by Melanie Best
The global financial turmoil of 2008 and subsequent aftershocks raised the profile of the financial industry’s infrastructure organizations – exchanges, central counterparties (CCPs) and central securities depositories (CSDs). Because the infrastructures continued to perform their critical functions despite the turmoil, and many served to contain the spread of financial damages, public policymakers now promote their use to cover more types of transactions, especially in the over-the-counter market segment. With the heightened interest in these entities has come a new scrutiny of their governance. Who owns them? How are they governed? How should they be governed? Such questions are now asked routinely.
A detailed, wide-ranging study produced by U.K.-based consulting firm Oxford Finance Group contributes to the discussion of infrastructure governance and features 10 case studies, including one for DTCC and its depository and clearing subsidiaries, DTC, NSCC, FICC and EuroCCP.
Learning from experience
The Governance of Financial Market Infrastructure, published in January, draws on the experience of infrastructure organizations around the world to advance a number of suggestions and conclusions about optimal governance and regulatory models for the entities responsible for operating the securities markets. The DTCC case study uses the establishment of EuroCCP to illustrate how the organization’s governance structure works in practice.
The study is timely in that market participants, regulators and legislators across the globe are re-examining the nature and role of market infrastructures. Some of the issues under discussion include the merits of infrastructure consolidation versus competition, the degree to which trading and post-trade processing should be centralized in infrastructure entities, and how best to manage risk to ensure infrastructure organizations can withstand market crises.
“Market practitioners now realize that the manner in which these [infrastructure] institutions are governed may affect both the fees they pay, and more generally the viability of their business models,” the study notes in its Executive Summary.
The case of DTCC
In its DTCC case study, the report recounts the organization’s history, dating back to the early 1970s, from the perspective of its ownership structure. “Ownership of DTCC common shares is not generally considered by its participants to be a financial investment but rather a vehicle for supporting each registered clearing agency, and influencing its policies and operations through the election of directors,” the study states.
DTCC’s corporate governance arrangements and board structure are explained, and the establishment of its several subsidiaries described in detail. The report also describes the legal and regulatory framework under which DTCC and its subsidiaries operate – the Securities Exchange Act and Securities and Exchange Commission in the U.S., and the Financial Services Authority in the U.K.
Learning from history
Oxford Finance Group focuses on EuroCCP’s first incarnation – as a clearing provider for NASDAQ Europe in 2000 and 2001 – and European banks’ single-CCP campaign that paved the way for the creation of EuroCCP.
The DTCC/EuroCCP case study revisits the European Securities Forum’s (ESF) industry blueprint formulated in 2000. The report states that the 26 banks that composed the ESF in 2000 called for the creation of a single European CCP to replace the multiple clearing and netting organizations that existed or were in construction across the region. The new entity would be equipped to handle all products, be open to all providers of trading systems and have separate ownership from that of the trading platforms it served.
But the ESF’s calls for Europe’s incumbent clearers to merge came to naught, and its request for proposals to build a new pan-European CCP attracted no responses. “The ESF’s efforts to build a European CCP were undermined by a range of factors, including politics, disconnects between different constituencies’ strategies, vested interests, and lack of commercial drive and funding,” says the Oxford Finance Group report.
It continues, “The ESF was also stymied by the demutualization of the major EU exchanges whose shareholders stood to gain more from owning their own clearing and settlement facilities, than from subcontracting out clearing to an independent provider.”
Despite the failed efforts, the ESF said it still favored “a horizontal structure which separates governance of clearing and settlement from trading platforms,” and some member banks discussed with DTCC, informally, the possibility of establishing a pan-European CCP.
DTCC did indeed proceed to create such an entity in late 2001, after being selected by NASDAQ as the clearing provider for its new NASDAQ Europe trading operation: NASDAQ could not generate interest from any incumbent European CCP to clear for it. EuroCCP was created as a wholly owned subsidiary of DTCC, although registered in England and governed by its own board of directors.
EuroCCP’s initial focus was to provide clearing for transactions executed on NASDAQ Europe in European and U.S. securities, but NASDAQ held no interest or control in the clearer and EuroCCP was free to bid for the clearing business of other exchanges. But the endeavor – occurring amidst the severe decline in the technology sector, general post-9/11 malaise and quite a few years before the Markets in Financial Instruments Directive (MiFID) was introduced to make it feasible for such multilateral trading facilities to compete with incumbent national exchanges – proved untimely and NASDAQ Europe shut down in November 2002. By then, EuroCCP had already withdrawn as the entity’s CCP in the absence of transactions to process.
The experience gained with this initiative facilitated EuroCCP’s return to the pan-European market in 2007, when it won the mandate to provide central counterparty services to the new Turquoise multilateral trading facility. EuroCCP subsequently was selected by three additional platforms to provide clearing services, has entered into a Memorandum of Understanding to provide clearing services for the NASDAQ OMX exchanges in the Nordic markets, and has continued to expand the national markets it covers and number and variety of instruments and types of transactions it clears.
More on the report
The other organizations profiled in Oxford Finance Group’s study are the Canadian Depository for Securities; Deutsche Börse; Euroclear; Hong Kong Exchanges & Clearing; LCH.Clearnet; the London Stock Exchange; NASDAQ OMX; NYSE Euronext; and Osaka Securities Exchange.
French regulator Autorité des Marchés Financiers (AMF), BNP Paribas, the Canadian Depository for Securities, Clearstream International, Euroclear, the International Capial Market Association, SIX Swiss Exchange, and some other undisclosed entities sponsored the report, which was authored by Ruben Lee.
The Governance of Financial Market Infrastructure is available for download at www.oxfordfinancegroup.com. @