Interview with Philip Brown in Börsen-Zeitung


This article was first published in Börsen-Zeitung (in German) on 1 March 2018.

Philip Brown: We have not yet seen any moving vans pull up in front of office towers in London

The Clearstream Manager speaks about extensive Brexit preparations, the client demand for simplified issuance processes as well as new regulatory requirements.

So far, Philip Brown hasn’t seen many clients turn their moving plans into practice yet. In this interview with Börsen-Zeitung, the Co-CEO of the International Securities Depository Clearstream Banking S.A., who is also responsible for managing global client relations for Deutsche Börse, gives his view on the implications of the new Central Securities Depositories Regulation CSDR, the further development of the European Capital Markets Union as well as the use of new technologies.

Mr Brown, what is your take on the EU Central Securities Depository Regulation (CSDR) and the potential consequences?

All European Central Securities Depositories had until last September to submit their licence applications. Now whilst this is a very extensive process for us, things are progressing the way we expected them to. In fact, we had to submit a number of different dossiers: one for Clearstream Banking AG, one for Clearstream Banking S.A., one for LuxCSD, and finally one for the so-called 'Bridge' to the ICSD Euroclear, which is considered an “interoperable link". This means several thousand pages. Right now, we are in the process of clarifying details with the regulators. As far as the Clearstream-Euroclear Bridge is concerned, there is an ongoing dialogue between the two companies and the responsible regulatory authorities. The necessary alignment of all parties involved makes this process a bit more complicated than an ordinary licence application. We are in a very active dialogue with BaFin and CSSF and making good progress.

What will the regulation mean for the market as a whole?

For companies which are not active in the capacity of a Central Securities Depository (a "CSD"), the regulation is a bit of an unknown. In fact, many market participants are not yet that familiar with its details. With its Markets in Financial Instruments Directive ("MiFID"), the EU initially only regulated the cash markets, this was followed by the European Market Infrastructure Regulation ("EMIR"), which covered derivatives markets and clearing. Now, CSDR covers the entire post-trading/post-clearing sphere. The market is, however, much more aware of what MiFID and EMIR are about than it is about CSDR. But we encourage our clients to assign more attention to it.

Why is that?

Although the regulation mainly concerns CSDs, CSD customers are also indirectly impacted by the regulation. To name a few examples, CSDR introduces new customer on-boarding frameworks and risk management protocols, new account segregation and reconciliation requirements, more stringent prudential requirements, and last but not least, a brand new settlement discipline regime which looks like it will be implemented in 2020. Moreover, it involves changes to intraday lending by CSDs, and a lot of other aspects. We have to ensure that more energy is devoted to this topic.

What role does CSDs' lending to clients play in this context (CSDR, Settlement Discipline Regime)?

There are numerous ways in which International CSDs (ICSDs) and CSDs extend credit today. The majority of such loans – which are always granted on an intraday basis – is collateralised by securities. But there are some clients who are allowed to take unsecured loans from us – a euro area central bank, for example. In such cases, certain very strict risk-related criteria have to be fulfilled.

How will this change under CSDR?

We will continue to be permitted to extend unsecured loans under CSDR only to those specific central banks. Yet there are also central banks outside the euro area that are not included on the CSDR list. The new regulatory framework does no longer allow us to extend unsecured loans to them in the future. This means that going forward certain market participants will no longer be able to borrow without providing collateral. And in fact, some participants will no longer be able to access even collateralised credit lines. The reason is that the requirements on collateral to be pledged has become more restrictive.

Do you anticipate tougher competition in the post-trading market, as a result of CSDR?

Not solely because of CSDR – I believe there will be more competition due to the changed environment. If we see T2S, the European securities settlement platform, in the context of CSDR and the implementation of capital requirements under Basel III, dynamics in European market infrastructure will change. Clients will require different solutions – which they cannot obtain today. This will change the competitive dynamics.

What kind of solutions might that involve?

Let me give you this example: once asset managers – the 'buy side' – are fully subject to mandatory clearing under EMIR, custodians will need to come up with ways to better support these clients in terms of collateral management. They cannot realise this through CSDs that have no collateral management infrastructure. We can already see the pricing of certain post-trading services change due to the CSDR and T2S.

Why is that?

For two reasons: firstly, some CSDs largely depend on settlement fees. Now whilst these fees have been reduced as a consequence of T2S, their cost base has not changed – therefore, these CSDs have seen their profits halved in some cases. In some markets, we have seen custody fees being increased to compensate for this effect. Secondly, collateral management capabilities are thus gaining importance: we see smaller CSDs that want to continue operating their business, approaching us to discuss in which way we may be able to support them with our technology infrastructure. Now whilst these discussions are still at a very early stage, this is a natural extension of regulatory requirements: many players are facing difficulties in implementing the business model, since it has become more expensive.

Will the future European capital markets be more harmonised, and less fragmented?

The way we see it, given the EU's initiative to establish a Capital Markets Union, alongside T2S and the CSDR, as well as MiFID II, issuers – especially in the fixed-income markets – will start placing their securities in those markets where they can access the biggest pool of investors. Hence, an issuer might no longer turn to his home market, but to the market offering the most extensive investor pool. In fact, this might be any of the 27 EU markets – any market with a cross-border T2S infrastructure. We already have clients not domiciled in Luxembourg or Germany, who approach us to issue their securities in Luxembourg or Germany. This is because they want to make use of our infrastructure – which, thanks to Clearstream Banking Frankfurt's T2S connectivity, offers broad access to a variety of European and international markets.

How far have these initiatives progressed already?

We are seeing interest in this field from issuers looking for a process that is more efficient, at a more attractive cost, and reaches more markets. We have already concluded agreements, which have yet to be formally executed.

What is the impact of restrictions in some markets, where central banks require primary market issues to be posted exclusively via an account with the national CSD?

This plays a certain role for sub-sovereign securities, which need to be issued via a primary dealer in the home market. This is not the case in Germany. Investors may, for example, subscribe to a bond in Germany and settle it through Clearstream, via a Euroclear account, using our CSD link in France. This would not work the other way around. Germany has a very open model: for instance, it is possible today to place securities issued under Irish law on the market, listing them on Xetra. Germany may turn into a hub for bonds launched on a pan-European basis.

Would you expect this to lead to a benchmark issuance?

If it were come to pass, yes. This would be very important indeed – it would mean that Capital Markets Union turns into reality in the fixed income business. We are building infrastructure where issuers can target investors in a variety of markets – via a single point of access. This is going to change the competitive landscape.

Might this give rise to launch a new type of international securities identification number (ISIN) – an EU-ISIN?

ISINs are governed by the rules set by the Association of National Numbering Agencies (ANNA). According to our technical experts, it is currently impossible to launch a foreign bond issue in Germany without a 'DE' ISIN: ANNA requires that the ISIN must be linked to the issuer CSD's home market.

Some market participants hold the view that [an EU-ISIN] would be sensible.

Wider use of EU ISINs outside of European institutions would be very sensible indeed. Some issuers want to be linked to the infrastructure without simultaneously being associated with the corresponding market. There are ongoing discussions in this respect. Moreover, given restrictions in their investment guidelines, some investment funds cannot buy any further securities from a given market – even though the issuer in question might not be domiciled there at all.

Let us turn to settlement discipline. From 2020 onwards, counterparties failing to settle transactions are supposed to be fined – or the securities are set to be procured elsewhere. What will the consequence be?

The German market is very efficient, with non-matching or unclear transactions being rejected immediately. Yet settlement discipline differs on an individual basis. There are market participants reaching close to 100% discipline – and there are others whose record is significantly lower. Overall, we expect discipline to improve. We see some investment banks already modelling their costs. For instance, there are prime brokers and custodians whose clients – hedge funds in particular – trade illiquid bonds. Should a settlement fail, this might represent significant credit risk for these market participants – and if we are talking about a large-sized transaction, this might turn out to be very expensive.

How do you deal with this?

We are currently investigating whether our data provides more information that we can support the market with: is a bond really liquid, is it being settled daily or not, and how do prices move? This will also provide an indication concerning the counterparty's ability to properly settle a trade. Here we can already leverage our existing data business: we can provide information on market risk, asset risk, and counterparty risk.

What proportion of market transactions fail?

There is a small number of market counterparties which regularly fail to meet their delivery obligations – whether that is on purpose, or because they are not organised as needed. An average figure for the market as a whole would not provide much insight on this.

Let us turn to another topic: Brexit. What effects are you seeing in this regard?

Clearstream is not affected by Brexit to any major extent. Whilst we have a branch office in London, our contracts are not settled via the UK – only via Luxembourg or Germany. But of course we pay attention to how our clients deal with this. The most significant impact that we expect – if any – is that our clients will be introducing new booking offices, due to the fact that postings via the UK would no longer be covered by their EU Passport. As a result, booking offices would migrate to an EU member state, and we would need to adapt the contracts accordingly – not the name, but the domicile.

What would be the consequences?

This would be an administrative process that requires lots of resources, and might turn out to be very extensive. Thousands of legal entities would need to be re-recorded. Right now, everyone is awaiting the results of the negotiations. News concerning Brexit change by the week. Nothing is certain – the only thing we are certain of is this date at the end of March 2019. Those wishing to adopt a cautious stance might want to respond and get prepared, which is what the majority of market participants are doing.

Have you already observed real changes?

There are a lot of statements out there, but I have not yet seen any moving vans pull up in front of office towers in London. Seriously; most market participants are not yet in the action phase – they are in the middle of their decision-making phase, or at the end of it. But to date, nobody has made any very concrete statement regarding a move. Some banks have announced that they will move, but they have not yet provided specific details on which departments will move – how many people, and which functions. When this will happen depends very much on the timing and content of statements from Brussels. There are institutions that will move their business booked in the EU to a EU-based entity. But that is only a legal transfer – it is as yet unclear as to what this will mean physically and tangibly. The question is what regulators will require in terms of the substance of such entities. Obviously, letterbox companies are not an option, but it is not yet clear just how extensive the requirements will be.

Looking at Deutsche Börse's product range: will there be new offers due to Brexit?

Not solely because of that. One thing is clear: we will guide our customers through these uncertain times and support them to best get through this transformation. Of course, where necessary and where it makes sense, we are also looking into offering respective services. However, leaving Brexit aside for a moment, at Clearstream, our focus in 2018 will be on two issues: firstly, we have to implement the CSDR requirements. We are working hard on that. The second one is the next phase of our T2S offering: the European settlement platform is set to evolve from a system with national characteristics into a true cross-border system. We plan to go live with a European market this quarter, offering cross-border business directly via Clearstream Banking Frankfurt. By the end of 2018, we intend that all major euro markets will be linked to Frankfurt. The plan is for more than 90% of our EU volumes to be available on T2S, in a truly cross-border structure linking CSDs to each other, by the end of 2018.

This means that your clients also use T2S.

We will be going live with our first broker-dealer client in 2018: UBS. They will be using our offering, alongside that of Citibank, to cover the largest euro markets through a single access 'window': fixed income and equities, using both central bank and commercial bank funds, managing all T2S and ICSD collateral through this window. This will probably be the most important step since the launch of T2S – the first test involving large cross-border volumes and transaction sizes. UBS will be using T2S and our collateral products as critical funding, liquidity and collateral management tools in their business model, thus leveraging those areas, which constitute the real value of T2S.

What's behind the new products for interest rate swaps?

Our derivatives exchange Eurex has launched a successful partnership programme, which is a good option for the market in the context of Brexit. Clients already holding assets with us will benefit from the entire ecosystem if they use Eurex for their interest rate swaps business. Our clients will also benefit if the collateral pool is less fragmented.

A word on technological innovations – what are your thoughts about distributed ledger (or Blockchain) technology?

We have a significant interest in this topic. We want to sit at the table of those who disrupt the market – as opposed to being left outside the door. We are currently working on a number of blockchain prototypes ourselves, one, for example, with the Deutsche Bundesbank and one jointly with other CSDs. We are, moreover, represented on the Supervisory Board of Digital Asset Holdings, we participate in the Ethereum project and the Linux Hyperledger project. Deutsche Börse is also engaging with numerous start-ups and market participants with focus on opportunities in the post-trade space. We have therefore established DB1 Ventures as our corporate venture capital platform to fund investments in ventures strategic to the organisation, across a broad swath of global FinTech firms. And finally, we have numerous fintechs on board, through our Deutsche Börse Venture Network. In other words, there is an entire ecosystem at Deutsche Börse dealing with new technologies.

What will be the role of distributed ledger technology (DLT)?

DLT has the scope for interesting applications and it might be a useful technology for us to be offering our clients even better services in the future. Yet our clients still want to have us involved in that chain. The concept of carrying around a sovereign wealth fund on a USB stick goes somewhat beyond a risk manager's horizon. Our clients still want a trustworthy third party involved. This means that developments are likely to move into the direction of a private Blockchain. Digitalisation will change the market, but it will not shake us.

When should we expect to see the first large-sized DLT application?

Well, we should watch the Australian Stock Exchange ASX, which is determined to use DLT for its settlement and clearing system. It is possible to implement such a technology in a relatively secluded market; if they are successful, implementation in the market as a whole will be accelerated.

What about Germany?

Germany is a more complex market – because of the products, but also given the higher proportion of foreign market participants. But we should not dismiss any concepts right from the start. As a market infrastructure provider, we would be stupid to ignore the risk of disruption.