fragmentation of liquidity were not enough for traders to cope with,
fragmentation of clearing and settlement seems set to present an additional challenge.
At a time when traders have to keep a more watchful eye on an ever-growing
number of trading venues to comply with best execution, they will also have to
monitor a series of clearing and settlement arrangements.
21 of MiFID, achieving best execution demands more than simply getting the best
price for clients. It also requires traders to take into account the likelihood
of settlement and overall trading costs, which includes clearing and settlement.
"Member States shall require that investment firms take all reasonable steps
to obtain, when executing orders, the best possible result for their clients
taking into account price, costs, speed, likelihood of execution and
settlement, size, nature or any other consideration relevant to the execution of
the order," Article 21 reads.
actively encourages cross-border trading and, alongside it, the cross-border clearing
and settlement of securities. Article 34 of the Directive allows investment firms
from one EU member state to access the counterparty clearing and settlement systems
At the best
of times, clearing and settlement makes up a large portion of overall trading
costs. Having to access multiple venues across Europe
only increases the costs. "For all transactions but particularly those
that are cross-border, clearing and settlement costs are likely to be many
times the trading cost because there are so many intermediaries," says Willy
Van Stappen, chief operating officer of pan- European exchange Equiduct. A
typical transaction could involve the broker who executes the trade, the custodian,
potentially a central counterparty and the local central securities depository
(CSD). These entities also have to report the trade, adding to the cost. "There
is an enormous amount of reporting among the same intermediaries, that goes all
the way back to the originator of the trade. That is many, many times the trading
cost," observes Van Stappen.
costs that are typically measured in euro cents are often swamped by clearing
and settlement costs that can add up to several euros, observes Van Stappen. The
settlement component of a ‘straightforward’ transaction can cost as much as €10,
he explains. When a large order is broken up – as would be the case when an algorithmic
engine is used, for example – the final bill is likely to be substantially higher.
"That applies across the board, whether it is fixed income or straight
equities," says Van Stappen.
clearing and settlement initiatives announced thus far by Turquoise and Chi-X
are going to cause fragmentation, predicts Van Stappen. He believes
fragmentation of settlement location, differing rules and different processing
for corporate events across Europe could
create risk and additional costs, including multiple margins. "You could
easily imagine a situation where a firm is long in a London Stock
Exchange-listed security traded on Turquoise – and cleared in EuroCCP – and
short in Equiduct. Without the clearing organised at the same place, you would
pay the margin twice and could potentially have stock borrowing and lending costs
too," he warns.
traders have taken on board the challenge, cost and complexity of clearing and
settlement in a post- MiFID landscape of multiple liquidity venues is seriously
in doubt. "Most traders to my knowledge have not focused on the precision
of post-trade activities; for example, trade confirmations of OTC derivatives,
impact on STP rates, the depot costs of settling securities and any unintended
consequences of MiFID on corporate actions," says Anthony Kirby, chair of the
MiFID JWG Best Execution Working Group. "Traders who are expecting the
costs of clearing and settlement to be expressed in basis points will be sorely
disappointed," he warns. "This is far from trivial."