Fund issuers will have to make a significant change to how they normally settle if they subscribe to Luxembourg's new central securities depository, finds Nick Fitzpatrick.
Clearstream may settle more than 225,000 transactions daily but activity at its Luxembourg complex came to a brief halt on February 1 as staff absorbed news that the merger to form the world’s biggest stock market group had been blocked.
The merger involved its parent company, Deutsche Börse, and NYSE Euronext. They wanted to build a globally competitive exchange group but were blocked on European competition grounds.
While Deutsche Börse’s efforts in the past year were destined to clash with the European Commission, at the same time its Clearstream subsidiary – a central securities depository (CSD) that settles stock market trades – was running a project likely to please Brussels, not antagonise it.
Clearstream expanded its settlement business to support the Commission’s Target 2 Securities (T2S) plan.
T2S is intended to become the main platform for settling equities, bonds and funds on a cross-border basis in Europe, replacing the present fragmented domestic systems within the EU by centralising settlement onto an IT platform operated by the European Central Bank. Among its advantages, it could bring down the costs of cross-border dealing and, because trading is backed by central bank money, it should lower risk.
LuxCSD, which Clearstream made operational last year in partnership with the Banque Centrale du Luxembourg, Luxembourg’s central bank, is the country’s gateway to accessing the platform. The CSD was necessary. Without it, the cross-border funds industry in Luxembourg might have accessed T2S through another country, like France.
But the success of its fund settlement function will depend on whether market players can be persuaded to move away from their current cross-border settlement model.
Settlement can be carried out by transfer agents, which are typically run by custodian banks. They could access the T2S platform directly. But transfer agents could also effectively outsource settlement to a CSD, either LuxCSD or one in another country, and gain indirect access to T2S.
The CSD option has given rise to concerns about transparency. The fear is that transfer agents would hand over the details of fund holders and their transactions, and consequently lose sight of important information, some of which may be necessary for regulatory reasons, or to calculate fees and commissions for fund distributors.
Luxembourg is steeped in transfer agents. It’s the way the Grand Duchy does things.
Sebastien Danloy, managing director at RBC Dexia Investor Services in Luxembourg, says the transfer agent [TA] model has delivered the most successful settlement process for cross-border funds so far.
“In the past, there have been two cross-border settlement models, which were the TA model used in Luxembourg, and the CSD model, which is used in France, for example. Both have strengths and weaknesses, but the one that has been the most successful in cross-border asset management and fund distribution is the TA model, which is the way Luxembourg does it.”
Danloy, who worked at Societe Generale Securities Services in Paris, says it is not uncommon for some French cross-border funds to use the Luxembourg transfer-agent model for distribution outside France.
The transparency concern is a key issue for Danloy. “With a CSD it is almost impossible to track down who the ultimate investors in a fund are and this makes it hard to track commission payments. There may be an agreement between a fund manager and a financial adviser to retrocede a percentage of the management fee, but under a CSD you would not have all of these details. It remains to be seen how LuxCSD will address these issues or how it will facilitate distribution.”
So what does LuxCSD make of this? Patrick Georg, the general manager, says: “It depends on perspective. From a fund perspective having the customers on your books, directly on the register, gives transparency. And that is an advantage.
“But from an investor’s perspective, if you are a custodian dealing with different TAs, that is an additional overhead. For a custodian, having direct access to a shareholder register via a CSD means you get access to each TA through a single account.”
The CSD approach, says Georg, offers “one process, harmonised deadlines, and harmonised conditions”. He acknowledges concerns in the funds industry, voiced by the likes of the European Fund and Asset Management Association, that have raised the issue of shareholder transparency.
Each custody bank will decide what its T2S policy will be – whether to access the platform directly or through a CSD.
Danloy says RBC Dexia is yet to make a decision about the best approach.
Societe Generale Securities Services, meanwhile, is set to access T2S directly from Paris.
“It would make sense for SGSS to become a direct participant in T2S,” says Régis Veillet, head of sales and client relationship at the firm. He adds that a direct player can also reduce costs, shorten the information flow on securities transactions, and control liquidity.
His colleague, Patrick Loutsch, deputy head of custody and trustee services, says LuxCSD is needed in order to widen the Luxembourg funds industry’s settlement options. “Before LuxCSD there was no real central depository in Luxembourg and the need to create one was driven not by the small domestic securities market but by the need to support the cross-border distribution model Luxembourg-domiciled investment funds. Investors could access T2S through other countries, such as France, so Luxembourg needed its own CSD to compete.”
LuxCSD processed its first transaction in February, when a client that intends to use the depository transfered a fixed income portfolio across to the facility.
©2012 funds europe