CAI0080

Written evidence submitted by Euroclear UK and International

Euroclear UK and International Limited (EUI), part of the Euroclear Group, is the UK’s Central Securities Depository (CSD). EUI runs the CREST securities settlement system, which offers real-time ‘delivery versus payment’ settlement in central bank money (pounds sterling, US dollars and euros) to over 150 direct members—including the world’s largest banks and asset managers as well as smaller intermediaries like retail brokers. EUI offers a variety of securities servicing tools to its clients, including collateral management, corporate actions processing and transaction reporting. As a settlement system, EUI is designated as a UK Critical National Infrastructure and, with issued assets of approximately £5 trillion, EUI is a Bank of England supervised Tier 1 Financial Market Infrastructure (FMI).

EUI welcomes this inquiry on an important and multi-faceted topic. As the CSD, we take an active part in the discussion around the future of securities markets and technological innovation in this context. In our response we specifically address the matter of DLT in relation to securities settlement.

Innovative technologies hold the potential to make financial services more efficient for end-users and UK financial markets more competitive globally. DLT is one of a number of potentially transformative technologies; it should considered as a mechanism to achieve market and public policy objectives rather than as an end in itself.

Benefits and opportunities of DLT

DLT has the potential to address some ‘pain points’ in securities markets and raises the possibility of new spheres of automation. As DLT facilitates transparency and the distribution of trusted data across a broad network, it has the potential to reshape the market architecture. For this, an array of stakeholders that today operate in different technological environments (issuer, primary dealers, custodians, secondary dealers) could be brought together onto a connected network. This would allow the possibility to simplify and streamline post-trade accesses and processes. Some benefits could include:

• Removal of the reconciliation workload between intermediaries
• Facilitation of the identification of end-investors and the management of registers
• Facilitation of a reduction of the trading settlement cycle (though this could be done with present technology)
• Facilitation of more efficient cross-border settlement
• Improvements to the resilience of the financial market ecosystem

As a Group, Euroclear is investing in becoming a digital financial market infrastructure (DFMI). A number of valuable DLT proof of concept exercises have taken place, including a collaboration between Euroclear and the Banque de France to experiment with issuing, settling, and managing the lifecycle of French government bonds on DLT. We working on the delivery of a production-grade  solution for the issuance of a digital Eurobond for one of the main European issuers. Euroclear is also partnering with Fnality with the intention to provide an innovative solution for the settlement of digital securities against digital cash on DLT.

Our Group Board is following with considerable enthusiasm developments in the UK crypto asset space and EUI is in on-going dialogue with HM Treasury, its agencies, the Bank of England and the FCA across this agenda, including the FMI Sandbox and HM Treasury’s aspirations to issue a digital gilt.

Costs and complexities of technological transition

As is common with the introduction of many new technologies, and particularly in the financial sector—which operates with high expectations of operational resilience and systems that exist and co-exist over the course of decades—it can be expected that the introduction of DLT will add complexity and transition costs in certain areas. Amongst these are:

• Costs: The development and launch of DLT infrastructures - and the costs for market participants to connect to them - will be significant
• Absence of netting: With atomic settlement, DLT allows instantaneous exchange of cash and securities, without the intervention of a clearing agent and across different ledgers. While this is expected to bring benefits in terms of counterparty risks, it may necessitate a fundamental change of market practices, wherein liquidity constraints are reduced through netting. On real-time DLT platforms, the settlement of trades takes place on a gross basis.
• Fragmentation: While DLT could conceivably open new avenues for competition, there is a distinct possibility of the fragmentation of the market architecture into vertical siloes if interoperability is not facilitated through regulation and common standards. Most experimentations and projects undertaken so far have not been designed with a full interoperability in mind.
• Co-existence: Uptake of a DLT capital market applications is unlikely to occur unless DLT market infrastructures are interoperable not only between each other but also if they cannot co-exist and interoperate with the current non-DLT market infrastructures. The creation of two parallel ecosystems that cannot interoperate (one on DLT and one on the legacy system) would be the source of inefficiencies, market fragmentation and lead to a lack of liquidity, which could hinder and potentially block the development of a nascent siloed DLT based environment.
• Maturity: Although the maturity of the technology has significantly increased over the last years, further advances will be needed before it can match the resilience, efficiency and velocity of existing infrastructures.

For these reasons, any significant move of mainstream wholesale capital market activity to a DLT environment is likely to take place only over the medium- to long-term.

Policy environment and infrastructure modernisation

Euroclear is working with the Bank of England on the modernisation of the UK’s market infrastructure and inputting into the RTGS Renewal process. We look forward to contributing to the future success of London’s international financial centre as the Euroclear Group invests substantially in the CREST settlement system. Our business strategy review, agreed with the Bank earlier this year, entails well over £100 million of investment devoted to modernising the settlement system. Our multi-year technology programme aims to further refine processes and provide a 21st-century platform for the UK’s financial system.

We welcome the Bank’s new omnibus account model which will facilitate a variety of ‘synthetic’ CBDC and note the recent recognition of the Sterling Fnality Payment System by HM Treasury in this context. As these developments indicate, systemically important activities, institutions and infrastructure should continue to be accountable and supervised using a risk-based approach, with proportionate governance and operational and financial resilience requirements. Any transition to a new or parallel legislative framework and market architecture should reflect the potential impact of the changes on markets, market participants and financial stability, and appropriately consulted upon by Government and scrutinised by Parliament, including with respect to the impact on competition and UK competitiveness.

Conclusion

The UK is embarking on a period of transformation, diverging from the EU regulatory architecture and rulebook, and constructing a framework fit for the future. The Kalifa Review, the UK Listing Review, the UK Secondary Capital Raising Review and the on-going Digitisation Taskforce are all making valuable recommendations to ensure the UK’s future success as a premier global financial centre and FinTech hub. Modernising post-trade infrastructure to increase its resilience, improve its cost-effectiveness and deliver internationally competitive service provision will help enable these aspirations. To the extent the recommendations of these reviews are adopted, EUI expects DLT and other technologies to play a significant role in facilitating change and concomitant transformations of the legal framework to be required.

We look forward to working with the Treasury Select Committee and across Parliament to ensure the market architecture and FMI framework is fit for this purpose in a new era.

September 2022