Horizontal and Vertical Integration in Securities Trading and Settlement
Tapking, Jens, Yang, Jing, Journal of Money, Credit & Banking
1.1 Securities Trading and Settlement Infrastructure in Europe and the United States
THE EUROPEAN SECURITIES trading and settlement infrastructure is highly fragmented. In the 25 member states of the European Union (EU), there are about 40 securities exchanges and a similar number of central securities depositories (CSDs). In the euro area alone, i.e. in the 12 EU member states that have adopted the euro as their single currency, there are about 25 legal entities that operate regulated securities exchanges (1) and 19 legal entities that operate a central securities depository (CSD). (2) In the United States, a single currency area of similar size, there are 12 national securities exchanges and only two CSDs!
Especially the fragmentation of the European settlement infrastructure has received a lot of attention in recent years. There is broad agreement that the high number of CSDs in the EU is an important settlement cost driver. Firstly, CSDs are characterized by relatively high fixed costs. (3) Full technical consolidation of CSDs could therefore reduce average unit settlement costs. Secondly, financial markets in the EU are getting more and more integrated. An increasing number of securities transactions are cross-border transactions, i.e. the buyer and the seller are not located in the same country. As it is expensive to participate in several CSDs, they are typically participants of different CSDs so that the transfer of the securities from the seller to the buyer often requires a costly securities transfer across systems. Again, full technical consolidation of CSDs would reduce the volume of transfers across settlement systems and could therefore decrease settlement costs.
This argumentation is supported by comparisons of settlement costs in Europe and in the United States. Lannoo and Levin (2001), for example, find that the average operating income per settlement as an indicator for the settlement fee of a CSD is 1.86 times higher in the EU than the United States and that the difference is to a large part due to the costs of cross-border settlement. Nera (2004) estimates that for an exchange-traded equity transaction settled on a net basis in a single CSD, the cost in the United States is around 0.10[euro] and in the EU in the range of 0.35[euro] to 0.80[euro] ($0.42 to $0.96), while a cross-border settlement in the EU can cost up to 35[euro] ($42).
In the United States, a full technical consolidation of all CSD (and clearing houses) for private sector securities was initiated in the 1970s and resulted in the creation of the Depository Trust & Clearing Corporation (DTCC), owner of the main U.S. CSD, the Depository Trust Company (DTC). The other U.S. CSD, the Fedwire Book-Entry Securities Transfer System, is the CSD for public sector securities and is operated by the Federal Reserve Banks. Although the DTC is linked to the Fedwire system so that public sector securities can be transferred from one to the other CSD, a consolidation of the two CSDs has not been envisaged, i.e. the cost reduction effect of such a measure is considered to be very limited. On a national level, several European countries also technically consolidated their CSDs. In Germany, for example, five CSDs were technically merged into a single CSD in 1989. Mainly due to consolidation in Italy and Spain, the number of CSDs in the euro area has gone down from 23 at the launch of the euro in January 1999 to 19 at the end of 2004. (4)
However, a technical integration of CSDs located in different EU countries still appears to be difficult. Legal and regulatory provisions as well as market practices create incentive to keep a technically independent CSD in each member state. (5) For example, rules that stipulate that trades on a domestic securities exchange have to be settled in a domestic CSD existed in most of the EU member states and are being removed only slowly. (6) As a consequence, international mergers of CSDs have so far been legal mergers without a full technical integrations of systems. …