Europe’s clearing infrastructure is crucial to mitigating risk and creating an integrated and efficient European capital markets environment. Market participants identified the benefits clearing could bring very early in the history of financial markets. The first clearing house was created by seven Scottish banks in Edinburgh back in the 18th century, to net the banks’ mutual receivables and liabilities. As early as 1826, some banks in northern England met weekly to settle their net balances with the Bank of England.
Yet, today in Europe, what clearing set up can best achieve those goals remains a source of debate.
Clearing houses in Europe developed primarily as parts of infrastructure siloes, in which the exchange and central counterparty (CCP) belonged to the same group. The concept of interoperability subsequently came to the fore with introduction of the European Code of Conduct in 2006. It aimed to enhance price transparency by promoting the unbundling of services and fostering competition between CCPs. The launch of new trading venues enabled by the 2007 Markets in Financial Instruments Directive (MiFID) added to calls for clearing interoperability.
To further engender competition, European authorities introduced the notion of open access in the Markets in Financial Instruments Regulation (MiFIR) published in 2014. Articles 35-37 of MiFIR stipulated that trading venues and CCPs should provide non-discriminatory access to one another and to benchmarks. The provisions require that, on request, trading venues must deliver trade feeds to a CCP that wishes to clear transactions traded on the relevant venue.
In promoting greater competition among market infrastructures, open access aims to reduce costs for end-investors. And, by giving participants choice between several CCPs, interoperability would seem to be the natural translation of the open access obligation for all European exchanges.
In recent years though interoperability has stalled, with most domestic European exchanges opting instead for the preferred clearing model. And, with Euronext Clearing (formed out of Italy’s Casa di Compensazione & Garanzia) set to become the default CCP for equities traded on Euronext Paris, Brussels, Amsterdam, Lisbon and Dublin from the end of this year, with Milan following in 2024 or 2025, the interoperability project appears to be further in doubt.
What are the differences between interoperable and preferred clearing?
Interoperability in the cash equity clearing space allows a trading firm to choose one CCP where a transaction is cleared, while its counterparty can select another i.e. the party and counterparty to the trade can be cleared by two different CCPs.
Interoperability relies on two pillars:
- an interoperability agreement signed between the interconnected CCPs, and
- extra collateralisation to cover the additional risk to the interoperating CCPs of being exposed to each other. This new collateral is brought by the clearing members through contributions to an interoperability fund.
Under the preferred clearing approach, a trade is sent to a trading firm’s chosen CCP only if both counterparties select the same CCP. If one counterparty hasn’t chosen a preferred CCP, or if the counterparties haven’t chosen the same preferred CCP, the transaction is sent to the default CCP designated by the trading venue. Since order books are anonymous, market participants cannot coordinate with their counterparty on the choice of clearing house, so there is no guarantee that transactions will be cleared by each trading participant’s preferred CCP.
What are the pros and cons of each model?
Competition introduced by the expansion of interoperability in the cash equity clearing space since 2008 has led to a massive decrease in clearing fees, estimated to be in the order of 50% to 60%. Interoperability has brought hidden costs though that are not easy to capture, and total costs are not easy to compare from one CCP to another. For one, the extra collateral required is not always easy to find, and the cost can be high. In addition, interoperable settlements may be charged at a higher price by some CCPs. Interoperability agreements between CCPs are not public and not on the same level playing field either, creating some distortions on the amount of collateral called to participants.
Preferred CCPs’ pricing tends to be highly competitive, so when preferred clearing works well participants can benefit. The problem is that counterparties can’t ensure their executions on a given trading venue will be handled by their preferred CCP. The advantage of transaction netting from cash equity clearing lies in having one settlement against the CCP. But if one execution is cleared on CCP A and another on CCP B, the result is two settlements and two charges.
What has Euronext Group announced in relation to European clearing? What changes will it bring?
The 2020 purchase of the Borsa Italiana Group from the London Stock Exchange Group brought Euronext the Italian exchange, along with the Casa di Compensazione & Garanzia clearing house (since renamed Euronext Clearing) and Monte Titoli central securities depository, establishing a new market infrastructure silo in Europe.
Euronext subsequently announced in November 2021 that it would change the default CCP for its trading venues. Euronext Clearing will become the default cash equity CCP first for Euronext Brussels on 23 October 2023, followed by the Paris, Amsterdam, Lisbon and Dublin exchanges on 6 November. The Amsterdam, Brussels, Lisbon and Paris markets are currently cleared by default by LCH SA, while Dublin is cleared exclusively by Cboe Clear Europe. The Euronext group’s listed derivatives markets will migrate to Euronext Clearing in mid-2024. The Italian stock exchange will move sometime in 2024 or 2025.
Non-Euronext trading venues will not be covered by Euronext Clearing for the time being. LCH SA currently clears Equiduct, for example, which to date has enabled participants to net their activity on Equiduct and the Euronext exchanges that LCH SA clears. While Equiduct has asked to be cleared by Euronext Clearing, that will not happen immediately, resulting in a fragmentation of the flows netted at present within LCH SA.
How will the Euronext Clearing launch impact on the wider European clearing environment?
Over the past two decades, European regulations have tried to curtail monopolistic infrastructures and the fragmented capital markets that have resulted. The Euronext move is a shift back towards a more siloed model with the exchange and CCP belonging to the same group.
Euronext Clearing’s launch will be the first time in years that a new CCP has been created with significant ready-made market volumes. That represents a big change for market participants and rival clearing houses. The redirection of the Euronext market flows to Euronext Clearing will hit LCH SA in particular, and to a lesser extent Cboe Clear Europe. Both will hope to mitigate the impact by further leveraging their positions as preferred CCP to all the markets where they are active.
How can a Global Clearing Member like BNP Paribas simplify this change for clients?
At BNP Paribas, we seek to act as a connector to as many CCPs and CSDs as possible, to provide our clients with the choice they want. Euronext Clearing will be no different. We will keep the same processing model and same connections to ensure it remains business as usual as much as possible for clients.
The objective going forward is to offer clients a single clearing and single custody contract covering all the Euronext markets. Once Euronext Clearing is up and running there will be a single trading platform for market participants and one CCP clearing all the Euronext exchanges. We in turn will align our local custody booking model so clients only need a single contract with BNP Paribas in Paris for the settlement and custody on all those markets. We plan to expand this new model to other T2S markets as well, with Germany a priority, then Spain.
Having a single booking model will offer our clients a simplified legal framework for the management of their relationship with us. They would only need to provide one set of ‘know your customer documentation’ and conduct one due diligence visit. It will be more efficient as well when a client needs to collateralise its activity with us.
Clients could also opt to centralise their cash for these markets on a single Euro cash account opened in BNP Paribas’ Paris books, giving them just one cash account they need to monitor and fund. Plus clients trading repos and reverse repos would have everything in the same cash account, one of the conditions they must meet to be allowed to compress their balance sheet through the netting of those trades.
The goal, as ever, is to help our clients navigate change, and simplify and optimise their access to Europe’s evolving clearing environment.