At a recent client meeting on Target2-Securities, we discussed the apparent minimum cost of EUR 3 million for a small market to prepare itself for T2S. I struggle to identify the reason for this cost as it seems excessive relative to the development to be delivered. Countries are also, perhaps unfortunately, neither considering outsourcing their infrastructures nor merging with others. That was one of the quieter suggestions for cost and operational efficiency of the T2S team. As I explain below, there may be barriers to this. However, the barriers are far from insurmountable.
So how should a smaller market face up to the challenge of, not only T2S, but also the other more complex, major OECD market-focused developments that we are seeing?
First, it is important to recognise the advantages of a local infrastructure in these markets. The markets in question are small and many of the companies on their markets are small. Domestic investors in these markets are local retail with a growing number of institutional funds. These are pension, insurance or investment funds. The key issue is that the local markets encourage issuance and investment. If there is to be a change, it has to safeguard this characteristic.
The key attribute of local markets is that they provide a centre of excellence for local law and regulation. And, most importantly, they provide a local language and accessible point of contact to their domestic users. Those two key attributes imply that a local office is needed to fulfil those functions. The big question, if this assumption is agreed, is whether such an office can function whilst outsourcing the core market infrastructure.
For the core market infrastructure is the main cost driver in the smaller markets. If we look at the trading platforms in some of the larger CEE markets, they are often sourced from third parties. CEESEG uses the Deutsche Boerse Xetra platform. The WSE is migrating to the NYSE Euronext UTP platform. Small local markets tend to develop their own trading platforms because they do not need the complexity of the major market ones. But that may change with the trend to greater complexity, caused by both globalisation of investment and especially EU regionalisation of regulation. The logical market trading platform of the future would be a regional one, operated remotely of most centres from a technical perspective, but managed locally from a structural one.
Further downstream, markets face added challenges. Focusing on the CEE, we have all bar two markets (Russia and Ukraine) in our coverage model which are members or aspirant members of the EU. They are thus affected by EU regulation and especially EMIR. Russia, with its ambitions to become a major global financial centre, is also keenly following best practice models. The EU regulations on CCP, with their requirements for capital adequacy and also wider coverage of financial instruments, are both a challenge and an opportunity. The opportunity is less in smaller markets because they are less mature markets but the challenge remains. The key one is the minimum capital requirements for a CCP. CSD regulations will affect two of our regional markets (Austria and Hungary) if, after all, there is any forced segregation, or, at least, dramatically increased regulation, of banking and securities processing facilities. Regulation generally is leading to increased pressure on post trade infrastructure. AIFMD and UCITS V raise the question of whether operator accounts will become the norm, extending the client reach of each infrastructure. T2S, in the eurozone markets, will lead to the emasculation of the local CSD product as settlement is so core to their current value proposition. And although only three eurozone markets are directly affected by T2S, the EU member states in the region are more likely than not, over time, to become full members of a single currency.
Downstream, the logic is to outsource. Again, sensitivity is needed and policies need to be aligned. But CCPs are being aligned, as we can see in the Vienna-Prague planned use, subject to the approvals of the relevant governance bodies, of CCP CEE. The process is technically relatively simple. The model to be used can be multi-local on a single platform or fully centralised with transaction capture in participant or local operator locations. Logically the latter is the most beneficial with the added value, especially to crossborder investors, of a single interface, a standard margining approach, a common collateral standard and the ability to increase offset between markets.
At the CSD level, there are examples of single platforms operating across multiple locations, but not in the CEE region. Much of the current M&A focus has been on the discussions between CEESEG and WSE, discussions that are primarilyconcerned with the Exchange space. There would have been some logic in looking to outsource CSD functions to common platforms, especially by those markets that are joining T2S for their core business.
Paradoxically, Austria already outsources the IT support for its CSD platform to a service provider, although the platform itself is operated by OeKB. Such a model could easily be made multi-market, especially in the smaller jurisdictions, where property laws may be more recent and more easily adaptable to such an environment.
But we must return to the main issue to be overcome. Local offices are needed to service issuance and investors. There is also a challenge for centralised locations to be sensitive to local needs. Harmonisation is always a critical by-product of unified infrastructures. That requires agreement on a single model across the participant countries. If one ignores the question of investor transparency, most markets are remarkably similar and those changes needed for a single infrastructure are well proven in other markets. Harmonisation reduces local specificity and thus demand for unique change requests. It will not eliminate them. At the minimum, a formula is needed to ensure that small locations do get priority for local needs in any centralised change agenda.
In reality there is no technical impediment to convergence of infrastructure. Language, script and structure are challenges but achievable ones. The key challenge is culture, and, as for all of us who work in large organisations, there has to be an equitable approach to local need and an appropriate balance between the centralised mantra of conformity and the local demand for specificity.
If the costs alleged for T2S in some of the smaller locations are close approximations of reality, the prize of convergence, across infrastructure, even in the EU subset of the CEE, could be in the hundred million euro range. Convergence will not happen overnight or by osmosis. The developments at CEESEG, the discussions between CEESEG and WSE, the original launch of CEESEG, the expansion of CCP CEE,the IPO prowess of the WSE, and the new world in Russian financial markets are all strong indicators, though, of the potential for the trend to become a reality.
In UniCredit, just as we operate a regional business across the CEE, we are keen for infrastructure to gain from the synergies that such models offer. And most of all, for our clients, both domestic and global, we are always keen for them to benefit from a more robust and lower cost regional infrastructure.
John Gubert
Chairman
Global Securities Services
Executive Committee