Commentary: Europe Needs an Independent Settlement System

By David Fairlamb

How many clearing and settlement systems does the single European market need? And who should own and control them? Financiers from London to Athens are asking those questions in the wake of the scandal that engulfed Clearstream International in May. Some predict the takeover of a damaged Clearstream by the Deutsche Börse, which already owns 50%. But investors should think twice before they let that happen.

Luxembourg-based Clear-stream is vulnerable. It's under investigation for money laundering, after allegations made in Révélation$, a book by French reporter Denis Robert and Ernest Backes, an executive at one of the two companies that merged to form Clearstream in 2000. The book says that Clearstream operated hundreds of confidential accounts for banks so they could move money undetected. While the probe goes on, Clearstream Chief Executive Andre Lussi and two other directors have stepped aside "temporarily." Luxembourg's regulators stress that so far there is no evidence of wrongdoing. But Lussi may be gone for good anyway. Earlier this year, Clearstream, which handles the back-office paperwork for some 40% of European stock and bond trades, was found to have overstated its assets in custody by $1.5 trillion. (It has $6.5 trillion.) If Clearstream makes $1.5 trillion math errors, customers are understandably nervous--and some have moved to rival Euroclear.

Lussi's departure is a golden opportunity for Werner Seifert, Deutsche Börse's ambitious CEO. Seifert has wanted for some time to buy all of Clearstream--a move that Lussi opposed. "Clearstream is the growth engine behind the German bourse," says Harry Harutunian, a European-banking analyst at Commerzbank in London. Indeed, Deutsche Börse's share of Clearstream fees--some $20 million--accounted for more than one-third of its 2000 net profits. Owning all of Clearstream would advance the German exchange's goal of becoming a "securities market silo," providing everything from trading and price dissemination to settlement and custody. It would cost Seifert's group about $1.4 billion to buy out Cedel International, which owns the rest of Clearstream and is owned by 93 banks. Seifert is already feeling out Cedel shareholders.

Bankers and institutional investors should fight this. Clearstream handles transactions from many European exchanges and offers an array of financial services to institutions. The temptation would be too great for Deutsche Börse to subsidize its trading costs by raising clearing and settlement charges on trades Clearstream handles. "We believe that a vertical silo of trading, clearing, and settlement in a single group leads to higher costs," says Pen Kent, executive chairman of the London-based European Securities Forum, which represents 24 top banks and securities houses.

SEIFERT'S AMBITION? What should happen instead? Clearstream should be allowed to merge with Euroclear. The two would handle up to 75% of European equity and debt transactions. Getting rid of duplicate computer systems alone would save as much as $360 million a year. It currently costs up to 20 times more to settle a cross-border trade in Europe than it does to settle a domestic U.S. trade. At present, Europe has 25 settlement systems, most of which are owned by exchanges. Don Cruickshank, chairman of the London Stock Exchange, estimates transaction costs would be one-seventh current levels with one clearing and settlement house.

It is imperative that the one system be independent of stock exchanges. The worst of all worlds would be for Deutsche Börse to take over Clearstream and then acquire Euroclear, which is owned by some 1,500 financial institutions. That, some insiders say, is Seifert's ambition. If Euroclear and Cedel shareholders can't keep that from happening, regulators in Brussels must.

Fairlamb follows European finance from Frankfurt.

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