll put it like this, more ambivalent on the question of whether consolidation is a good idea. Let’s have the third chart now, please. Our second question was, what are the biggest obstacles to the consolidation of European CSDs? Here, we did and did not get a definitive answer. Did not because none of the options attracted even as much as a fifth – 20 per cent – of the vote. And we did because our audience is, if you add up what they see as the major obstacles, pretty clear about where the responsibility lies. It lies with governments and with regulators. They think harmonisation of laws, rulebooks, elimination of national market practices, introduction of standards- those are the keys to change. And that we need – this is a very important observation – a single European regulator to kind of do a Gary Gensler on the European infrastructural problem. Now, of course, the lack of these things, in one sense, is just a restatement of the problem. No harmonisation, you get no consolidation. No consolidation, you get no harmonisation. So it is quite hard to work out here which is the cart and which is the horse. But what is abundantly clear, if you look at the columns I’ve marked in red on this chart, is that the people who operate the current system, i.e., the CSDs and the ICSDs, and the people who use it, i.e., the custodian banks, the corporate issuers, the investors, are not the heart of the problem in the estimation of our audience today. Now, I do wonder how true that is. Are national CSDs and their domestic clients really not obstacles to change? And I’m sure we’ll discuss that question further today. Could we have the fourth and final slide? Now, this was our third question, and it wasn’t asking the audience whether consolidation of CSDs was the answer. It was really: “How can European CSDs contribute to the challenge set by Christine Lagarde to create a single European capital market?” Here again, we’ve got no very clear answer, but I’m struck by the option that came top. That’s on the left-hand side. Technology. You are saying that CSDs should build a single programmable platform onto which all manner of digital assets could be issued, traded, settled and safekept. Now, there is a challenge. The future of the capital markets of Europe, and by extension, the future of the CSDs of Europe, lies in the hands of the CSDs themselves. In fact, if you look at this chart carefully and add up the things CSDs could do on their own, without having to ask regulators or governments or central banks or the European Commission to do anything at all, they do add up to 60 per cent of the vote. On that basis, our audience are not waiting, as you might conclude from the previous slide. They’re not waiting for officialdom to do something and publish a single rulebook or set up a single regulator. A clear majority think that CSDs should simply get on with it themselves. But that ends our brief survey of what our audience thinks needs to be done. And, as I said, we look forward to hearing more from the audience during our discussion, which I’m now going to kick off by asking our panel whether they think Christine Lagarde is right. And I’ll come to you first, Chris.
11:41: Dominic Hobson: In this Kantian speech, the president of the ECB spoke about how this fragmented infrastructure within the euro area is restricting the size of capital markets. It’s increasing the cost of capital to European companies. It’s inflating the transaction costs of trading, settling, custodying financial assets. It’s perpetuating the reliance of European business on debt rather than equity capital. It’s making it very hard for securitised bond, asset-backed bond markets and venture capital industries to develop. And those have proved extremely important to continuing investment and innovation in the United States. In short, I think Christine Lagarde was saying that European CSDs are more important than they think they are, really, that they’re actually lowering the growth rate of the European economy, or certainly helping to do that, and so making everybody in Europe a lot worse off than they need to be. And that’s quite a big charge to make. Chris, you are not only our sponsor, but you also work with national CSDs in Europe. I mean, is Christine Lagarde right? Are the costs of this fragmented market infrastructure as high as she seems to imply?
12:56: Chris Richardson: No. The question is ludicrous, actually. I don’t understand how CSDs get tarred with the brush that it’s all our fault and that somehow the problems in the market, or the market, such as it’s defined, how people perceive it, is equivalent to how the CSD sits within that market, because that’s not true. The market is a cooperative effort of a number of stakeholders in it, of which the CSDs are an important one. But I wouldn’t say that they are necessarily the major player. I mean, one of the biggest issues that I see in terms of trying to consolidate – if you accept that we would even want to do that – one of the largest issues is the complete difference in terms of concept and structure of the markets within Europe. Okay, here’s how it breaks down. In the official definitions, you’ve got two kinds of CSDs, direct holding and non-direct holding. Non-direct holding most people know around the world as an omnibus market. So there are layers and layers of intermediaries that provide services to the market. And most of western Europe uses omnibus markets, whereas the Scandinavian countries, the UK to a certain extent, most of the new joiners to the EU, have beneficial owner level accounts. And that’s not just the level of consolidation at account level within a CSD. That speaks to fundamental differences in the flow of information and how business is done in each market. So, yes, so let’s have a single CSD in Europe. Let’s take that under consideration. Well, which model are you going to use? Who loses their shirt in that consolidation? No, I don’t even accept the basic premise on which she reached her conclusion.
15:09 Dominic Hobson: Andrea, perhaps you could comment on that. I think two things about what Chris has said. One is to revert back to one of the charts I showed. Clearly the audience is alive to the fact that differences in national market practices are an obstacle to creating a single CSD. On the very specific point he raised about omnibus versus end user accounts, that’s an area in which there has been a debate in Europe in recent years, and the custodian banks in particular have fought back against switching to a sort of Scandinavian model. They wanted to keep the omnibus model and they’ve argued very strongly that it’s to the benefit of clients. And if Christine Lagarde is to believed, she’s going to start dismissing those arguments in future. So what’s your view, Andrea, of the Lagarde view that actually we can’t go on like this because it’s just too damaging?
15:59 Andrea Tranquillini: Well, thank you. Thank you, Dominic, and good afternoon to everyone. I think the fundamental question we need to ask ourselves is that according to the golden [inaudible] rules is: Which problem are we are trying to solve here? So if the problem we are trying to solve is the creation of the capital market union, is T2S the solution? Because this is the most advanced solution that the European Union has so far identified. To the point of Chris, I agree that the infrastructure as it is today, does not respond to the nature of the problem, because that’s what fundamentally Chris is saying. So what T2S has tried is to harmonise settlement, one of probably the most commoditised function across all of them in Europe. But what has not been done is facilitating market access to, in particular tier two and tier three market participants that remain in certain markets hidden to a number of intermediary levels before reaching the market. Now, the markets are more immediately into the market themselves, but fundamentally, most of them have a pure national horizon. So T2S has been conceived in a standardised manner for large institutions that could afford upgrading their technology, have created an enormous spending at domestic level, but fundamentally has not attract the tier two and the tier three market participants. Plus, it has not changed their market practice, which was the ultimate objective. Was the fact of sort of imposing a SWIFT monopoly for communication a mistake? Maybe. But fundamentally, I do think that T2S is not the solution. If Lagarde believes that this is the embryonic status of what can become a real European CSD, okay, we can debate, but a lot of work needs to be done. At this stage, there isn’t a European market for very good reasons. Chris highlighted them. I do believe that we fail, that the current system fails in attracting an important component of the market, so failing in putting together, realising the CMU, and that ultimately stands with the regulators to guide and to lead the way for a unique infrastructure in Europe.
18:53 Dominic Hobson: Dirk, could I bring you in on this question? And I’ll refer to a remark John Falk has made here, which is kind of helpful, perhaps, in setting the scene on this question of national market practices. He says, “If I remember correctly, Euroclear’s attempt at harmonisation just across the countries where they own CSDs some years ago ended as it was too difficult and costly.” So even within one organisation, if you own five or six CSDs, you can’t necessarily eradicate those national market practices. But tell us, Dirk, how close to the truth is Christine Lagarde, are we talking here about an issue for Europe which is so important that these national differences need to be overridden by some means?
19:37 Dirk Loscher: Thank you, Dominic. I mean, from my perspective, it is not really just about the consolidation. I mean, we are at this stage looking at very fragmented national laws, right, looking at insolvency law, securities law, tax regulation, how share registration process works on top of omnibus versus segregated accounts. So it is not just a technology solution we are looking for here. It’s much more. It is that we really support from our end the efforts around the Capital Markets Union (CMU) by means of strengthening the attractiveness of the EU markets, and also then at this point, make more use of private funds, which is one of the things she is pushing for, right, especially in the light of the tense public budgets. And at this point, we might also reconsider the EU supervisory set-up for the next legislative period. But in general, I mean, we are very supportive of T2S and the cross-border settlement. We have probably been one of the most active CSDs in the segment, and we are very actively working on that for a very long time already. One of the key challenges we have identified is that the cross-border settlement didn’t really work for dual-listed securities. It sounds like a technicality, but when you have conversations with clients and you spend 80 per cent of your time to explain why 5 per cent of the portfolio can’t be settled cross-border the way it should in T2S, then there’s something wrong, right? So we have very good dialogue with the ECB and the [inaudible] to get that changed. And there is going to be a change request put in place or has been put in place and it’s going to be executed next year. And the other thing we came across, it’s also very interesting, is that a lot of market participants, for historic reasons, connect the PSET [Place of Settlement] field for a given market with … For example, a Spanish PSET is for Spain, a French PSET is for France, right? But in order to really make cross-border settlement successful in T2S, you need to combine this. So you have to be able to, for example, have a Spanish security and settle with a counterparty who has a German PSET or the other way around. Only then you will be able to really make cross-border settlement happen. And that is the applicable standard. Just for historic reasons. The system infrastructure is not really able to accommodate for a lot of market participants, which means that we have a lot of clients being really interested to have more consolidation and more cross-border activity. But they face a challenge that their counterparties can’t communicate with them this way because they can’t support this PSET field. So from that perspective, there’s still a lot of work to be done and we are ready to move forward with that. We are very active. You have referred to as a very low percentage number of cross border settlement, but 80 per cent of that is basically [inaudible] related activity, right? Because not many CSDs have really moved forward on the cross-border activity so far. We see a little bit of movement now also with other CSDs, like Euronext, for example, is moving into that direction at this stage. So I’m sure there’s going to be more to happen, but it’s going to take some time, and in my view, it has taken much too long already and we really need now to fix the source problem, which is to get the change request done from a T2S perspective, which the ECB has committed to do.
23:04 Chris Richardson: Interesting. I just comment there. Dirk, do you find actually, even within the industry, I’m talking about as a whole, not just CSDs specifically, that a lot of major participants don’t really, the ones that are not involved in CSD operations really, truly don’t understand how a CSD and their operations actually fit into the capital market. They really don’t appreciate the issues that we have to deal with and the role that we play in the market. That’s what I find. There’s ignorance at the highest levels about what we do.
23:36 Dirk Loscher: I think it is not very obvious, right? If you are not in that industry, it is very difficult to understand what a CSD does. So if you ask the random man on the street, they will be able to tell you, if you’re lucky, a little bit about investing into stock, but that there is a CSD in the background doing all the asset servicing and all the safekeeping and everything else, nobody knows. Right, so, to your point, yes. So, CSDs, what CSDs do, is not very well known to the public.
24:06 Dominic Hobson: I think the man in the street knows more about CSDs than he has ever known before, because Euroclear is in the newspaper and the press all the time for holding hundreds of billions of euros of Russian financial assets. Could I bring Bill in at this point? Bill, you’ve been listening to both Andrea and Dirk talk about the shortcomings of T2S, and clearly a lot of things went wrong with that project. It took too long, it cost too much. It did nothing, as we’ve just been hearing, to encourage cross-border trades. It’s still incomplete, to be honest, UK and Greece are not inside the thing. It didn’t address asset servicing, it was only settlement. It didn’t increase collateral mobility, blah, blah, blah. But then I’ve been surprised how basic are some of the things that are going wrong. The failed trade rate is actually going up, not down, both in terms of volume and in terms of value. We’ve got a million-plus cash penalties for failed trades being paid a month – a month, under CSDR [the Central Securities Depositories Regulation]. That’s €1¾ billion a year, probably, which market participants are paying. Those same market participants did their best to destroy the one form of pain which might have encouraged them to change their behaviour, which was mandatory buy-ins. They killed that off even though it was originally inside CSDR. So, my question is, what explains these continuing, at that granular level, Bill, what explains these continuing settlement efficiencies? Is this late matching? Is it lack of reference data? That stuff I was writing about when we founded global Custodian magazine in 1989. Are these still reissues?
25:48 Bill Meenaghan: Yeah, I think to some extent they are. Dirk mentioned the PSETs, and it’s a tiny point, but it’s a very good technical point. When transactions were being settled many years ago, a UK security would settle in the UK and other countries into whatever country it was. When you have a cross-border settlement, PSET is actually your counterparts’ depository – it’s where you’re delivering the securities to. So it’s almost like booking a taxi and say, I want to go there. But you don’t tell them where to pick it up from. What should be included, and if there is a rule change coming in, one of the things that could be included is where is the security now and where is it going to go? And a lot of the time it will be the same. But if you want to truly allow for a market that allows that free movement of securities across borders, saying it’s in Germany, it’s going to Spain, or whatever the two countries are, that would allow for the right information to be included within that. The increase in the settlement fails, it was initially put down to COVID, and I’m sure that definitely played a big part. But we’ve been out of COVID for some time now. We’ve had the launch of the settlement discipline regime in 2022, and as you pointed out, just under €1¾ billion of penalties have moved around. So that’s not changed behaviour either. So I think there’s a fundamental problem with the way that the system is set up today. And it should be something, it could be reference data, it could be that the SSIs [Standing Settlement Instructions] are incorrect, it could be late matching. So I think if you put all of those together, there are a lot of reasons that are stacking on top of each other, and maybe it’s compounding the problem, but we haven’t been able to unwind those problems with all of these penalties coming on as well. So there do seem to be quite a lot of things playing into it that are still causing fundamental problems in the industry.
27:35 Dominic Hobson: But Chris and Dirk have just been telling us that the man on the street doesn’t understand what great work they’re doing. If I listen to you, actually, it’s pretty terrible work that’s going on in the back office. Okay, so 98 per cent of these things, or 94 per cent of these things, are settling on time, but there is still basic problems caused by systems, by lack of data, by rekeying, by people not knowing what they’re doing.
27:58 Bill Meenaghan: Yeah, again, we can’t blame them completely. They’re at the end of the cycle, they’re being told what to move and when to move it. So if those instructions aren’t getting to them on a timely basis, then they can’t really do things until they’re told to do it. They’re not mind readers in that regard. But the fundamental problems that are causing the delays, that’s what should be addressed. My company is looking at SSIs and making sure that’s a more efficient process. Things like trade matching, doing that on trade date, getting the instruction down to the custodian, who can then forward it onto the depository. That should all happen on T[+0], but quite a lot of the time it’s happening late, and part of the fines are for that late matching part, as well as the late settlement. So I think it is looking at the basics of the problem and seeing where we can make fundamental differences. And some of them probably shouldn’t be too hard to solve. If you know where the securities are, you know where you’re delivering it to, and you can get all of the economics agreed on a timely basis, then that should lay a very solid foundation to making sure that those trades settle on time. As you point out, 6 per cent don’t, and that’s gone up from about 2½ per cent a few years ago to that 6 per cent. So we really need to get over this curve and start getting it down the other end. Otherwise buy-ins will be back on the agenda. I was at a couple of conferences last year where people from the ECB were talking and they said that’s something that they’re looking at. They want to see whether buy-ins are needed. I think the CSDR refit is going to look at that penalty amount. Are the amounts too low? You would imagine that €1.7 billion shouldn’t be too low, but if it’s not changing behaviour, then maybe it is too low. And maybe the threat of buy-ins coming back in is something that the industry needs to fundamentally change how they operate today.
29:47 Dominic Hobson: I remember being at Global Custodian [magazine], maybe back ten years ago, running a survey for your friends at Omgeo, and the industry admitted the only thing that would ever change their behaviour was mandatory buy-ins. Sorry, Martin, I feel you’ve been very silent there. You’re on mute, I’m afraid. So do switch.
30:09 Martin Watkins: No problem. No problem. No, I think partly why I was listening more than participating in the first bit is obviously the type of issues you’re talking about here have evolved over the last 30 years. If you look the growth of CSDs coming through the Nineties, many of whom are still operating on the same technology, the same procedures and processes, and that also goes with the ecosystem for which they support. So it’s not a single blame item. This is actually the evolution to get to a number of the inefficiencies. And basically, if I go back to my days as a Big Four consultant, I’d say I wouldn’t have started here. And the reality is we are here. Now, from our perspective, we look at it from the Montis perspective, that we’ve now got clearly defined regulatory rules and definitions of what’s required. We’ve also got the transformation of financial markets, from conventional to digital securities. And we firmly believe that in the years to come, everything will be a digital security. Now, the challenge that we’ve got here is how do we address some of these?
31:24 Dominic Hobson: Martin, can I just be clear about what you’re saying? You’re saying that in the terms of digital assets, you’ve now got regulatory clarity. Is that what you meant?
31:30 Martin Watkins: We’ve got regulatory clarity. First, I was meaning on what a CSD is, what the rules are. It’s very clear. So if you wanted to specify the requirements for CSDs, the regulations are very clearly set out and you’ve got the CSDR refit. You then go to look at digital securities, which wasn’t the point I was making, but to answer your question there, you’ve actually got, in certain countries, you’ve got legal certainty, but you haven’t got it across the board. And I know we come onto the Pilot Regime a bit later, so I’ll answer that bit there. But I do think this starts to come to the point that Chris quite eloquently made, which is where we’ve got several models – we’ve got an indirect holding and a direct holding type model – the type of consolidation that I would see, that Christine Lagarde could successfully be identifying, is actually that we’ve got too many providers of the service across, in, let’s take the European Union, across 27 member-states. Not the point of you either have indirect or direct, but actually there should be fewer who provide either of the two services, and then you allow the market dynamics to decide who wishes to use which. So it’s really, what’s your term, consolidation, as opposed to – and I totally agree, there are far too many CSDs in Europe, and there are actually, in many cases, the majority of them are, if they stood alone, uneconomic. And that only costs corporates and investors and issuers. It costs them vast amounts of money. So taking that all forward, what I’m looking at is saying how do we transform out of where we are, and how do we get harmonisation around the standards from our case for the new digital securities and actually leverage the fact that we can accommodate conventional securities in the same environment? And that comes down to where’s the right laws, where’s the right regulations and also the right operating procedures for a digital environment, not analogue.
33:37 Dominic Hobson: Well, digital securities are one thing, they are a way off yet. We’re talking about analogue securities, if you like. You mentioned market forces. Can these actually be effective in Europe when 60 per cent of the CSDs we’re talking about are owned by stock exchanges. Those stock exchanges obviously have a vested interest or an interest – it doesn’t have to be vested and sound contentious – but an interest in vertical integration. They like to control the trading, the clearing and the settlement. Quite understandably. How can you ever get these market forces to work towards consolidation? Because they’ve got all these national monopolies. They want to control all three stages of the trading and post trading process. And I don’t see many CSDs around Europe kind of being for sale, so I don’t see how market force can ever be effective.
34:23 Martin Watkins: Well, I’ve seen some that are for sale, but sometimes, yes, not necessarily ones that you want to buy. But you also look, and you look at the. I mean, you wrote in your article that Euroclear has six different CSDs. I’m ex-Euroclear. Six different CSDs – it’s not harmonised. And if you can’t do it in-house, don’t even try and do it outside. So you then start saying, actually, what is the purpose and what’s the basis? And you come back to the concentration around certain asset classes, around certain markets, and that’s where you build out from. You’ve seen it in the clearing side. That’s why I was referring to CCPs [Central Counterparty Clearing houses] earlier. You look at any particular market that is cleared, it is concentrated in a particular entity that does it, and the same will evolve for CSDs, because that’s how we actually need to build out. You do need to have an element of natural consolidation, so I don’t think you go for a single solution. So if we look at the way that Cedel, now Clearstream, was evolving in competition with Euroclear, that gave optionality. It didn’t give a single answer. But when you’re coming back to it, I think the way you’re going to actually see the growth coming out of this is around particular assets, in particular markets which are dominant. And then the question is, can that practice embrace the other markets around the EU 27? Or are you actually going to turn around and say that simply will be the only option, because, same as you do with Brent Crude and with WTI [West Texas Intermediate], there are only two benchmark products that you invest in, and you’ll have the same happening around financial securities, which are settled through CSDs. Food for thought, Dominic.
36:20 Dominic Hobson: Thank you, Dirk. I want to come to you about blockchain technology. Before I do, John Falk makes another comment. Part of the reason, just to deal with this cross-border thing, part of the reason for T2S not increasing cross border trading is that the investment industry as a whole is still domestically focused. The point I was making is that actually the clients of CSDs are an obstacle here, although it’s not really picked up in our survey of the registrants. And then another attendee has said, “Do we need to worry about cross border settlement in Europe at all if we have a European super-CSD and harmonised market practices?” So we end up with a kind of DTCC [Depository Trust and Clearing Corporation] for Europe, and then everybody else can go hang themselves, as it were. And maybe that’s imposed upon us by the European Commission or the European Central Bank, or some combination thereof. Anyway, you may have thoughts about that, Dirk, but what about this, what Martin was alluding to there about digital assets, about blockchain? Cast your mind back to the fact that 25 per cent of our registrants think that a single programmable platform is the one thing CSDs could do to actually accelerate progress towards a single capital market. And by that they mean multiple blockchains, I guess, linked together by a single set of smart contracts, set of APIs [Application Programme Interfaces] , so that the seams between them are invisible.
37:43 Chris Richardson: What do you mean by programmable in this context?
37:44 Dominic Hobson: In this context, you can programme both the network and you can programme the assets which are moved around on it using smart contracts. So smart contracts that sit on the network can also be inside the financial assets themselves, but it’s a standardised programmability. So a bond is like an equity, is like a commodity, is like a real estate, so you’re operating to kind of technical standards. I think that’s the model. Now, Dirk. Clearstream is obviously doing quite a lot of work on the digital asset side. What part do you think blockchain technology has to play in creating an infrastructure that can support a single European capital market?
38:32 Dirk Loscher: Yeah, very happy to take that question, Dominic. Currently, blockchain is not being used as much as people probably have thought it is in [20]24. Now, Clearstream, being part of Deutsche Börse Group overall, is obviously very actively engaged on these blockchain developments. So being in the digital security space, along the value chain of security, and along the value proposition of Deutsche Börse overall, we are building and investing into the relevant components. So there’s HQLAx, for example, there’s Funds DLT. We are building D7, which probably a lot of people know best. And we are also investing into cryptocurrency asset safekeeping. And we have alternative assets on-chain via 360x. So there are a lot of things going on from an overall group perspective. Now, many elements are missing, and we have expressed in a joint paper with DTCC and Euroclear in September last year that interoperability and standardisation are, in our view, the key drivers for adaptation of blockchain technology in the wholesale banking industry. At this stage, we are aiming for innovative solutions which are complementary to the traditional technology. So D7 is basically working along the value chain. You are starting with the issuance part, digitising this part, and then we connect to the traditional world, because what we should not underestimate is that also our clients – so the market participants – have to go with us on this journey. They have to also invest into their technology in order to accommodate those market changes. We have seen a number of examples in different locations where there was a lot of investment done to then find out that the market probably wasn’t ready for it, looking at Australia specifically. So there have been a lot of things done in the past where there was this big jump from where you are today into the future, which have not been as successful as people were hoping them to be. So we are trying a different approach here, working along the value chain, and we are very committed to also work, for example, on those ECB trials. All our CSDs are going to participate, not only the ICSD, but also CBF [Clearstream Banking Frankfurt and Lux CSD. So the two domestic CSDs are going to participate and, in that view, we are very supportive. But it’s going to take some time, right, and it’s going to require standardisation and a common framework. That is going to be key. So far, there have been isolated initiatives, and those things will not really move the needle, right? We need to have something which is accessible and doable in a bigger environment with multiple participants. So we need to have the connections built between those different solutions. And that is what we are focusing on next to, especially the D7initiative, on our side. And I don’t know why my camera just switched off, so let me try to fix it.
41:50 Dominic Hobson: It is rather disconcerting seeing your face being still but hearing your voice. Andrea, I know you’ll want to comment on the blockchain, but Bill, I’d like to come to you after Andrea, just to give us a sense of how blockchain can help us overcome some of those old-fashioned problems that we know, the lack of reference data and late matching and all that. But Andrea, you ran a blockchain-based CSD based in Paris, focused on money market instruments, if memory serves, that went for two years but was eventually not a success. What have we learned from that experience about the technology and about the wider environment in which a blockchain based exchange – sorry, CSD – must compete?
42:37 Andrea Tranquillini: Well, thank you. I think there are a number of factors, right? So, first of all, the project started in a context … or with a focus on money market instrument, in a context of lowering interest rates or extremely low interest rates. The prediction was for interest rates to rise, but they didn’t. So on the contrary, what happened was the central bank, the European Central Bank at the time, extended the quantitative easing and allowed financial institution to finance with a very competitive overnight rate, which created an alternative to financing with short-term instruments. Then the Pandemic occurred. So also the corporate moved financing with the Pandemic system. So this was not in itself associated to the technology. So we managed to create the company. The company was up and running well. Let’s say macroeconomic factors drained the liquidity from the company. But to the point of [inaudible], which claims the need of creating interoperability to develop cross-border and communication between the different environments, the whole point here is the creation of liquidity. If you don’t have liquidity, it becomes a Catch-22. An issuer comes on your platform only if he has asset managers that buy. And an asset manager buys only on the perspective of measuring the risk of reselling or not reselling an asset. So if this risk is high, the asset manager will have assets, in this case with digital assets, in only a very limited part in its portfolio. So the point Dirk makes is very valid. We need to create an environment, to create an ecosystem, where many participants speak with each other. And so there is the possibility to create a secondary market. Otherwise we can have the most fantastic technology – and I can think of many providers have proved that this new technology since the last ten years is efficient, is lean, is probably more economic than conventional technology – but beyond the pure use of an innovative technology, the market may not work. So that the initiative may not work because there is no liquidity. Now, in addition, in Europe, we know that there is no settlement. Digital settlement is still impossible because you’re obliged to settle in T2S. So this is an additional element that is pulling the brake on issuance in a new form, which is a digital form.
45:29 Dominic Hobson: Now, Bill, one thing I don’t see is the CSDs of Europe, as opposed to the ICSDs, which are doing things in blockchain, I don’t see CSDs doing much. Indeed, I hear they don’t see any business case for getting involved with blockchain at all. Now, I don’t know whether they’re right about that, but that certainly seems to be the view. I know you’re working with Chainlink, for example. What part can blockchain play in improving that pretty dismal operational performance? Just narrowly on the settlement question in Europe?
46:07 Bill Meenaghan: Yeah. For me personally, I think the direction of travel is that there will be DLT [Distributed Ledger Technology] experiments over the next few years and they will start to become more of the norm and we will start to see a lot of volume going through those. I think between now and then, though, what we have to do is make sure that we’re getting the house in order and we’re doing things in the right way. So making sure that all of the relevant data needed for settlement is all aligned, all set up, all correct. If you knew where all of the positions were, again, that would help greatly to lower the fail rate that we see today. So for me, the current model doesn’t work. The fact that we have such a high fail rate, and even if it’s just gone up in the last few years, it’s still pretty high. If you went into surgery and they said there’s a one in 50 chance of you not coming out the other end of this for a fairly basic surgery that you’re going in for, you’d think twice about going in for that surgery. I think what we have to do is look at that whole process, and for me, putting blockchain alongside it and having a Prius model where you’ve got the blockchain that will help improve efficiency along the way and it coexists with the current ecosystem that exists, is a way that you could almost start to drive the process to be more DLT-based. You’re not going to get all clients to move over in a single hit. As was mentioned before, there are going to be companies that need to invest in their technology to make sure that they’re all aligned with the new way of doing things. And that’s why I think the work that Chainlink are doing, where you can use the current SWIFT message infrastructure, if you want to, and connect that into either to get the messages from a blockchain environment and connect it through SWIFT into the current technology, I think that could be a way that this could work quite well. But again, for me, this process all comes back to having all of the right information in the right place and making sure that everybody understands what they’re doing when they enter into that contract. And that’s at the exchange layer. You could also flip it around and say, if something’s put onto an exchange, you drive it from there. So that was one of the other things that we’re looking into with the client is, “Is the current model the right model? Could you do this slightly differently and allow the exchange to drive that down to the depository rather than going around the different intermediaries that you see today? Is there a better way of doing it?” So we’re looking at something along those lines as well.
48:37 Dominic Hobson: We have a very interesting question from Hugh Simpson. And Hugh, I have noticed it and we’ll come back to it. But just while we’re on the blockchain topic, I’ll just read some comments from attendees. Monica Singer says, should traditional CSDs and exchanges not learn from the successes of high liquidity being achieved by, for example, Uniswap in decentralised finance, but bring the regulatory credibility that traditional finance has achieved? In other words, let’s have automated market makers operating in traditional finance, but fully compliant with regulations. So that’s the challenge there. And that’s an area where, obviously, Christine Lagarde and her friends could help. Another attendee has said the potential for DLT remains enormous to disrupt the archaic state of post-trade market infrastructure, but wholesale adoption and cost interface from participants remains a barrier. That’s the point you were talking about there, Bill, that you can keep the SWIFT interface and still be active in digital assets. That addresses that problem, although possibly there are lots of people that want to preserve failed systems, right?
49:39 Martin Watkins: I’d certainly like to come in on that, Dominic.
49:42 Dominic Hobson: Okay. I don’t know. John Falk also asks who’s defining the standards for these smart contracts – back to the single programmable platform.
49:50 Chris Richardson: Thanks, John.
49:52 Dominic Hobson: Which is not smoke and mirrors. The Bank for International Settlements has used this term, albeit for digital money rather than digital assets. And the Regulated Liability Network is working up a programme for this as well. So it’s not something which I sucked out the end of my thumb. It’s a live discussion, the single programmable platform. Anyway, Martin, go ahead. You wanted to come in on these [issues]?
50:14 Martin Watkins: Yeah, I’ll come in on the token one or smart contract one afterwards. But I think first dealing with, and I’m absolutely in line with Monica Singer and we’re delighted that Monica is very kindly a member of our advisory council and helping us steer through, given the work she did over at Strate [the South African CSD]. And also picking up on the anonymous attendee who’s talking about the enormous disruption that can be achieved. The whole point behind this, and it’s exactly the same that you’ve talked about the issues in the last 30 years, it’s about getting people to harmonise, getting people all to be at the right levels. So if we think that a CSD … And we’re building a digital CSD, we’ve applied for a licence in Luxembourg because the laws and the regulations support us very much there. But this is to go live. It’s not about Proof of Concept and so on. And what we actually are working with is we’re working the participants who create that ecosystem, who then support the issuances for exactly the reasons that Dirk and others have been making. The issuers need to then know that they’re issuing into a liquid market. The liquid market has to have the investors who are going to support around it knowing that they can also sell out of those positions. That then goes in through to actually the custodians and then onto, in our case, settlement banks, because we’re settling through Target2 (T2). Some of the key aspects behind this are actually reducing the level of change that needs to come on. Now, we’re already doing that from the basis – subject to getting authorisation permission – is to actually retain the SWIFT messages that are required to go back and forth, but still deliver the benefits of actually getting exchange traded messages from an API and giving wallet access for all our participants so custodians can see their live positions at the point that the Settlement Finality [Directive] gives them legal enforceability around those instruments. From the point of view of what we’re also creating, we’re creating the ability to have tokens. Tokens only become smart contracts when you’ve got the executable code. And the big benefit there is to get away from this concept of the lifecycle management being complex and expensive. You already pre-programme that lifecycle into the asset right at the beginning. It means there’s an element, more work and cost upfront, but then the lifecycle of that is fundamentally different. And if we look at it, I want to take you to the stage where you talked about different systems and intermediation and so on. Interoperability has come up. Today, we have the technical ability, but not all the laws and the regulations in place. And it’s not something we should rush to, but we should recognise it’s there. We’ve got the technical ability for J.P. Morgan to sell or buy using Onyx, for HSBC to sell or buy using Orion. And what we’re looking at from a CSD’s perspective, if that state change is recognised in Montis, we automatically have achieved right through to Settlement Finality, just by recognising the state change. So technically that is available now, the financial innovation is there, but we need to step through that carefully with all the ecosystem participants and with the regulators and the legislators. But that capability is what we’re building for today, and that fundamentally addresses those barriers.
53:37 Dominic Hobson: It’s interesting listening to you, but it’s like you’re doing this in a parallel universe to what’s going on in CSDs. And question to you plainly, in a just world, if CSDs were excited by this technology, you wouldn’t exist because your clients would have been able to find a CSD to do this work for them. But the CSDs are really not responding to that. You exist only because the CSDs are not [doing it].
54:01 Martin Watkins: Well, okay, there’s a couple of things here. I think, first of all, we can actually do it not in a parallel world. We can do it with conventional securities, okay? So we can do it with conventional under Luxembourg law, registered using article three of CSDR in book format onto a blockchain. Now, some of the comment that was made earlier around ASX and Australia had a go and it didn’t work very well. Well, I seem to recall Euroclear wrote off €750 million for the inability to develop a single platform. And we can look at a number of other CSDs who’ve had very big problems with basic technologies. So I don’t think it’s around the technology or us going off on a different tangent. If you look at what SDX are already doing, SDX have got that capability and have had that capability to both do conventional and digital securities for some time and are extending further from their side. And there are other CSDs who are gradually getting there. Dirk and the team at D7 are able to do some form of digital securities, but that needs to commingle alongside conventional. And that’s the part we’re looking at, because we’re seeing a lot of institutional demand coming in at this stage for tokenisation. If that’s tokenised, you need to be able to have it admitted on the secondary market, which means you need CSDs. It does mean that in the future there will be fewer CSDs because fewer of the incumbents are going to be able to close the gap. So it is something, and it’s absolutely sitting square and centre as a conventional full scope CSD, but with digital securities – the sort of thing I tried to do when I brought Paxos and Euroclear together many years ago.
55:42 Dominic Hobson: Okay, thanks. We’re within five minutes of our official stop time, but I’m going to let this run on because the audience seems very engaged. We’re getting lots of questions coming in. Andrea, you wanted to comment. Can we talk about the Pilot Regime? Because, to Martin’s point, about you have to issue these tokens into a CSD is a kind of barrier to the growth of digital assets in Europe.
56:10 Andrea Tranquillini: I do believe so fundamentally, it has been badly conceived, and I think the …
56:14 Dominic Hobson: Demonstrably. it’s not just badly conceived, it’s actually a flop. I can only find one start-up exchange, which is talking part.
56:20 Andrea Tranquillini: Absolutely. But I think Montis is the demonstration that they are looking for a full licence, if I’m not wrong, instead of going to the Pilot Regime, right? Because the limitation that the Pilot Regime imposes in terms of issuance, in terms of … It imposes [on] a company to lose money through the year and never break even fundamentally. I don’t know which is the foundation of the rationale behind that. I may have my idea, which maybe there was interest of someone to gain time to be ready to …
57:02 Martin Watkins: No, it’s true. It’s true. It’s true.
57:06 Andrea Tranquillini: Sorry to be blunt, but I think, without mentioning, but I think from what I saw from outside Europe, or still when I was there, I saw very good progress from the company that Dirk is representing today, but not by someone else. And then I don’t know how, but the Pilot Regime came out as a showstopper for settlement in digital assets in Europe, so ultimately today is unusable. And so if a version of an equivalent of a Pilot Regime, then maybe work will appear nearby the European Union, will be in the UK, hopefully, if the [FCA, Financial Conduct Authority] sandbox will not create a similar barrier to development. So, Pilot Regime, I think we should really forget it, is a useless barrier, a totally useless piece of legislation. On the contrary, is an obstacle to development, in my view.
58:13 Dominic Hobson: So, Chris, we don’t see many CSDs queuing up to join the Pilot Regime, do we?
58:18 Chris Richardson: No, no, because they look around them and they see, in the wake of lots of failures and lost money, they don’t see anything attractive there to follow. Look, what we’re discussing is, does Europe need a single CSD? It’s got nothing to do with technology. We’re talking about integrating into a single CSD. If you have a technology that works, it’s going to succeed and people will use it. That’s a completely separate question from consolidating CSD business into a single structure with the idea that you’re going to engender a better market.
58:57 Dominic Hobson: That’s not what we’ve been saying. The audience has been telling us, and some of our panellists have been telling us that technology is a way forward to a consolidated infrastructure precisely because of all the barriers, all those political, legal, market practices, old Spanish practice barriers to actually getting this done in any other way.
59:16 Chris Richardson: But those exist in the regulations.
59:21 Martin Watkins: Can I…
59:22 Chris Richardson: You can’t get around legal barriers with technology. If you’re not allowed to do something, you’re not allowed.
59:28 Dominic Hobson: Exactly. The European Commission is offering to do that. They’re saying we’re fed up. We waited 20 years for nothing to happen.
59:35 Andrea Tranquillini: Let’s think about two key factors. The giant here is in the room. It’s not that T2S is not working and is the only case, the only possibility for investors, issuers and investors to trade in Europe. So we have today two entities that have been successfully developing their business since the late Sixties and the beginning of the Seventies on the basis of hunting door-to-door the issuers and investors. So tier two and tier three and tier four level investors offering tailor made services to their needs, especially when they had not the capability to use SWIFT and have facilitated issuance on the basis of a single legal environment, which for the Eurobonds is the English law. So if these are two key success factor of success for the ICSDs today, we should ask ourselves why T2S is not working. So the governments in Europe do not want to issue outside their country on a different issuance law.
01:00:51 Chris Richardson: Thank you.
01:00:52 Andrea Tranquillini: Guess what? Italy. So France. They have a trillion of debts. You imagine to issue Italian debt or French debt under German law because T2S is paid in Germany. But this will never happen.
01:01:08 Chris Richardson: It’s not a technology problem. You can’t solve it with technology.
01:01:15 Andrea Tranquillini: So, in addition to that, if you are unable to facilitate – that’s a CMU [Capital Markets Union] factor- the access of those that cannot afford to stay up to the level of any SWIFT upgrade from [ISO] 775, 15022 or 20022, then you lose one part of the market. So the market will remain always domestic – to the point of John. Correct. These are the two key factors that once you address the liquidity, the creation of a centralised liquidity for government debt, then you are on the right track because you will not have enough business to justify the fragmentation of infrastructure.
01:02:02 Dominic Hobson: Okay, we’re getting lots of comments coming in now I’d like to read. Keith Bear says to us, what are the three key items the UK DSS, by which he means, I assume, the Digital Securities Sandbox is [inaudible] to the Pilot Regime. The UK is setting up its own pilot regime, if you like, called the Digital Securities Sandbox. They promise to have none of those ceilings on market cap which have hobbled the Pilot Regime. And, of course, UK being out of Europe, I guess it’s a problem to set yourself up in the UK rather than Europe. But Keith is asking, what are the three things that the UK Digital Sandbox needs to get right, given the issues with the EU Pilot Regime. Scrapping the ceilings is one, right? Andrea, what else would you name? Are there a couple of other things you can think of?
01:02:48 Andrea Tranquillini: Well, I’ve not followed the most recent development, but I think if we look at really what was was not working in the Pilot Regime, this is the amount of issuance, the amount of overall centralised assets. And I think what is important, I think they highlighted, is the need to create interoperability because there are multiple initiatives, there will be fragmentation of liquidity if you do not manage to create a unique interoperability. This is a must. And I think I would say one thing that needs to be addressed is really a standardisation of issuance in the sense that, when you create digital assets, you need to define the protocols so that the digital representation of an equity in an environment is equivalent to the other one. So you need to create registers that have this function of, let’s say, framing what an asset is. So a definition of an equity corresponds always to the same parameters.
01:03:59 Chris Richardson: Legally, not in a technology sense. Legally.
01:04:02: Andrea Tranquillini: Legally.
01:04:05 Martin Watkins: I’m absolutely with both of you on that and I think this whole element of having it sitting correctly under the laws but recognising – and this came in one of the comments from Ian Hunt, one of the questions or comments – is actually you then start to say, if we can have a single record, then why can’t that single record that can be used by the transfer agent/registrar be used by the CSD? Now, the CSD only needs to see the legal owner level. The transfer agent wants the UBO [Ultimate Beneficial Owner] level, but all that information can sit in one permissioned chain. Now, I agree with you, Chris, that this isn’t about a technology play. This is about understanding how we can reimagine and redesign capital markets going forward. So many things have been step by step by step. We have to have multiple different intermediaries, and the intermediaries will still remain, but the work they do, we will remove the zero value add. And that’s why we’re really pleased at Montis to be following on the work that Andrea launched a few years ago, because this is the journey that we’re on. It will take time to get to, but there’s a huge amount of things which add no value whatsoever, and those are the ones that need to be replaced because that’s when the cost and efficiency comes down. Chris …
01:05:22 Chris Richardson: Chris, a lot of people are on the market for secrecy. That’s a fundamental interest in the larger vested interests pretty well around the world. They’re looking for secrecy. The drive towards programmability, centralisation of CSD function, runs across that. This is an issue and that’s got nothing to do with technology. But you’re fighting a political battle in another arena. That’s a separate battle that’s going on.
01:06:01 Dominic Hobson: We’re into our last ten minutes now, and I’d like to think about how we wrap this discussion up. The Ian Hunt comment you referred to, Martin, is, “Are CSDs taking the wrong view of blockchain potential?”
01:06:12 Martin Watkins: Exactly.
01:06:13 Dominic Hobson: “They seem to see it as a way of doing exactly what they do now, but a bit sexier rather than a transformation of the ecosystem. CSDs may be the blockbusters of tomorrow as soon as a credible Netflix appears.” And I know where Ian is coming from on that.
01:06:28 Martin Watkins: Can I answer that one?
01:06:30 Dominic Hobson: No. Another attendee said, “My understanding of the purported benefits of DLT is decentralisation and distribution of a process that’s typically centralised across a small number of intermediaries, Bitcoin, Ethereum, which this technology was invented, did not require a central bank.” His main point is, if we’re keeping these intermediaries, such as CSDs, what’s the point? Very interesting observation here from Viraj Kulkarni here. Says, the evolution of CSDs India to handle over 140 million investors digitally – that’s your end-investor account model. The Indians are proving this actually works. So thank you, Viraj, for that point. It’s a good one. [Inaudible] is saying, “We suggest the host give consideration to an upcoming webinar on CBDC programmability and ramifications thereof with TradFi [Traditional Finance], albeit theoretical for Europe notwithstanding a justified exercise – Europe lags ten years behind the front runners. Chris prompted a challenge which was semi-muted by the host.” Was that me? I’m the host. So sorry if I shut you up there, Chris, but we’ll get on to that. Viraj says “regulators need to focus in developing markets on liquidity and wealth creation, removing the reg barriers and using tech solutions to enable it.” Yeah, that’s the sequence I think you would like to see, Chris. Let’s get the laws and regulations right. It’s indeed what our attendees have said in response to our multiple-choice questions. We need to get the regs and the laws right and then we can build the technology. So I’d like to go back now just to wind up our discussion to the point which Hugh Simpson asked about actually how we get to – and you raised this, Chris – how we get to this consolidation. Hugh says, “Is it more realistic to think regionally. Three to four major CSD groups in Western Europe is probably manageable, but there are ten or more individual, tiny CSDs through eastern and southern Europe, many not even in T2S yet. That must hold back the integration of their markets into CMU. Should it be a priority to consolidate at the regional level? Who wants to do it?” In other words, Hugh is asking what is a concrete, rapid way forward to get a set of CSD services that can actually support Christine Lagarde’s idea of a single European capital market? What can we actually do? I don’t know how we get to Hugh’s regional integration, but that’s one idea. Does that require regulatory intervention? I think we’ve talked a lot about whether technology is enough, and I think we’re agreeing that we’ve got to clear the regulation and laws first, and then move to technology. You may remember only 4 per cent of our attendees thought that a kind of Deus ex Machina, a huge technological innovation, could actually do the job. So I think we’re now agreeing that this has to be a combined effort. Now, Dirk, you’ve been very patient, listening to me ramble on here. What’s your suggestion as to the right way forward to get a more efficient infrastructure? I’m going to ask each of you this question.
01:09:45 Dirk Loscher: Yes, it is a very good question, and it very nicely fits to the topic of our webinar today. So I think we need to probably take one step back, look at a situation that we shouldn’t hide the fact that historically there might also have been some aspects of national pride, right? And similar considerations preventing more consolidation on the CSD space because countries just would like to have their own one. Now, I think that, in the future, scale is going to be very important. We have seen that in the custodian space over the last few years, where several institutions have decided to exit the custody business just because they have realised that you need to have a significant scale in order to cover the investment required in order to be successful in this space. Now we will need to see, and I cannot decide on behalf of others, right? But I think we would surely welcome more consolidation in the interest of scalability and efficiency in the European landscape. And key will be to deliver operational efficiency and client benefit on the back of that. We invest heavily in our system infrastructure, and we are very supportive on digitisation and blockchain solutions. Our aim is also to fully integrate, to the point we made earlier, that ICSDs seem to be more active on the blockchain. I mean, the ECB trials is going to be the CSDs as well on our side, and I suppose others are going to join as well. But we also fully integrate ICSD and CSD. I mean, to the outside world it should not really make a difference at the end. So what we are working on right now is to fully integrate the technology platforms internally on our side, use them on both sides, make them very efficient and move to the Cloud at the same time. This is part of the journey. And I suppose that some of the smaller CSDs are going to realise that the investment needed in order to become or be part of T2S and jump all those hurdles is probably not really worth it if you have really very low volume, because the charge you would have to apply on a single instruction is going to be outrageous, right? That is probably driving the consolidation at a certain point of time, maybe slower than on the custodian side because of those other considerations. But I think over time it’s going to happen. And we are a very strong advocate for that from our perspective. And we really tried our best to support our clients with solutions which also give them access to blockchain solutions, but not in an isolated way, right? It needs to be an infrastructure; it needs to be connected. You have to have liquidity pools. And that is why we have decided to work along the value chain rather than do the Big Bang approach.
01:12:32 Dominic Hobson: Thank you, Dirk. Commercial economics will tell. Bill, just very quickly, what’s the best thing we can do to come up with this set of supportive CSD services for a European capital market?
01:12:45 Bill Meenaghan: Yeah, I think Hugh makes a great point. There’s three or four major CSD groups out in Europe now. So for me, the one thing that we can do is make sure that they can interoperate within each other. So we’ve got two ICSDs, and I’m sure that within the ICSD to the CSD, within Clearstream, they can move assets about intraday quite easily. Euroclear can probably do the same, but it’s in between all of those different entities. That needs to be a more efficient process for me to make that, to give you the choice that clients may want to make sure that everybody stays on their toes and provides the best service.
01:13:22 Dominic Hobson: And fewer bilateral links?
01:13:24 Bill Meenaghan: Yeah, but I’d also go back to get the fundamentals right, get everything in place to make sure that everything’s got the best chance of settling.
01:13:30 Dominic Hobson: Yes, we’re apt to forget that when we talk about blockchain – reference data and matching and all that. Andrea, what’s your answer to this?
01:13:38 Andrea Tranquillini: My view, I think the very first point to address is the creation of a unique legal framework for issuance in Europe that will incentivate government and treasuries to put everything in the single pot, facilitating access to the smaller market players. So for me, SWIFT only option, as per article, I think, 35 of CSDR, if I remember correctly, is a barrier to entry and mandating also rule for asset servicing, including fiscal services, remain three points for success. But the platform itself, we have already, I think, acknowledged that is largely insufficient to the creation of a single European market.
01:14:26 Dominic Hobson: Okay, so we need legal changes. Martin, very quickly, your last thought on how to make this progress.
01:14:34 Martin Watkins: The key element for us, this will be driven by economic benefits, the economic benefits to the corporates. And if you can get a lot of the inefficiency driven out of the market at one level, you’ll be surprised how much more will come. It’s going to be driven by the economics and that goes through to the corporates.
01:14:52 Dominic Hobson: Thanks, Martin. It falls to you, Chris, to have the final word from the panel before we sign off.
01:14:59 Chris Richardson: I think a couple of things. I think Giovannini is turning in his grave. Barriers to entry into the capital market have just gone up. Look, we’ve been in this business for over 35 years. If I was starting now, starting a business, I wouldn’t be able to become a CSD vendor. That’s the first thing. Now, I support what Andrea’s comments, but he’s from operations. I’m from the technology side. For me, the biggest point on technology is interoperability. You look at America and think, “Oh, it’s a single integrated market”. No, it’s attractive because there’s only one way of doing business with it, one way for the entire country, not because it’s integrated. We don’t care about that. We just have one way of interacting with them. Are those two the same thing? They’re closely linked, but they’re not the same thing. Interoperability is key. And having SWIFT as the only vendor for transport, not a good idea. You can standardise on SWIFT messages, but yet have much cheaper forms of transport. That’s it.
01:16:05 Dominic Hobson: Thank you, Chris. I’m going to actually let John Falk have the final word in which he says …
01:16:12 Chris Richardson: I thought you’d retired, John.
01:16:15 Dominic Hobson: Well, he’s obviously still a very keen observer of what’s happening and he brings to this a lot of experience. He says, “20 years on from Lamfalussy and Giovannini, I think we’re facing another 20 years of split financial infrastructures. Apologies for the negative view.” And I can’t blame him after listening to this discussion for thinking that. Anyway, I think we must …
01:16:34 Andrea Tranquillini: That has to restart.
01:16:35 Dominic Hobson: We must stop now. We’ve more than run out of time. I’d like to thank our panellists, Dirk Loscher from Clearstream, Chris Richardson from Percival Software, our sponsor today, Andrea Tranquillini from the Securities Depository Centre in Riyadh, Bill Meenaghan from SSImple, and Martin Watkins from Montis Group. Our next webinar is due to take place in April. At it, we’ll be discussing challenges raised in the inaugural edition of our digital asset tokenisation guide. I would refer everyone listening to, for example, if you wanted to find out what’s happening at D7 in Germany, do have a look at the latest issue of our digital asset custody guide, which has a lengthy discussion about blockchain developments in Germany. So I hope lots of you will look at that and I hope lots of you will join us at our next webinar in April. But for now, it’s goodbye from the six of us. Thank you. Goodbye.
