“OTC derivatives regulation is working in our favour”

October 2011

(Part 2 of 3) Conversation with Tim Howell, CEO of Euroclear, on – new regulations are playing into the hands of clearing houses – the debate about inter-operability among clearing houses – expanding into other markets.

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Here is the transcript of the video.

1. Role of clearing and settlement houses during the European debt crisis

Emmanuel Daniel (ED): The European securities processing industry is in turmoil. Many different players competing and cooperating on a variety of fronts. The processing business as a whole is being commoditized and new third party players are coming into the field. At the centre of this world is Euroclear and I’m here, very happy to be able to speak with Tim Howell, the Chief Executive of Euroclear, the player that has held the vast majority of the securities processing industry in Europe and today finds itself inundated by competition and collaborative differences on a number of fronts.

What is the core proposition of Euroclear going forward, given the fact that the transaction itself is highly commoditized? The value proposition of the different players, the CCPs, the new players and the new securities platforms and so on increasingly takes away your role as a processing house and sends you more and more toward the back end in a way. What is core to Euroclear today?

Tim Howell (TH): There are clearly a significant number of changes in the landscape in Europe, some of which give us a lot of opportunities and some of which threaten some of our core businesses. The real focus and real understanding, I think, is to look at what has evolved in the market in the last few years. If we take the period pre-Lehmans, the focus was all about doing things cheaper. It really didn’t occur to people that significant risks, such as the risk of a major broker-dealer going bankrupt, was really relevant. It was technically feasible, but it wouldn’t happen.

So consequently, there has been a move towards more commoditization of certain processes like settlement, which is what we do quite a lot of, and that is understood and most likely to continue. The big change over the last few years, and which becomes core to Euroclear – and frankly should be the core to any infrastructure provider – is risk.

So pre-Lehmans, it was all to do with costs because there wasn’t really an appreciation that risks could happen. There was an understanding that they existed but they wouldn’t happen. Now, of course, the world has moved on; we’ve had Lehman’s, we have moved from concerns about corporate insolvency to country insolvency. Europe is clearly in some difficulties at the moment in terms of the future of the euro itself. Both the United States and Europe – you could say some sort of North Atlantic grouping – have some political challenges that amount to some particularly big issues.

So the focus to me is risk. And what that means is when events happen, and there’s not much point in trying to determine what those events could be, because what we have learned over the last few years is that they can be almost anything people haven’t originally thought of. When these things happen we are always there, we’re always stable,  we’re financially sound and we can carry on with the infrastructure role. So the infrastructure firms always need to be in place.

ED: But am I hearing you correctly? I mean, you’re saying that risk is really where the industry itself is at the moment in the sense that there’s an appreciation that is not just a question of cost or transaction or efficiency, but where the risk lies. And you’ve been pushed as a business to take on risks as part of the service that you provide.

TH: No. Risk – the disintermediation of risk, the resolution of risk – is our central role. The forms those risks can take change over time as markets develop. So, for example, again, if you go back a couple of years, Europe has faced various changes in terms of regulator changes. A major one that came in was called MiFID. This was to do with market infrastructures, which mainly affected the stock exchanges, and basically reduced the cost of dealing.

The consequence of that, of course, is that there are far more exchanges, each having to do the basic role of executing a cheap transaction. But then the credit worthiness of various participants have been affected, because you are spreading out, you’re disintermediating, you’re spreading the liquidity across far more players.

So if you were driven by just cost, you would have lots of players with not much liquidity; if you’re driven by just risk, you would have one player and then you would try to get the right balance with competition to ensure that you don’t have monopolistic pricing. On the other hand, you cannot have too much disintermediation of liquidity, otherwise you don’t get the necessary depth of market and you increase the risk factor.

This applies everywhere. And in almost every financial crisis that has existed, liquidity is the watch word. When people say “what are the issues in banking”, the usual answer is some version of “liquidity, liquidity, liquidity”. You can have all sorts of technical value at risk measures. You can have all sorts of theoretical understandings. They all rely on the fact that there is a market in which you can do business. You can buy, you can sell, you can correct. Hence, there must be liquidity.

So the infrastructure world – and Euroclear in this infrastructure world – spend a significant amount of time determining where the risks are and looking at those risks, not from a profit maximisation perspective, but from a “how do I resolve those risks” point of view.

Simple example: We have three incredibly big and quite expensive data centres. Most infrastructures have two. Why do you have two? You have two because if one goes wrong you’ve got a backup. Being the infrastructure people we are, we know that if we do not do our day-to-day jobs, significant parts of the European landscape simply cannot work. You cannot buy/sell. They have to stop.

So we decided, okay, most firms have two data centres. But just in case another one also goes wrong, we’ll have three data centres. That is not an economic decision.

Economically that’s an expensive investment, which may well never be used. But this is the difference between looking at it from an ordinary player to an infrastructure player. Those decisions we have to take are done on the side of risk. That is what our clients pay for.

ED: Right. While you make those sound logistical decisions, the markets themselves – and the market players themselves, the exchanges and the users of your service – are not necessarily loyal to you any more. They have choice. They have choice in terms of providers. They have choice in terms of the way in which they want to have securities processing settled.

So in that sense, liquidity is important, but the market will continue to be fragmented somewhat before it starts consolidating. Would you say that about the European marketplace today?

TH: What I would say is that I think people really understand risk. Our volume, our amount of business, is going up significantly because people understand that there is value in working with us. Competition works and we currently have a lot of providers in our field. And there’ll be some customers who say “I want it cheap and I don’t care about risk.” Fine, they will go somewhere else. I don’t have a problem with that.

ED: Is it that the biggest contributor to your volumes going up, or is it the fact that there is a tremendous amount of interest in Europe in government bonds?

TH: If you look at the market as a whole then clearly, Europe is going through a difficult time in terms of economic growth. It is one of the slow growth areas of the world. We understand that. It is still a very large trading area, so there are still an awful lot of transactions that take place within Europe and from outside Europe, even if they’re only investing for portfolio diversification. You know, you need something in the States, something in Asia and something in Europe.

So there’s a significant amount of activity still taking place within Europe. In terms of our share within that, we have a very high market share which is incredibly stable. And the reasoning is that different clients want different things. Most clients genuinely understand that there is a price to pay for having risk appropriately addressed. And there are some who won’t pay for it. That’s fine. They can go next door.

We still have to be very conscious of price. It is just not the only factor, so we will always work, as everyone does these days, in continuous improvement mode to drive down price. Trying to chip a bit off the price here, a bit off the price there – it’s a bit like racing car manufacturers. When they try and knock off one-tenth of a gram from every single component, it adds up to something worthwhile. We run a multi-faceted process, there are a lot of processes involved. You take bits off every one, it adds up to something significant. Over the last two or three years, our core pricing has gone down 35%. We can do that whilst maintaining – and this is the key point – maintaining the results we need to make the investments in people, infrastructure and systems needed to address risk.

ED: So, at the core of your business the critical mass of your business is still intact.

TH: Oh, absolutely. Let’s not get too complex about this. Our core business – as someone said – our lot in life, is post-trade made easy. We make it simple.

ED: You’ve made it easy, you’ve done the make-it-easy part quite extensively, and right now it’s a business of reducing the cost of that highly transformed process.

TH: Well, there is – and always will be – a need to reduce the price. That will always be the case. Again, however, the focus is on the risk side, so in the current climate, post-Lehmans, there is now a far greater demand for collateral management. The collateral management requirement comes from the fact that the banks are not as trusting of each other as they were –

ED: And the central banks are allowing the market to decide.

TH: Precisely. So we are the people who look after €22 trillion of assets. Those assets form the basis of collateral management. And, that is a service which will increase. What are the criteria? Clients want someone who can look after those assets well. We are that that someone who is independent of other players and shows no bias towards one exchange or CCP over another. And, we are efficient at processing. That’s our history; we do that.

So in commoditized environments, like settlement, there are a lot of opportunities. Collateral management is the most critical one at the moment, where we manage daily exposures via collateral management on the order of €600 million euros. This is a significant increase from years ago.

ED: Let’s take the conversation forward a little bit. What are the new areas that prove to be promising for you, and you need to have a game plan going forward? The CCPs, for example, and the need to bring on more asset classes onstream. Is that an area that is promising for you?

TH: The role of a CCP is to mitigate risk. That is the role of the CCP. So again, at the risk of being boring, we go back to risk. CCPs are becoming more important. Regulators are focusing on them more because they appreciate their role in risk reduction and are looking to clear more products through the CCPs.

ED: The regulators see more of the throughput, so –

TH: They do. There is a slight dichotomy which is being pushed through, along the lines of a general CCP requirement, i.e. something to do with Dodd-Frank in the States, something to do with EMIR (European Market Infrastructure Regulation) in Europe in terms of putting over-the-counter instruments through CCPs. Okay, we understand that.

But mathematically, CCPs basically work on trying to reduce risks; the more trades you put in, the more offsets you get. So there’s a slight problem at the moment in Europe whereby we have too many CCPs fragmenting the underlying business. Therefore, too many CCPs are reducing the amount of risk offset by definition.

Therefore, again, you have to get the right balance between cost and the amount of risk mitigation. So there are – if you take the cash world – too many cash CCPs in Europe. They’re not making a lot of money, and there will probably be some form of consolidation. That’s fine. But, it is not something which I feel a requirement for Euroclear to do.

In the OTC world, there are a sufficient number of concerns about risk for CCPs to have a role here too. But when you have done the clearing you then have to collateralize the exposures. That’s where Euroclear comes in. We will establish business relationships with the CCPs, but not with a view to doing the clearing ourselves.

ED: But how would you describe your relationship with the banks as users of CCPs? Because in one sense, with the fact that the regulators are promoting greater use of CCPs, it is actually freeing up the banks to be able to do whatever they want in terms of how they want to trade, who they want to trade with, which platform they want to trade on.

TH: Absolutely. Then we come along – we are completely platform agnostic. What I can say is that when you have gone through the CCP process, no matter where you’ve done it, there will be an exposure arising from bank A to bank B. They will want someone in the middle who is not bank A or bank B to make sure that the exposure is collateralized.

ED: So has regulation been working in your favour?

TH: Tremendously. Because clients need someone who’s independent, who already has the collateral, who can stand between the counterparties after the trades have been netted and CCPed, that’s where we come in.

ED: But your users seem to see a role for yourself as a post-trade infrastructure provider.

TH: That is post-trade. We come in after they’ve done the trade, after the trade has gone through to a CCP. The CCP mitigates risks through netting, through clearing, which is all post-trade. Then there is a residual exposure of bank A on bank B, on bank C etc. That exposure needs to be collateralized, and that’s where we come in. The European landscape is very focused on risk – which can can manifest itself in many ways.arket and you increase the risk factor.

This applies everywhere. And in almost every financial crisis that has existed, liquidity is the watch word. When people say “what are the issues in banking”, the usual answer is some version of “liquidity, liquidity, liquidity”. You can have all sorts of technical value at risk measures. You can have all sorts of theoretical understandings. They all rely on the fact that there is a market in which you can do business. You can buy, you can sell, you can correct. Hence, there must be liquidity.

So the infrastructure world – and Euroclear in this infrastructure world – spend a significant amount of time determining where the risks are and looking at those risks, not from a profit maximisation perspective, but from a “how do I resolve those risks” point of view.

Simple example: We have three incredibly big and quite expensive data centres. Most infrastructures have two. Why do you have two? You have two because if one goes wrong you’ve got a backup. Being the infrastructure people we are, we know that if we do not do our day-to-day jobs, significant parts of the European landscape simply cannot work. You cannot buy/sell. They have to stop.

So we decided, okay, most firms have two data centres. But just in case another one also goes wrong, we’ll have three data centres. That is not an economic decision.

Economically that’s an expensive investment, which may well never be used. But this is the difference between looking at it from an ordinary player to an infrastructure player. Those decisions we have to take are done on the side of risk. That is what our clients pay for.

ED: Right. While you make those sound logistical decisions, the markets themselves – and the market players themselves, the exchanges and the users of your service – are not necessarily loyal to you any more. They have choice. They have choice in terms of providers. They have choice in terms of the way in which they want to have securities processing settled.

So in that sense, liquidity is important, but the market will continue to be fragmented somewhat before it starts consolidating. Would you say that about the European marketplace today?

TH: What I would say is that I think people really understand risk. Our volume, our amount of business, is going up significantly because people understand that there is value in working with us. Competition works and we currently have a lot of providers in our field. And there’ll be some customers who say “I want it cheap and I don’t care about risk.” Fine, they will go somewhere else. I don’t have a problem with that.

ED: Is it that the biggest contributor to your volumes going up, or is it the fact that there is a tremendous amount of interest in Europe in government bonds?

TH: If you look at the market as a whole then clearly, Europe is going through a difficult time in terms of economic growth. It is one of the slow growth areas of the world. We understand that. It is still a very large trading area, so there are still an awful lot of transactions that take place within Europe and from outside Europe, even if they’re only investing for portfolio diversification. You know, you need something in the States, something in Asia and something in Europe.

So there’s a significant amount of activity still taking place within Europe. In terms of our share within that, we have a very high market share which is incredibly stable. And the reasoning is that different clients want different things. Most clients genuinely understand that there is a price to pay for having risk appropriately addressed. And there are some who won’t pay for it. That’s fine. They can go next door.

We still have to be very conscious of price. It is just not the only factor, so we will always work, as everyone does these days, in continuous improvement mode to drive down price. Trying to chip a bit off the price here, a bit off the price there – it’s a bit like racing car manufacturers. When they try and knock off one-tenth of a gram from every single component, it adds up to something worthwhile. We run a multi-faceted process, there are a lot of processes involved. You take bits off every one, it adds up to something significant. Over the last two or three years, our core pricing has gone down 35%. We can do that whilst maintaining – and this is the key point – maintaining the results we need to make the investments in people, infrastructure and systems needed to address risk.

ED: So, at the core of your business the critical mass of your business is still intact.

TH: Oh, absolutely. Let’s not get too complex about this. Our core business – as someone said – our lot in life, is post-trade made easy. We make it simple.

ED: You’ve made it easy, you’ve done the make-it-easy part quite extensively, and right now it’s a business of reducing the cost of that highly transformed process.

TH: Well, there is – and always will be – a need to reduce the price. That will always be the case. Again, however, the focus is on the risk side, so in the current climate, post-Lehmans, there is now a far greater demand for collateral management. The collateral management requirement comes from the fact that the banks are not as trusting of each other as they were –

ED: And the central banks are allowing the market to decide.

TH: Precisely. So we are the people who look after €22 trillion of assets. Those assets form the basis of collateral management. And, that is a service which will increase. What are the criteria? Clients want someone who can look after those assets well. We are that that someone who is independent of other players and shows no bias towards one exchange or CCP over another. And, we are efficient at processing. That’s our history; we do that.

So in commoditized environments, like settlement, there are a lot of opportunities. Collateral management is the most critical one at the moment, where we manage daily exposures via collateral management on the order of €600 million euros. This is a significant increase from years ago.

ED: Let’s take the conversation forward a little bit. What are the new areas that prove to be promising for you, and you need to have a game plan going forward? The CCPs, for example, and the need to bring on more asset classes onstream. Is that an area that is promising for you?

TH: The role of a CCP is to mitigate risk. That is the role of the CCP. So again, at the risk of being boring, we go back to risk. CCPs are becoming more important. Regulators are focusing on them more because they appreciate their role in risk reduction and are looking to clear more products through the CCPs.

ED: The regulators see more of the throughput, so –

TH: They do. There is a slight dichotomy which is being pushed through, along the lines of a general CCP requirement, i.e. something to do with Dodd-Frank in the States, something to do with EMIR (European Market Infrastructure Regulation) in Europe in terms of putting over-the-counter instruments through CCPs. Okay, we understand that.

But mathematically, CCPs basically work on trying to reduce risks; the more trades you put in, the more offsets you get. So there’s a slight problem at the moment in Europe whereby we have too many CCPs fragmenting the underlying business. Therefore, too many CCPs are reducing the amount of risk offset by definition.

Therefore, again, you have to get the right balance between cost and the amount of risk mitigation. So there are – if you take the cash world – too many cash CCPs in Europe. They’re not making a lot of money, and there will probably be some form of consolidation. That’s fine. But, it is not something which I feel a requirement for Euroclear to do.

In the OTC world, there are a sufficient number of concerns about risk for CCPs to have a role here too. But when you have done the clearing you then have to collateralize the exposures. That’s where Euroclear comes in. We will establish business relationships with the CCPs, but not with a view to doing the clearing ourselves.

ED: But how would you describe your relationship with the banks as users of CCPs? Because in one sense, with the fact that the regulators are promoting greater use of CCPs, it is actually freeing up the banks to be able to do whatever they want in terms of how they want to trade, who they want to trade with, which platform they want to trade on.

TH: Absolutely. Then we come along – we are completely platform agnostic. What I can say is that when you have gone through the CCP process, no matter where you’ve done it, there will be an exposure arising from bank A to bank B. They will want someone in the middle who is not bank A or bank B to make sure that the exposure is collateralized.

ED: So has regulation been working in your favour?

TH: Tremendously. Because clients need someone who’s independent, who already has the collateral, who can stand between the counterparties after the trades have been netted and CCPed, that’s where we come in.

ED: But your users seem to see a role for yourself as a post-trade infrastructure provider.

TH: That is post-trade. We come in after they’ve done the trade, after the trade has gone through to a CCP. The CCP mitigates risks through netting, through clearing, which is all post-trade. Then there is a residual exposure of bank A on bank B, on bank C etc. That exposure needs to be collateralized, and that’s where we come in. The European landscape is very focused on risk – which can can manifest itself in many ways.

2. Interoperability between clearing houses

ED: Is there a role for you in promoting greater interoperability between CCPs?

TH: I think interoperability is an interesting debate. I was reading the other day a superb speech on the value of interoperability given by the chairman of the London Stock Exchange. Then I realised the speech is ten years old and it’s still relevant today.

Interoperability, if done properly, can reduce costs. You should also be able to increase the amount of risk mitigation. To get back to my example of having too many CCPs that don’t work with each other, you can get more benefits from using a single CCP.

The danger with interoperability– and this is what we’re going to have to work on – is that you end up with a chain that’s as strong as the weakest link. So if all CCPs are equally strong, that’s terrific. If one of them has almost no capital, that is the one that becomes the weak link in the whole chain. Personally I don’t think there’s any intellectual issue with interoperability. I think there may well be some pragmatic issues. But if they were being looked at in terms of solvency, from a regulatory perspective, that should be resolvable.

But make no mistake, a lot of this– and again we saw it with Lehman’s – a lot of what goes on is dependant on someone else investing with a fund manager, doing deals or asset management… it is a chain of events. The key is to make sure you have an appropriate level of risk control and quality to handle all those chains. Otherwise, like all chains, the whole chain collapses.

ED: Yeah, but as this chain is being formed, a number of potential business opportunities arise, but also roles. If you take securities lending, for example, is that a tempting area for Euroclear?

TH: Securities lending is a very generic term. It covers all sorts of things. Say, for example, the securities loan occurs during the settlement process when there is a potential fail because someone hasn’t got the stock to deliver. We work to make sure that the right security is automatically lent to them. So that way, the settlement process works seamlessly. That is not securities lending in the sense of enabling someone to short the marketplace. And so, one has to be very careful in terms of what securities lending means. So for us, yes, securities lending is a significant role we play, but it’s done with the purpose of smoothing the settlement process of the market, smoothing the operation of the market.

We see a lot of trends at the moment, like in exchange traded funds. There are issues when markets do not function as efficiently as they could. It gives opportunities for ambiguities to appear. In that particular sense, securities lending takes away a potential inefficiency in the market.

ED: Given the complexity of products that you are adding on to your proposition, is the Euroclear proposition exportable outside of the European context? I mean, in Europe you have the lion’s share, 22 trillion euros of securities that you hold for your customers. And that will continue to ensure your role for a long time to come in a sense. But is it something that you can ride the back of in order to expand into other markets, maybe by linking it back to the interest that other markets have on Euro bonds?

TH: Well, interaction is the answer. But, again, let’s think how this works. We have a very significant market share in Europe, probably over 50%. Now, the reality is that the core concepts of reducing risk are required almost anywhere. No one deliberately sets out for more risk. Because of the way the European markets have developed, we have a lot of history in reducing risks.

So we are always having a lot of dialogue with clients around the world, whether it be Asia, the Middle East or wherever, in terms of how we can work with them to share ideas or leverage our systems. The key is to jointly agree on the right initiative; details of the local market are known by the local participants. So while we may have done a lot of intellectual thinking about new products, we need the two sides to work and play together, otherwise–

ED: But your efforts in finding these linkages and finding the formula has not been entirely successful or consistent enough for you to be able to build into Asia.

TH: Well, I wouldn’t say that. We do an awful lot of business in Asia. If you look at the offshore renminbi market, 25% of that market goes through the ICSDs, the Euroclear-type structure. What we don’t do is make a big song and dance over it. That’s not our role.

We are discussing with many government organizations, many securities depositories, many groups of banks within groups of countries, whether that be in Asia, in the Middle East or in Latin America, with a view to establish whether there is anything which we can help people with? And I think it’s key that we contribute, as we have the experience, and we should help the market with that experience. So I don’t have any intention of coming up with something completely brand new in those countries.

The other thing about infrastructure, which is painful to grasp at times, is that change takes a long time. The fact that we’ve been in discussions with a group of major Asian regulators for two or three years, and you’ve not seen a new product out there, doesn’t surprise me in the slightest. These things take time. But a lot of progress is being made in terms of how to take some of the fundamental risk management techniques and use them where they are applicable, knowing that they’re not applicable everywhere.

ED: Asia being much more fragmented than Europe, and no supra-national initiative to create some of the transaction efficiencies that you’ve benefited from and you’ve been part of creating in Europe, every marketplace in some sense wants to create its own infrastructure. And you are seen more as a supplier, more as a third party best practice provider. And that role in that market place is not necessarily guaranteed in a sense.

TH: Oh, yeah, nothing’s guaranteed but it’s not quite like that. If I think of Europe, the biggest change in Europe has been the harmonization of market practices between some major markets. This was done as a private sector initiative by Euroclear. So –

3. Clearing initiatives taken by regulators out of Europe

ED: So do you see private sector initiatives in Asia that make sense?

TH: We are involved in both private sector and public sector initiatives in Asia. It is true that some of them won’t will really get traction, because it’s just too difficult to get on the same level, but some of them will. Clearly, one has to be grown-up about which ones you can put a lot of resources into and which ones you can’t.
But, again, let me go back slightly here. The role of Euroclear is to facilitate efficient markets. We’ll do this under what we call a profit-constrained model. It is not our job to profit maximize and net the last dollar or euro in our opinion on anything. We need to make enough to invest so that we can create efficiencies.

So, what about Asia? Asia has over the last 20 years achieved some very substantial growth. Great place to be. However, most countries have their own laws. There is now an understanding that as growth begins to come down a bit, but still very strong compared to the rest of the world, this may encourage people to do more work in making the laws less different. It’s not to say they have to be the same, but they can be made simpler.

We are, quite frankly, easy to speak to about this issue. We’re not going to try and make a significant amount of profit out of it, because that’s not what our remit is. We will try and make it efficient. We can give advice and guidance, which may or may not be taken up. So I think there are significant opportunities outside Europe in this field and we are spending a significant proportion of our time on foreign market infrastructure. Whether that be, as I say, in the Middle East, Asia, Russia or wherever, I’m just giving advice as to how we can move things forward, some of which will be relevant, some of which will not be relevant.

ED: If Asia were to get its act together as a super national initiative of sorts to create greater efficiencies and greater linkages, you would also come into competition with other players who are playing in Asia today. In that sense, what would your value proposition be to a group of Asian sovereigns wanting to build a market infrastructure?

TH: Our value is saying we’ve done that. We’re the only people who’ve built a post-trade structure crossing countries. And let’s be frank, it is not easy to get countries to agree, ever, to different laws. And everyone tends to agree at 50,000 feet to harmonize rules, but what they really mean is everyone follow my country’s rules. And so these things take time.

We have experience and we have resolutions to a lot of these issues. And so I think we can bring a lot to the party in terms of experience and what we’ve done. But if it’s a game people want to play and they don’t want to use us that’s entirely their prerogative. Now, as it happens, we are doing a lot in Asia, because we’re also seen as being somewhat independent because we’re not owned by a major bank, or a stock exchange; we are owned by all of them one way or the other.

So if you’re looking for help to establish a structure which is deemed to be independent rather than potentially favouring one part of the financial community over another, it is a path of least resistance to have a chat to see what we’ve got to offer. But I’m not going to be arrogant about this, you know. I think we’ve got a lot we can offer here. But if a group of countries get together and say it’s better to do it on their own, then that’s entirely their prerogative.

ED: And there are initiatives like that in Asia. The ASEAN countries, for example, and China.

TH: Absolutely. And we are involved in those now. Let’s get this straight. We are very strongly involved in those, but we do not shout about it from the rooftops. We don’t want to look like some sort of colonial European initiative going in and telling people how to do things.

So in nearly all of these initiatives, in the background, we are there. Being in the background is fine for us. We’re just trying to get these processes more efficient and better understood. We’re not paid, and it is not our role to export a European solution. It is our role to make more operational efficiencies in the marketplace. If that means another provider uses something we do and they change it to their local name, I don’t care. We don’t have to have our name in big letters over the whole project.

ED: The other engine of growth, the new algo traders, the black boxes, the hedge funds, how do you playing that field right at the moment?

TH: Well, it’s an interesting concept. When you say growth, presumably you mean financial transactions growth rather than economic growth –

ED: Well, it’s interesting because for you, when I’m discussing growth with Euroclear, I’m actually thinking about how you’ll be moving out of your core proposition, and then looking for what may well become peripherals, but still very profitable peripherals that benefit from the core business that you’re clearly not going to be moving out of any time soon.

TH: We will look at some of the things you talked about and understand where we can add value in that chain. Now, clearly, I think we are operating pretty efficiently in terms of cost; I think clients have been very cost-driven. But if we stand back and look at the bigger picture, there are areas which are going to be subject to some significant regulatory scrutiny. Today, we offer various services to provide information to regulators about what is happening. Not just who did what deal with whom, and at what price, but in terms of volumes, amounts of assets, all of this sort of thing. Requests for data is something which we get involved with.

So we will continue to do a significant amount of business with the trading organizations, the broker dealers who tend to deal with high frequency trading and algo trading. But data reporting is not a main part of our business. It is part of the relationship we have with trading counterparties. The amount of underlying trades that go through Euroclear, from a stock exchange perspective, is a very significant part. On the settlement side, it comes through to us as a transaction. We don’t know if the deal started from your mom and pop who wanted to buy a share or if it started from an incredibly efficient high frequency trader. And so again – and this is something to do with risk – you really don’t care how these trades started. Nearly all risks compose into – decompose into – cash moving from there to there. And either it moves at a high level or it’s netted down to a low level.  But whether it started as an equity trade, as a bond trade, as a foreign exchange trade or whatever, from a risk perspective, it doesn’t matter. What it comes down to is, at a certain point in time, someone has to pass cash around the system. And that’s what we do – we focus on the post-trade. So I can be somewhat agnostic as to where the trade starts.

We also focus on who is trading in the marketplace, who are their clients and how to manage the resulting risks that come from them. The originating product is secondary.

ED: Well, the point today is that the originators themselves are creating infrastructure that helps them to do a lot of the trade themselves. And they risk putting you in a corner and giving you a role that is very, very specific.

TH: No. Nearly all of that is pre-trade. We’re not pre-trade. We’re post-trade.

ED: They put you in a corner and prostrate you basically sort of mirror custodian role basically.

TH: No. We’re quite different from a custodian.

ED: Technically.

TH: It’s more than just technically. The winning custodians will be able to do a great deal of asset servicing to a very granular level, and globally. That is not what we’re trying to do. We will try and simplify the asset servicing processes around the world. We will encourage harmonization. And so we work very significantly with the global custodians. In fact, they are some of our biggest customers.

What is interesting is the general value chain dynamics. There are services which global custodians ask us to do now, which three years ago they would’ve said was a fundamental part of their value chain. And this is what comes out. When you get increased transparency in the market place, and you get pricing which is less bundled, people can stand back and say “I make my money doing A, B and C, and it really doesn’t matter who does D & E.” Whereas you go back a few years and many custodians said, “I must do everything from A to Z. That is my selling point”. And so, the more people who actually say their selling point is focused on the customer relationship, and want someone who will do a scaled and efficient job on the rest, that we can do. And it is much easier, frankly, for us to do a scaled and efficient job than for many others. For example, suppose you are a bank and another bank comes along and says we’ll do the work for you. Or, we come along as a non-bank and say we’ll do the work for lots of banks. Banks have a natural preference not to give work to their competitors.

So, ours is an ever-changing role as people change their knitting, what they really have to do. And that will continue to evolve as custodians redefine what they have to do. What does a broker dealer have to do? Where do they really earn their money? And to the extent that some obligations come from the back end, and are relatively commoditized, they will look for someone who can act very efficiently. They tend to knock on our door and say, that’s what you do. You are a factory for us to process transactions and reduce the risk on the way.

So, that is why there is continual movement along the value chain.

ED: Tim Howell, thank you very much for giving us a perspective of how this industry’s going to evolve, and the fact that Euroclear’s own proposition is very clear in that you are in post-trade and you want to provide the value add on the risk and the settlement and the liquidity front of your business.


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