Europe – A market transformed

Since Sibos last took place on the shores of mainland Europe, the region’s securities markets have faced innumerable challenges. As delegates gathered in Amsterdam for Sibos 2010, the supervisory and industry response to the 2008 global financial crisis was still taking shape. Over the next half decade, against a backdrop of severe macro-economic and monetary policy conditions, Europe’s securities markets have had to contend with an unprecedented wave of regulatory and market infrastructure change.

Some of these reforms were prompted directly by the crisis, others were already in train, such as proposals for harmonised settlement under the European Central Bank’s TARGET2-Securities (T2S) project and front-office rule changes under the Markets for Financial Instruments Directive (MiFID).

With all of these regulatory developments thrown into the melting pot of the European securities market, what have been the main impacts of these changes and what can we expect in the foreseeable future?

Post-trade harmonisation

Almost a decade on from its genesis, the ECB’s T2S single securities settlement platform went live in 2015. In harness with the Central Securities Depository Regulation (CSDR), the overall aim of this harmonisation initiative is to increase efficiency and reduce costs, while also introducing an element of competition among national post-trade infrastructure providers.

The project’s path has not been entirely smooth so far. Delays to various markets joining up to T2S have increased the number of implementation waves from four to five along with intense scrutiny over costs. While the time horizon for cost savings to market participants has lengthened, industry experts still feel the project will overcome the remaining hurdles to successful adoption.

Hugh Palmer, T2S product manager, financial institutions and brokers, Societe Generale Securities Services, feels that the benefits will be felt when more markets are involved. “The tipping point of T2S will be from February 2017 when the lion’s share of the markets will be on the platform. At that point, the benefits will start to kick in,” Palmer asserts.

“In terms of a major driver for T2S, the amount of cash we will need to mobilise every day to settle the business of our clients across Europe, we are looking at a 35-40% estimated economy.”

Alongside T2S, the wider principal of harmonisation has been addressed through CSDR. The regulation not only brings Europe onto a shorter T+2 securities settlement cycle, admittedly causing certain interim operational challenges, but paves the way for a more dynamic post-trade market. “In the short term there hasn’t been a huge impact from T2S, but there has been from CSDR because the sell-side is being forced to deal with buy-side clients that are slower to adapt their market practices to reduce settlement failures,” says Virginie O’Shea, senior consultant at Aite Group.

Henry Raschen, head of regulatory engagement for HSBC in Europe, says securities settlement processes had been neglected prior to the crisis. “In 2010, regulators were not looking at CSD legislation as a priority, but now we have CSDR coming in, with elements to be implemented over the next couple of years. Questions are now asked about CSDs and the critical part they play in the whole financial markets infrastructure,” he says.

Visibility and liquidity

If post-trade issues were not receiving necessary levels of attention prior to the crisis, it may be in part due to the focus of European policy-makers and market participants on the wholesale changes to front-office processes and interaction with investment clients represented by MiFID, which came into force in November 2007.

Focused on the equity markets, MiFID had the effect of unleashing a wave of competition among national exchanges and independent trading venues, with new clearing houses also emerging to offer lower overall transaction costs in the main European stock markets.

Scott Coey, head of broker-dealer services, EMEA, BNY Mellon/Pershing sees one of the biggest legacies of MiFID as increased levels of pre- and posttrade transparency, which are due to be expanded into other non-equity asset classes under MiFID II from 2018.

“When MiFID initially came out, the emphasis was on providing greater visibility and liquidity, with greater fragmentation a by-product,” said Coey.

As MiFID was rolled out, it was always the intention of European policymakers to draft MiFID II to extend and refine the scope of the original directive. However, MiFID II also became a vehicle for Europe’s response to the financial crisis, outlining rules for new electronic venues for derivatives (known as organised trading facilities), while the separate European Market Infrastructure Regulation (EMIR) detailed plans for central reporting and central clearing of derivatives.

“MiFID and EMIR have to be looked at together in Europe, whereas in the US the exchange-based trading, clearing and reporting of derivatives were all picked up together under the Dodd Frank Act,” explains Raschen.

Like any major piece of regulation, MiFID II imposes short-term burdens on service providers and infrastructure operators in pursuit of long-term benefits, in this case a more transparent and integrated securities market within the EU and increased cross-border investment.

With this in mind, experts are quick to recognise the new directive’s future benefits. “MiFID II offers the prospect of improvements in best execution and client categorisation,” says Raschen.

While MiFID II may cover a lot of ground, perhaps Basel III has had the most pervasive impact of post-crisis regulations, both in terms of securities and the wider financial markets, due to the restrictions it imposes on banks’ use of leverage, capital and liquidity. “Basel III changed the entire cost dynamic of doing business in the capital markets,” notes O’Shea. “There have already been exits from certain clearing business lines as a result of seeking to avoid capital charges.”

For HSBC’s Raschen, Basel III represents a necessary corrective for the industry. “Back in 2008 a number of banks around the world had much lower levels of collateral than they should have had. Basel III requires them now to have higher levels,” he says. “It is also a preventative measure, in view of an extension of the responsibilities of banks, notably through depositary liability for custodian banks. Regulators have sought to ensure that banks have adequate capital to be sufficiently resilient.”

Despite the upheaval associated with Basel III, Coey also believes its guidelines will have a positive overall impact on the market. “Initially, regulatory change has been restrictive particularly for the sell side, but the message for both the sell-side and the buy-side is that regulatory change is now the norm,” he observes.

New sources of uncertainty

Compared with 2010, we certainly have a much clearer idea about the regulatory framework for the European securities market. But with so much effort still involved in effecting internal change to meet compliance requirements, securities market may still be some way from understanding fully the future shape of the industry.

As O’Shea notes, “The main difference between 2010 and now has been the amount of change that comes with regulation. Previously, implementation of regulation would impact various segments of the market, but it wouldn’t impact the whole market in the same way as Basel III has done.”

The unforeseen implications of such major pieces of legislation will become more evident over time, but new sources of uncertainty continue to arise. Will reflections on the reality of MiFID II top the agenda at Sibos 2019 in London, for example, or will we be discussing the implications of Brexit?