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Page last updated
February 16, 2003

 

 

I

The Effects of the Introduction of the euro on the German custody market

 

On 4 january 1999 the euro was sucessfully implimented in a big-bang approach in the German security market

Whilst of course the euro has had an immediate practical impact on the settlement and custody procedures adopted by all German banks, it will also have long-term effects on the structure of all European securities markets. In this article we not only intend to outline the former but also wish to discuss some of the strategic developments that have started and are likely to continue over coming months and years. These developments are already mapping out the future framework for securities markets across the euro-zone. In addition, they will require central depositories and sub-custodian banks to review both their strategy, technical infrastructure and range of services.

New Procedures for the German Securities Market
With effect from 4 January, 1999 the prices of all securities quoted on the German Stock Exchange have been published in euro. In addition, the settlement and processing of income (i.e. dividends, interest, redemptions) within the systems of Deutsche Bourse Clearing AG (the German central securities depository) has also taken place exclusively in euro. As a result of the above, the German banks are required to communicate for settlement and custody purposes with Deutsche Bourse Clearing AG exclusively in euro. However, in the case of communication with their clients, for the three year transition period (i.e. 1 January, 1999 to 31 December, 2001) dual currency processing continues to be a necessity. Within the context of our wholesale business, a large part of the time spent preparing the transaction processing systems for the implementation of the euro was allocated to ensuring the efficient support of both incoming and outgoing S.W.I.F.T. messages in euro and Deutsche Mark. This has resulted in the ability to transmit highly flexible message specific client reporting.

Clients can decide for the three year transition period to operate their cash accounts in Euro, Deutsche Mark or both. As is the case in all euro-in countries, domestic banks have had to develop their systems to process cash amounts using pre-defined parameters. Whilst it has been universally recommended to our wholesale clients to immediately operate only a euro cash account, in line with the principle of no compulsion, this is not obligatory. Most of the retail client base will remain in the Deutsche Mark environment until towards the end of the transition period.

“The success of a trading platform is also dependent on the ability of custodian banks to provide efficient clearing and custody services to their clients”.

Finally, an integral part of the custody business is the provision of a tax reclaim service. In Germany, similar to many of the countries that make up the euro area, the tax authorities had initially officially announced their reluctance to process euro amounts. In January 1999 this position changed; whilst the refunds themselves would continue to be initiated in Deutsche Mark, an indication was given that tax reclaim forms will be accepted in both currencies. Therefore, for the three year transition period the German banks will have to provide their clients with a tax reclaim service that can monitor, reconcile and report the processing of refunds in both euro and legacy currency.

Securities Funding
One area where the introduction of the euro has already had significant impact is the way securities positions are funded. Whilst there continue to be eleven securities markets each with different settlement practices, tax regimes and market infrastructures, the opportunities and benefits associated to more efficiently managing cash in those markets need to be realised. Over coming months procedures will be further fine-tuned. As institutions and banks continue to improve their ability to route payments via the various euro clearing systems, demand will intensify for the provision of intra-day cash balance and turnover reporting. Only with the receipt and automatic routing of just-in-time information can euro balances be pooled and funded using one or more central cash clearing banks.

Trading
The announcement last year of the co-operation between the German and London Stock Exchanges came as a surprise to much of the German financial community. Whilst the potential for establishing a pan-European Stock Exchange has been discussed for many years, the reality, albeit for initially only 300 securities, is likely to come sooner than expected.

However, the euro will continue to be a catalyst for structural change throughout Europe’s securities markets. Competition, similar to that seen between LIFFE and Eurex, is expected to continue as the exchanges of each euro-in country attempt to establish a competitive advantage for the future. Yet a pan-European exchange needs to be supported by an efficient trading system. In this context, there will also be an increase in focus on the functionality and competitiveness of the present domestic trading systems, i.e. Xetra (Germany), SETS (United Kingdom), CAC (France), etc. Xetra (the electronic trading platform operated by Deutsche Bourse AG) replaced the IBIS system in November 1997. Originally catering only for large transactions executed in equity securities, the Xetra system has now been enhanced to support smaller sized transactions in most of the equities and bonds listed on the German Stock Exchange. Remote access via a dealer workstation is possible from any country within the European Union and certain other jurisdictions. Working on an order book principle, it has allowed the German Stock Exchange to centralise liquidity and helped the exchange members to cut dealing costs. Furthermore, due to the success in the German market, the Finnish and Austrian Stock Exchanges intend to adopt the system for their own domestic exchanges.

The success of a trading platform is also dependent on the ability of custodian banks to provide efficient clearing and custody services to their clients. Leading banks have developed an “Xetra Settlement Bank Service” which utilises both automated securities borrowing and collateral administration products to supplement traditional fully automated clearing services. In addition, with a flexible system infrastructure combined with highly trained staff, the demands of the remote member community can be efficiently supported.

Central Depository Links
Over recent years Deutsche Boerse Clearing AG has developed numerous links to other Central Securities Depositories, e.g. Necigef, Sicovam, SEGA, etc. However, to date, the majority of these links have been limited to the processing of free of payment instructions.

With the introduction of the euro and specifically in order to support the transfer of collateral within the context of the European Central Bank’s monetary policy operations, the priority of establishing efficient cross-border delivery versus payment links has increased. To facilitate this process, the European Central Securities Depository Association (ECSDA), which represents each of the domestic central securities depositories, has taken on the role of ensuring that the necessary developments result. This is expected to continue with Deutsche Boerse Clearing AG taking a leading role by adding both to their existing network of free of payment links, as well as enhancing these links to support against payment transactions.

In addition, however, the possibility of establishing a pan-European clearing house, used for the settlement of equity and bond transactions executed throughout the euro area, can not be ruled out. With the S4 development in Scandinavia recently being abandoned, it will focus minds on the difficulties, both cultural and technical, that hinder such a project. Conversely, the formation of Eurex (a co-operation between the German and Swiss derivative exchanges) is evidence that a more centralized European securities market infrastructure, including exchanges and central depositories can technically become a reality.

All of the above demonstrate the competition that has and will continue as a result of the euro. We expect Deutsche Bourse Clearing AG to play a significant role in ensuring the successful development of a securities market framework for the future.

Euro-Custody Services
One of the largest segments of the market which will be influenced by the euro is the role played by the sub-custodian banks. Traditionally, institutional intermediaries have employed the services of a domestic bank in each market in order to settle and clear securities transactions. Yet with the introduction of the euro the scope for a bank to offer custodian services across the euro-area increases. This objective can be achieved using a branch network (either self-built or obtained by acquisition), a sub-custodian network or the eventual use of established central depository links. In the case of the latter, in Germany we have already seen Deutsche Bourse Clearing AG enhance their own custody and clearing services. Whilst of course this will blur the historically separate roles performed by the central depository and sub-custodian banks, it will lead to increased competition and service levels both of which can only be good for the end investor.

“Complacency is dangerous. The need to continually developnew innovative products can not be disregarded”.

We mentioned earlier that there are still eleven securities markets each with different settlement practices, tax regimes and market infrastructures. With the proposed establishment of a pan-European stock exchange, a first step has been taken to standardise the trading of securities transactions. Settlement and clearing will follow and domestic sub-custodians must begin now to position themselves to be players in the future.

In considering this point, it is important to recognise the advantages that a sub-custodian bank has when comparing it to a central depository. One of the significant differences lies in the ability of a bank to operate multi-currency cash accounts as well as both credit and cash management facilities. The processing of cash amounts is integral to the securities business. In the case of the large majority of Europe’s securities markets, cash is ultimately processed within a domestic Central Bank. This is unlikely to change in the short term. However, the most important advantages of a sub-custodian bank are the value added services they bring to the custody chain. The ability to quickly react to client requirements, the provision of flexible fails management facilities and the technical intelligence to fully automate incoming as well as outgoing trading, settlement, corporate action and cash reporting.

Furthermore, being able to offer automated solutions at volume driven pricing levels is paramount. Complacency is dangerous. The need to continually develop new innovative products can not be disregarded. We believe that whilst the focus for sub-custodians may change, their services will very much continue to be in demand.

A challenging future therefore lies ahead for all market participants. The service differences that have traditionally existed between sub-custodian banks and central depositories across Europe will continue to diminish. Custody providers will have to re-define their strategy, as well as invest in the research and development of new products thus allowing them to compete on both a European and domestic level.

Provided exclusively for Banking 2000 by Dresdner Bank Germany

 


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