A Brief Summary of the Proceedings of IMExcellence's
Clearing, Settlement & Custody Conference

The Conference Chairman, Dr. Hans-Günther Nordhues of Ashurst Morris Crisp welcomed those in attendance and introduced the first group of speakers, who addressed new developments in European clearing, settlement and custody.

The first speaker was Mr. David Richards, Director of Product Design, Clearstream Banking. Mr. Richards gave us a detailed presentation of changes in the German domestic settlement environment and current developments in collateral management. The present model offers finality in two batches during daytime processing, with finality meaning the completion of securities transactions on both the cash and securities side. Clearstream Banking Frankfurt (CBF) has worked to improve this model following the recommendations of its Market Rules Committee, the Deutsche Bundesbank, and the European Central Bank (ECB). The new settlement model and cash clearing allow finality in an additional, third batch during nighttime processing on the basis of a reservation of liquidity by the Bundesbank, with booking or debit of accounts taking place around the opening of TARGET. Bund custody payments would not be netted against settlement net funding requirement, but would be included in each customer's payout at about 7:00 am. Mr. Richards also outlined how Xemac could provide collateral to the Bundesbank, Eurex or in the context of securities lending transactions, and how international customers can use the continuous link available through Clearstream Bank Luxembourg to access CBF's RTS cycle.

Mr. Scott Riley, Sales Director, Euronext and Clearnet SBFSA then discussed the benefits of Clearnet's central counterparty and its benefits for the market. Mr. Riley began by outlining the recommendations presented in the Group of 30's recent report, "Global Clearing and Settlement: A Plan of Action" with regard to creating an interoperable global network, mitigating risk and improving governance. The Clearnet CCP has been developed to allow an increasing amount of interoperability among various jurisdictions by providing a settlement network capable of international access, and its contractual alliances will further this process. Mr. Riley then reiterated how the novation of obligations into a CCP established on a sound legal basis with precision risk management and good governance works to mitigate risk, thus further addressing the recommendations of the Group of 30.

Mr. Gerald Noltsch, Head of Frankfurt Branch, BNP Paribas Securities Services made the case for agent banks' interests in the development of a European system for clearing and settlement. Agent banks are concerned about ICSDs engaging both in agent banking services and acting as the ultimate custodian and settling agent of securities transactions on a given market. Mr. Noltsch explained that this would create an uneven playing field by allowing the ICSD to cross subsidize its "agent bank" unit with the returns of its settlement unit. Mr. Noltsch explained that BNP Paribas supports a "DTCC" utility-type model for Europe, in which the utility-like settlement agent would not compete with its own customers. Mr. Noltsch also illustrated how CBF's new settlement model will reduce settlement risk.

Following a break for lunch, Mr. Claus Hilles, Deputy Chairman, Euro Banking Association (EBA), explained the EBA's Step2 project to create a pan-European system for interbank payments with direct participation open to any financial institution in the European Union. This system would build on the Euro1, Step1 system that has been in operation since January 1999. Step2 would allow any EU bank to engage an EBA participant bank for the transfer of payments to the EBA system, thereby greatly increasing the scope of the EBA network through which payments could be made. Another new service would be the ability to send files containing a number of payment instructions to the Step2 system, which would allow banks to make more payments with less administrative effort and cost.

Ms. Bernie Kennedy, Project Manager for CLS Services then explained the operation and benefits of the CLS system, pointing out how CLS addresses settlement, liquidity, market, credit and operational risks. Ms. Kennedy argued that CLS will become the standard for all FX transactions in light of the existing proportion of custody third party FXs and the many advantages of FX settlement post-CLS. Ms. Kennedy also explained the impact of the CLS Custody Working Group on third party identifier codes and CLS mapping with respect to custodians.

Ms. Kennedy, togther with Messrs Richards, Riley, Noltsch and Hilles where then joined by Mr. Roland Neuschwander, Direktor, Deutsche Bundesbank, and sat as a panel chaired by Mr. Nordhues. The panel discussed further transaction services that may be offered by in the processing field, as well as the role that the regulator may play in providing support and achieving fairness. With respect to the law on which the various international systems are based, the panel was of the opinion that no single country offered a clearly superior legal framework for clearing and settlement.

Two very interesting presentations followed the panel discussion. First, Mr. Andreas Mall, Treasury Information Manager for FSTO Shell Finance Services Shell Centre discussed the expectations of a corporate customer with respect to its banks that perform settlement and related services. Mr. Mall outlined the vast financial network of the Royal Dutch/Shell Group, which is active in 135 countries and must account for payments to and from some 40,000 service stations. Mr. Mall explained Shell's primary bank project, which – through its design of architecture, processing and communication – seeks to streamline the concern's worldwide financial relationships. One interesting detail is Shell's move to use internet communication globally after certain proprietary lines were temporarily disabled on September 11, 2001, when recourse to the internet proved a successful alternative.

The day was topped of with a valuable presentation by Dr. Martin Bösch, Managing Director of Financial Markets Service Bank, who argued that the use of specialized transaction banks facilitated attainment of efficiency and cost reduction through economies of scale. Mr. Bösch explained that not all increases in scale lead to like increases in efficiency and reductions in costs, but rather increases in scale with respect to like tasks from the same clients – such as through the concentration of certain services in transaction banks – can maximize such increases. In concluding, Mr. Bösch clarified that the opinion that there are "too many players in the market" is overly simplistic, given that competition of many players leads to an efficient allocation of tasks and resources and the creation of solutions based on a number of available economic models.

A very pleasant cocktail reception concluded the day's activities.

Day two of the conference began with Chairman Nordhues introducing Ms. Corinna Linner, General Manager of State Street Bank, Munich, who explained how the global custodian services offered by State Street Bank are well tailored to meet the problems facing the current European market. Echoing the concerns expressed in the European Commission's Giovannini Report, Ms. Linner explained that the European market for clearing and settlement is plagued by a lack of interoperability arising from inconsistent data formats and reporting systems, a lack of centralized operations and communication between market participants, and – as a result – a higher degree of settlement risk. Ms. Linner illustrated how the consolidated management, reporting, custody and settlement systems present in the State Street Bank global network point the way to a more efficient market in Europe.

Next, Mr. Ronny Vogt, Deputy Chief Executive Officer, SIS SegaInterSettle presented the impressive capabilities of SIS for realtime settlement and also outlined a project – supported by Switzerland, Portugal and Italy – for a globally operative Central Securities Settlement Infrastructure (CSSI). This somewhat futuristic structure would attempt to sidestep the problems arising from conflicting legal systems by isolating the minimal number of processes necessary for settlement, and placing them in a CSSI facility. This would reduce the applicable number of applicable legal principles and eliminate a great deal of conflict. The CSSI project provoked a lively debate among both the hopeful and the critical members of the audience – showing just how desirable such a system is, but also how far out of reach its realization remains.

Mr. Karsten Schröder, of Euroclear Bank then explained Euroclear's two-pronged strategy for correcting fragmentation in the European market: the consolidation of settlement through use of book-entry transfers and the simultaneous harmonization of rules and usage across markets. The Euroclear business model would allow customers to operate a single, operational account for their entire business. Securities for which an agent bank or the Euroclear Group is the domestic CSD, would be eligible for a "domestic" package under local law. Securities eligible for inclusion in Euroclear Bank would receive a "full service" package under Belgian law. Mr. Schröder explained that Euroclear seeks to optimize services for its users rather than maximize profits, and that it does not cross-subsidize between its domestic and full service packages. Mr. Schröder also responded to a number of questions regarding the transparency of ICSD pricing.

Mr. Mark Kirby, Head of International Policy, CRESTCo, then offered some very useful suggestions on how to approach the need to harmonize the European market for clearing and settlement services. Mr. Kirby demarcated what he believes to be the range of an (I)CSD's influence in this project. He explained that although the (I)CSDs cannot enact tax reform, harmonize legal principles of ownership or impose a single language on Europe, they can work on harmonizing system functionality by leading the debate on market practice and lobbying for legal and tax reform. Mr. Kirby stressed that no participant in this project should assume that its own market practices are the best ones, but should remain open to change. He also pointed out that although the processes used by (I)CSDs may vary, the functionality of a given action may be quite similar, such as freezing assets and allowing conditioned unwind in the case of pledges and takeover acceptances, and in some areas, such as collateral management, the products are quite uniform across Europe: securities loans, repos and pledges.

Dr.Wolfgang Mansfeld, President, European Investment Fund Association FEFSI shared his insights on the expectations of funds from the providers of fund processing and custody. He explained that there is an "urgency for action" in the reform of the infrastructure and operations of investment management processes and fund order processing. The costs borne by fund companies amount to 10 basis points on fund assets, with an earnings margin of 50 basis points. Fund order processing is impeded by varying business practices, differing communication standards protocols and a failure to exploit potential scale effects. Dr. Mansfeld offered an outline for a "connectivity manager" as a possible, market neutral solution to these problems.

The final speaker of the day, Mr. Dietmar Rössler, Business Manager European Investor Services, BNP Paribas Securities Services, provided his insight on the role of global custodians and the challenges they face with respect to fund management and fund distribution. Mr. Rössler explained that fund distribution requires order capture tools, STP execution and settlement of fund orders with monitoring and reporting of the order status, custody or registration services, calculation and reporting of trailer fees and funds reference databases. He further distinguished between the needs of retail distributors and those of institutional clients. Mr. Rössler also illustrated the important role of global custodians in meeting market challenges, noting that global custodians do not restrict their focus to either off-shore or local markets, but cover all the markets. Global custodians also integrate custody services with funds products and are in a position to calculate and manage trailer fees for both promoters and distributors of funds. In addition, they are in a position to offer a complete, integrated and fully automated service to both retail and institutional investors.

On the legal side of the challenges facing clearing and settlement, Chairman Nordhues remarked in closing that the project of dematerializing securities – albeit announced decades ago – has not made encouraging progress, and deserved continued attention.