Action plan for clearing and settlement
The European Commission has adopted a Communication on an action plan to create a genuine single market in securities in the European Union and to make cross-border clearing and settlement effective, safe and efficient at European level.
Communication from the Commission to the Council and the European Parliament of 28 April 2004 on "Clearing and Settlement in the European Union - The way forward" [COM(2004) 312 final - Not published in the Official Journal].
"Clearing and settlement" refers to the full set of arrangements required to finalise a securities or derivatives transaction. This process comprises several stages, each carried out by a different institution.
In this Communication the Commission sets out its objectives in detail and proposes specific measures for achieving an integrated, efficient and safe market for securities clearing and settlement.
The current arrangements for finalising transactions are considered to be efficient at national level but very inefficient at a cross-border level.
The inefficiencies at EU level are due to:
- a lack of global technical standards;
- the coexistence of differing business practices;
- inconsistent fiscal, legal and regulatory underpinnings.
As a result of these inefficiencies, cross-border clearing and settlement is more costly, complex and less safe than at purely domestic level. This situation is no longer acceptable at a time when a single European market in financial services is being created and when investment strategies are increasingly based on pan-European sectoral conditions.
Given recent developments such as the introduction of the euro and improvements in information technologies, the number and the relative importance of cross-border transactions have increased. As a result, the strains on and the expectations from clearing and settlement arrangements have also increased. Clearing and settlement service providers therefore need to enhance performance, reduce costs and establish a pan-European presence. Similarly, regulators and supervisory authorities are improving the clarity and homogeneity of standards for clearing and settlement systems, and updating their supervisory methods in order to meet the challenges posed by safety requirements and market developments.
The Giovannini Group has produced two reports on the main barriers related to the fragmentation of the European clearing and settlement markets and the resulting inefficiencies. The "Giovanni Barriers" are classed as technical or market-practice barriers, legal barriers and barriers related to tax procedures, namely:
- diversity of IT platforms and interfaces;
- restrictions on the location of clearing or settlement;
- national differences in rules governing corporate actions;
- differences in the availability or the timing of intra-day settlement finality;
- impediments to remote access;
- national differences in settlement periods;
- national differences in operating hours/settlement deadlines;
- national differences in securities issuance practice;
- restrictions on the location of securities;
- restrictions on the activity of primary dealers and market-makers;
- withholding tax procedures disadvantaging foreign intermediaries;
- tax collection functionality integrated into the settlement system;
- national differences in the legal treatment of securities;
- national differences in the legal treatment of bilateral financial clearing;
- uneven application of conflict-of-law rules.
It is in the light of these barriers to the integration of the clearing and settlement market that the Commission underlines its concrete objectives and initiatives. The main aim is to achieve a safe and efficient European clearing environment which ensures a level playing field among the different providers of the services in question. In order to achieve this objective, the Commission proposes:
- to liberalise and integrate existing securities clearing and settlement systems, particularly by providing access rights at all levels and removing barriers to cross-border clearing and settlement;
- to remove restrictive market practices and to monitor industry consolidation in accordance with the requirements of competition policy;
- to adopt a common regulatory and supervisory framework that ensures financial stability and investor protection, leading to the mutual recognition of systems;
- to implement appropriate governance arrangements so as to address national authorities' concerns regarding the way in which clearing and settlement infrastructures operate.
The Communication proposes that a framework Directive on clearing and settlement be drawn up. The Directive would grant rights of access to infrastructures and would define the conditions for their exercise, thereby facilitating EU-wide liberalisation. Developing the cross-border clearing and settlement system will involve national authorities cooperating more closely in order to achieve effective cross-border regulation and supervision. As a result, it is important to determine which authority is responsible for regulating and supervising cross-border clearing and settlement activities. The Directive will therefore establish a regulatory framework and lay down a common set of high-level principles that will ensure greater legal certainty and guarantee a level regulatory playing field. Finally, the Directive will lay down appropriate governance rules for clearing and settlement entities, namely:
- accounting separation;
The Commission also proposes to set up an advisory and monitoring group (CESAME) composed of experts from public and private bodies, and tasked with improving coordination between public- and private-sector bodies (such as the ESCB and CESR) and with creating the necessary synergy to remove certain Giovannini barriers for which the private sector will be responsible. Given that there may be diverging interests among different market participants, this working group, operating as a forum, will aim to convince the markets of the need both for particular action and for an overall approach. It will also inform the public on the state of the reforms. Finally, it will liaise with the groups of experts that will tackle the legal barriers and the barriers related to tax procedures in conjunction with the Group of 30 and other international bodies so as to ensure that European initiatives are consistent with those developed at international level.
Furthermore, the Commission proposes to tackle legal and tax barriers. The smooth running of the clearing and settlement system depends on the soundness of the legal system on which it is built. The legal framework must be clear, reliable, coherent and predictable in its interpretation and implementation. The Giovannini group has identified the main important barriers to further integration:
- uneven application of national conflicts-of-law rules;
- different legal systems;
- different treatment of bilateral netting among Member States;
- the absence of an EU-wide framework for treating interests in securities;
- national disparities as to the moment a purchaser is considered to be the owner of a security for the purposes of corporate actions.
The current legal framework already addresses some of these issues. The Settlement Finality Directive and the Financial Collateral Arrangements Directive, for example, deal with issues such as the legal treatment of netting and conflicts of law.
However, there are other legal barriers, particularly the absence of an EU-wide framework for the treatment of interests in securities held with an intermediary. Securities are increasingly held and transferred on the basis of book entries. When dematerialised securities are represented exclusively by a book entry in an account held by an intermediary, it is necessary to determine the nature of the investors' rights and the legal interpretation, which can vary from one Member State to another. It is also important to determine the legal framework which applies to transfers of rights in respect of indirectly held securities.
In addition, the issues of how to determine priorities between competing interests as recorded in the relevant accounts and how to avoid creditors attaching or claiming an investor's right at a level in the chain of holdings higher then where such right is actually recorded or constituted need to be addressed.
Corporate action processing can vary in line with differences in national legislation. A specific example is the determination of the exact moment when a purchaser is considered to be the owner of a security for the payment of dividends. This date may vary depending on the legislation of the Member State in question.
Lastly, restrictions on the issuer's ability to choose the location of its securities act as a further barrier to the integration of securities settlement systems.
The Giovannini reports also looked at taxation issues. Firstly, it was noted that there are procedures whereby only certain intermediaries are permitted to apply a reduction of the normal rate of withholding tax. For example, some Member States permit only institutions established on their territory withholding tax procedures. In other Member States, foreign intermediaries are allowed to operate these procedures, but on the condition that they appoint a local tax representative. A foreign operator is therefore prevented from operating on a cross-border basis or using the intermediary services of a securities settlement system. This limits competition in securities settlement, since market participants cannot choose the most efficient way of operating in other Member States.
Secondly, there are differences between Member States in collection and in granting relief from withholding tax. Even if investors can be granted partial or total relief from this tax, they may have to pay it before it can be reclaimed. Procedures vary between Member States and can be very complex, increasing the cost of cross-border settlement.
In order to deal with these legal and tax issues, the Commission is proposing to set up two groups of experts tasked with looking at the issues and studying the different systems in the Member States in order to assess whether they can be more closely aligned.
Competition policy must be consistently applied for clearing and settlement systems to be integrated. The Commission monitors mergers and acquisitions in this sector in order to ensure that there are no market restrictions and to establish ground rules for consolidation practices.