Clearing and Settlement Top-of-Mind for Front-Office Execs
Who would ever have thought that clearing and settlement could be sexy? Before I get letters from everyone in operations, let me just say that I started my career in the back office, and I believe that learning what happens in the back office is critical to understanding how this industry really works. But I always thought that I was in the minority.
That may be changing. Clearing and settlement seem to be on the minds of a greater number of front-office executives. Clearing has been center stage at a number of industry events. At TradeTech in Paris, the annual Options Industry Conference in Las Vegas and the IOMA (International Options Markets Association) conference in Malaysia, exchange leaders from around the globe all spoke about clearing and settlement as if it were the latest new product to hit their trading platforms.
So why is clearing all the rage among exchanges?
As the business of matching buyers and sellers increasingly becomes a commodity, the keys to clearing are cost, lock-in and integration. If you analyze markets where the trading and clearing are vertically and tightly integrated, you will see two major trends: One, it has been more difficult for outside exchanges to take away market share. And two, vertically integrated exchanges and clearing entities tend to be more profitable. These are two topics very near and dear to exchange leaders' hearts. (Note: I'm not saying that the integrated model is better or worse for the industry -- arguments can be made on both sides.)
While there is some excitement in the U.S., the real focus is occurring in Europe, where the European Commission (EC) is trying to get the fragmented clearing and settlement infrastructure players to play nicely in the sandbox. The EC's "Code of Conduct" is trying to get Central Counterparties (CCPs) and Central Securities Depositories (CSDs) to become more open and accepting of flow from multiple and/or nonaligned exchanges.
The challenge with the Code is that many CCPs and CSDs have significant linkages to exchanges, and developing more open linkages allows more open competition in the exchange and CCP arena that these organizations have not been prepared to entertain. These competing interests are being played out through the media -- and now, the courts -- as bilateral/multilateral agreements between cooperative entities seem to be a bust. CCPs and CSDs have gone through stages of accommodation, intimidation, remuneration, litigation and, now, threatened legislation.
But for competition to work on the front end, there needs to be a more integrated back end. This would seem to be a strategy for fending off competition from Multilateral Trading Facilities, or MTFs, the new pan-European trading platforms created by MiFID. The MTFs, however, have gotten around this barrier through the development of CCPs within an integrated clearing firm. The best examples of this are EMCF from FORTIS and DTCC's EuroCCP.
So the players that may be hurt most by the lack of progress on the Code may well be the traditional exchanges that have not been able to bar competition through a vertical agreement and are reliant on old-line CCPs and CSDs that either don't believe in or can't react fast enough to a new and changed environment.
While the European CCPs and CSDs may wind up in a catfight over the Code of Conduct, they'd better watch their flanks -- if an industrywide solution is not adopted, commercial enterprises will fill the gap. While the Code currently may not be working as planned, it is in the best interest of the industry to get it back on track, as the real competition will not be from the traditional players; it will come from the new upstarts hiding in plain sight.
Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio
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