Communication from the Commission to the Council and the European Parliament - Clearing and Settlement in the European Union - The way forward
Date: 2004-04-28
Institutions: European Commission
Subjects: capital market, financial transaction, stock-exchange transaction, tax system

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 28.4.2004 
COM(2004) 312 final 

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE 
EUROPEAN PARLIAMENT 

Clearing and Settlement in the European Union – The way forward 

EN 

   EN 

 
 
 
TABLE OF CONTENTS 

Introduction 

Current Situation 

1. 

2. 

3. 

4. 

The Clearing and Settlement arrangements 

The barriers identified by the Giovannini reports 

Absence of a common regulatory/supervisory framework 

Absence of a level playing field 

The Commission's Objectives 

The Commission's Practical Initiatives 

1. 

2. 

The setting up of the "Clearing and Settlement Advisory and Monitoring Group" 

A framework Directive for efficient and safe, pan-European Clearing and Settlement. 

2.1 

Rights of access and Choice 

2.2 

Common regulatory/supervisory framework 

2.3 

Governance 

3. 

Addressing legal and tax law discrepancies 

3.1 

The Legal Certainty Project 

3.2 

Taxation issues 

4. 

Competitive issues and competition policy 

Conclusions 

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INTRODUCTION 

The  creation  of  an  integrated  and  efficient  European  capital  market  is  one  of  the  most 
important and ambitious economic projects currently under way in the European Union. Since 
1999, when the Financial Services Action Plan was launched, considerable progress has been 
made towards this goal, both in terms of legislative measures and market integration.  

A  crucial  element  of  this  framework  will  be  the  safety  and  efficiency  of  the  arrangements 
required  to  finalise  securities  transactions  ("Clearing  and  Settlement").  These  arrangements, 
largely  invisible  to  the  retail  investor,  lie  at  the  core  of  all  securities  markets  and  are 
indispensable for their proper functioning.  

Although the concepts underlying these processes and mechanisms are quite straightforward, 
the mechanisms themselves are very complex to put in place and to operate, especially in a 
cross-border  context.  Purely  domestic  clearing  and  settlement  activities  in  the  EU  are 
relatively cost effective and safe. But cross-border arrangements are complex and fragmented, 
resulting  in  much  higher  costs,  risks  and  inefficiencies.  Without  efficient  clearing  and 
settlement arrangements, the ability and willingness of participants to trade in EU securities 
will be sub-optimal; the liquidity of financial markets will be affected and the cost of capital 
will be higher than it need be.  

Against this background market forces are driving the demand for far greater pan-European 
efficiency.  The  introduction  of  the  euro  and  improvements  in  information  technology  have 
contributed  to  the  increase  of  the  number  and  the  relative  importance  of  cross-border 
transactions.  As  a  result,  the  strains  on  and  the  expectations  from  cross-border  clearing  and 
settlement  arrangements  have  increased  considerably.  Clearing  and  settlement  service 
providers  are  seeking  to  enhance  performance,  reduce  costs  and  establish  a  pan-European 
presence,  on  their  own  or  through  mergers  and  alliances,  which  is  beginning  to  lead  to 
significant  restructuring.  At  the  same  time,  regulators,  supervisors  and  overseers  are  taking 
steps  in  order  to  increase  the  clarity  and  homogeneity  of  standards  applicable  to  securities 
clearing  and  settlement  systems,  to  update  their  supervisory  methods  in  order  to  meet  the 
challenges posed by market developments, and to enhance safety. 

In this Communication, the Commission outlines the actions it intends to undertake in order to 
improve Clearing and Settlement arrangements. The Commission's approach is based on the 
following considerations: 

–  the objective to be pursued is the achievement of an efficient, integrated and safe market 

for securities clearing and settlement; 

–  the  integration  of  securities  clearing  and  settlement  systems  will  require  the  combined 
intervention of market forces and public authorities. In this context, the Commission will 
seek to promote co-ordination between private sector bodies, regulators and legislators so 
as to achieve the desired outcome as efficiently as possible; 

–  in an integrated barrier-free environment, infrastructure providers and users of the relevant 
services  should  have  access  to  and  choice  of  their  preferred,  properly  authorised  and 
supervised  clearing  and  settlement  system,  operating  in  full  conformity  with  the  EU's 
competition  rules.  In  order  to  arrive  at  such  a  liberalised  environment  and  to  ensure  the 
mutual recognition of systems, regulatory intervention at an EU level, through the adoption 
of a framework Directive, will be necessary; 

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–  in exercising its powers, the Commission will respect the subsidiarity and proportionality 
principles enshrined in the EU Treaty as well as the diversity of approaches in the different 
Member States as regards market structures. 

–  the legal underpinnings of clearing and settlement in the EU should be clear, reliable and 

coherent. 

–  further consolidation in clearing and settlement in the EU should mainly be market-driven, 

to the extent that legitimate public policy concerns are met. 

The Commission invites comments on all aspects of this Communication from the European 
Parliament,  the  Council,  the  European  Central  Bank,  the  European  Economic  and  Social 
Committee,  the  Committee  of  the  Regions,  national  regulatory  and  supervisory  authorities, 
other  EU  level  and  national  organisations  and  federations,  market  practitioners,  institutional 
investors, infrastructure providers and all other interested parties by the 30th of July 2004. 

It will then finalise its decisions during 2005 as to the course of action it will adopt and the 
exact contents of any measures that may prove necessary. 

CURRENT SITUATION 

1. 

The Clearing and Settlement arrangements 

In this Communication the term “Clearing and Settlement” is intended to describe the full set 
of  arrangements  required  to  finalise  a  securities  or  derivatives  transaction1.  These 
arrangements  encompass  a  broad  collection  of  institutions,  instruments,  rules,  procedures, 
standards and technical means.  

The  performance  of  clearing  and  settlement  functions  has  been  entrusted  mainly  to 
institutions  such  as  Central  Securities  Depositories  and  Central  Counterparties.  The  former 
mainly perform functions relating to settlement and custody, while the latter typically perform 
functions relating to clearing. Central Securities Depositories and Central Counterparties do 
not usually deal with retail investors. Access to these institutions is offered by other entities – 
namely,  Custodians  and  Clearing  Members  –  which  act  as  Intermediaries  for  clearing  and 
settlement  activities.  However,  certain  Intermediaries  may  not  wish  to  access  directly  these 
institutions;  they  use  other  Intermediaries  instead.  As  a  result,  a  multi-tier  intermediary 
structure is possible.  

In  a  nutshell,  the  full  set  of  institutional  arrangements  required  to  finalise  a  securities 
transaction can be defined as a Securities Clearing and Settlement System. Within this broad 
framework,  we  can  further  distinguish  among  Securities  Settlement  Systems,  Central 
Counterparties,  Custodians  and  Clearing  members.  Securities  Settlement  Systems  can  be 
considered to include all institutions performing the Pre-settlement, Settlement and Custody 
functions;  Central  Counterparties  can  be  defined  as  institutions  performing  the  Clearing 
function. In this Communication the Clearing function is defined as the activities that have as 
effect to guarantee from the potential losses arising in the event of default of a counterparty to 
a trade (“replacement cost risk”). Custodians provide Intermediary services in the Settlement 
activity, while Clearing Members provide Intermediary services in the Clearing activity. 

1 

Unless  otherwise  specified,  the  term  "transaction(s)"  will  be  deemed  to  include  both  securities  and 
derivatives transactions. 

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Traditionally, clearing has mainly referred to the process of calculating the mutual obligations 
for  the  exchange  of  securities  and  money,  on  a  gross  or  net  basis,  prior  to  settlement.  This 
process  may  also  include  netting  with  novation  which  has  as  an  effect  to  guarantee 
counterparties from replacement cost risk. As the risk profile for these activities is different, 
in this Communication, the former activities (i.e. the mere process of calculating the mutual 
obligations) are considered as part of Pre-settlement, while the latter activities (i.e. those that 
have as effect to guarantee counterparties from replacement cost risk) are defined as Clearing. 
Settlement, on the other hand, is considered as including the final transfer of securities from 
the seller to the buyer and of funds from the buyer to the seller. 

Cross-border transactions can be settled through the following channels: 

1) 

2) 

3) 

direct remote access to the foreign Securities Settlement System; 

use  of  a  custodian  having  direct  or  indirect  access  –  typically  through  a  local 
participant – to the foreign Securities Settlement System; 

use, as an Intermediary, of a Central Securities Depository or an International Central 
Securities  Depository2  that  has  direct  or  indirect  access  to  the  foreign  Securities 
Settlement System. 

In a cross-border context, Securities Settlement Systems may offer direct services to remote 
participants  in  relation  to  securities  for  which  they  represent  the  final  point  of  settlement 
(option  1  above).  As  already  mentioned,  custodians  typically  act  as  Intermediaries  for 
settlement activities. They act in this capacity with respect to cross-border settlement as well 
(option 2 above). Securities Settlement Systems may also act in an Intermediary capacity, i.e. 
as  Investor–Securities  Settlement  Systems,  in  relation  to  securities  kept  in  final  custody  in 
another  Securities  Settlement  System,  named  Issuer–Securities  Settlement  System  (option  3 
above). 

In the provision of cross-border settlement services, therefore, Securities Settlement Systems, 
acting  in  their  Intermediary  capacity,  and  the  custodians  are,  at  least  potentially,  in 
competition  with  each  other.  The  possibility  for  the  Issuer–Securities  Settlement  System  to 
offer  direct  remote  access  means  that  it  can  also,  at  least  potentially,  compete  with  the 
Investor–Securities  Settlement  Systems  and  the  custodians  in  the  provision  of  cross-border 
settlement services3. 

Current  arrangements  for  the  finalisation  of  transactions  in  the  EU  are  generally  considered 
efficient at a national level, but very inefficient at a cross-border level. Securities Clearing and 
Settlement  Systems  in  the  EU  have  historically  developed  on  a  purely  domestic  basis,  as 
cross-border trading activity has, in the past, been very limited. Given the large economies of 
scale  and  scope  that  characterise  Securities  Settlement  Systems  and  Central  Counterparties, 
domestic  systems  have  experienced  a  process  of  consolidation  leading  to  the  creation  of 

2 

3 

International Central Securities Depositories are Securities Settlement Systems for Eurobonds. The only 
two  examples  of  International  Central  Securities  Depositories  are  Euroclear  Bank  and  Clearstream 
Banking Luxembourg. 
The  same  is  also  true  for  clearing  through  a  Central  Counterparty.  Cross-border  clearing  can  be 
performed  either  on  a  remote  access  basis  or  through  the  services  of  a  general  clearing  member  or 
through  the  services  of  a  different  Central  Counterparty.  In  the  latter  case,  the  foreign  Central 
Counterparty  will  treat  the  "Investor-CCP"  as  a  participant  requesting  margins  commensurate  to  the 
latter's positions. 

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domestic monopolies or quasi-monopolies operating under uniform technical, regulatory and 
legal frameworks. 

The inefficiencies of cross-border arrangements in the EU are due to a lack of global technical 
standards,  the  existence  of  differing  business  practices  and  inconsistent  fiscal,  legal  and 
regulatory underpinnings. As a result, cross-border Clearing and Settlement in the EU is much 
more  costly  and  complex  than  at  purely  domestic  level  and,  potentially,  less  safe.  This 
fragmented market structure is no longer acceptable at a time when investment strategies are 
increasingly  based  on  pan-European,  sector-based  considerations  and  a  single  EU  financial 
market is being created. 

The European Parliament’s Resolution of January 20034 underlined that the existing clearing 
and  settlement  arrangements  do  not  enable  cross-border  transactions  to  be  processed 
efficiently  and,  in  consequence,  it  is  impossible  to  exploit  to  the  full  an  internal  market  in 
financial services. The Parliament noted that the existing state of the market makes it essential 
for a proposal for a directive to be drawn up. The Parliament suggested that the exercise of 
risk by CSDs should be limited to operational risk and that provision of value added services 
by  CSDs  should  be  subject  to  functional  separation.  It  also  called  upon  the  Commission  to 
study  thoroughly  the  US  example  of  a  unified  clearing,  settlement  and  custody  framework. 
The  Commission  invites  any  comments  which  interested  parties  might  wish  to  make  in  the 
light of the EP’s request for this issue to be given further study. 

2. 

The barriers identified by the Giovannini reports  

The nature of the problems in this area has been the focus of much attention recently. Among 
other reports on this subject, the two reports of the Giovannini Group identified 15 barriers, 
divided into technical or market practice barriers, barriers related to tax procedures and legal 
barriers ("the Giovannini Barriers")5, as the main causes of fragmentation and inefficiencies. 
The reports concluded that until these barriers are eliminated, the EU clearing and settlement 
environment will remain a juxtaposition of domestic, non-integrated markets.6  

While all the Giovannini Barriers constitute an impediment to the integration of EU securities 
clearing and settlement systems, they have different effects on the way cross-border clearing 
and settlement is achieved. The reports acknowledge that one of the most important barriers to 
integration  relates  to  the  restrictions  on  the  location  of  clearing  and  settlement.  Such 
restrictions  do  not  allow  market  participants  free  access  to,  and  choice  of,  clearing  and 
settlement locations and so they remove an essential condition for increased competition and 
efficiency in the provision of cross-border services. 

4 

5 

6 

European  Parliament  resolution  on  the  communication  from  the  Commission  to  the  Council  and  the 
European Parliament entitled “Clearing and settlement in the European Union: main policy issues and 
future challenges”. 
See  annex  1  for  the  list  of  barriers  identified  in  the  Giovannini  reports.  The  full  text  of  the  two 
Giovannini reports are available on the Commission's website and are therefore not discussed in detail 
in this Communication. 
The relevance of the barriers identified by the Giovannini Group, along with the absence of a common 
regulatory/supervisory framework for and of a level playing field in Securities Clearing and Settlement 
Systems (see below), were considered in the first Commission Communication on Clearing and 
Settlement, “Clearing and settlement in the European Union – Main policy issues and future 
challenges”, COM(2002)257, 28.5.2002, available at 
http://europa.eu.int/comm/internal_market/en/finances/mobil/clearing/index.htm. 

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However, even if the obstacles as to the location of clearing and settlement were lifted, other 
barriers  identified  by  the  Giovannini  group  would  still  restrict  the  effective  exercise  of  the 
relevant  rights  of  access  and  choice.  For  instance,  some  of  these  barriers  make  it  more 
attractive or even impose the use of local participants to access foreign Securities Settlement 
Systems.  This  is  the  case  for  all  actions  the  performance  of  which  requires  specialised 
knowledge or local expertise (e.g. national differences as regards the treatment of interests in 
securities  held  with  an  intermediary,  corporate  actions,  securities  issuance  practices,  etc)  or 
when  local  participation  is  actually  imposed  (e.g.,  by  Member  States'  rules  that  give 
withholding tax responsibilities exclusively to local intermediaries). These barriers effectively 
prevent  the  use  by  foreign  investors  or  intermediaries,  of  cross-border  settlement  channels 
other than through local participation. 

Another  category  of  barriers  constitute  an  effective  impediment  to  the  use  of  Securities 
Settlement Systems as intermediaries in cross-border settlement. An example of this type of 
barriers would be the collection of transaction taxes only via a functionality integrated into the 
local  Securities  Settlement  System;  using  a  different  system  could  mean  paying  higher 
transaction taxes. As a consequence, market participants may, because of cost concerns, not 
use their preferred settlement location. 

Other  barriers  are  a  source  of  additional  costs  and/or  risks  when  compared  to  domestic 
Clearing  and  Settlement  (e.g.  differences  in  information  technology  and  interfaces,  etc). 
Eliminating  such  barriers  will  reduce  the  overall  cost  and  risk  differences  between  cross-
border and domestic clearing and settlement. 

3. 

Absence of a common regulatory/supervisory framework 

Another  important  element  characterising  the  European  Securities  Clearing  and  Settlement 
Systems  is  the  absence  of  an  agreed  common  regulatory/supervisory  framework.  Public 
authorities  have  responsibilities  concerning  the  safety  of  Securities  and  Clearing  Settlement 
Systems,  both  from  the  point  of  view  of  investor  protection  and  systemic  stability.  When 
systems  operate  cross-border,  national  authorities  need  also  to  be  satisfied  that  all  linked 
foreign systems are properly regulated and supervised.  

In the absence of a common regulatory framework, regulators may deny access to, or oppose 
the  use  of,  foreign  systems  in  order  to  maintain  the  smooth  operation  of  markets  and  to 
guarantee financial stability.  

In  response  to  these  concerns,  the  European  System  of  Central  Banks  (ESCB)  and  the 
Committee of European Securities Regulators (CESR) have launched a joint working group, 
the  ESCB/CESR  Working  Group,  to  develop  common  standards  for  entities  providing 
clearing and settlement services in the EU. Their work is based on an adaptation of the CPSS-
IOSCO7  Recommendations8  to  the  European  context.  ESCB  and  CESR  published  for 
consultation  their  draft  standards  in  July  20039.  The  standards  will  not  be  mandatory;  they 
will  not  therefore  supercede  any  national  legal  provision  that  may  affect  their  practical 
implementation by the competent national authorities.  

7 

8 

9 

Committee  on  Payment  and  Settlement  Systems  of  the  G10  central  banks  and  International 
Organisation of Securities Commissions. 
Recommendations  for  Securities  Settlement  Systems,  Report  of  the  CPSS-IOSCO  Task  Force  on 
Securities Settlement Systems, November 2001. 
"Consultative Report: Standards for Security Clearing and Settlement Systems in the European Union", 
July 2003. 

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4. 

Absence of a level playing field 

The  absence  of  an  appropriate  legislative  framework  in  the  EU  on  Securities  and  Clearing 
Settlement  Systems  along  with  the  fact  that  certain  institutions  providing  clearing  and 
settlement services are licensed as banks/investment firms raises two major level playing field 
issues. 

While banks and investment firms can offer custody and settlement services on a cross-border 
basis based on their ISD passport, no corresponding right is provided for providers of clearing 
and settlement services which are not banks or investment firms. 

In  the  same  vein,  differences  exist  as  to  the  capital  adequacy  requirements  applying  to 
providers of clearing and settlement services. In particular, differences exist between entities 
licensed as banks, on one hand, and those that are not, on the other. Moreover, because of the 
lack  of  harmonisation  in  this  field,  differences  also  exist  among  those  entities  providing 
clearing and settlement services that are not licensed as banks.  

In  addition,  while  there  may  be  entities  licensed  as  banks  that  can  offer  intermediary  and 
banking services as well as core infrastructure custody and settlement services, the same set of 
rights may not be available to custodians in some Member States. 

THE COMMISSION OBJECTIVES 

The  Commission's  overarching  objective  is  the  creation  of  EU  Securities  Clearing  and 
Settlement Systems that are efficient and safe and which ensure a level playing field among 
the different providers of Clearing and Settlement services. In order to achieve this objective, 
the Commission considers that the following measures and policies need to be pursued: 

(a) 

(b) 

(c) 

the  liberalisation  and  integration  of  existing  Securities  Clearing  and  Settlement 
Systems through the introduction of comprehensive access rights at all levels and the 
removal of existing barriers to cross-border clearing and settlement; 

the  continued  application  of  competition  policy  to  address  restrictive  market 
practices and to monitor further industry consolidation; 

the  adoption  of  a  common  regulatory  and  supervisory  framework  that  ensures 
financial  stability  and  investor  protection,  leading  to  the  mutual  recognition  of 
systems; 

(d) 

the implementation of appropriate governance arrangements. 

Liberalised and integrated securities clearing and settlement systems in the EU will require 
that  all  different  options  for  cross-border  clearing  and  settlement  are  available  to  markets, 
Clearing and Settlement service providers and investors. It is only when they enjoy full choice 
on how to clear and settle cross-border transactions that competition will be fully at work and 
able to generate positive effects in terms of price reduction and economic efficiency. 

For such choice to be fully available, systems must be able to have access to each other. The 
Commission  considers  therefore  that  a  fundamental  step  in  achieving  a  liberalised  and 
integrated  market  for  clearing  and  settlement  in  the  EU  is  to  grant  comprehensive  rights  of 
choice  and  access  to  all  providers  of  Clearing  and  Settlement  services,  including  Central 
Counterparties  and  Securities  Settlement  Systems.  This  is  not  the  case  today,  nor  will  it  be 

8 

 
 
  
 
with the adoption of the new ISD, due to remaining national and commercial restrictions to 
the clearing and settlement location. 

The introduction of comprehensive rights of access and choice will, however, not be effective 
or  sufficient  without  the  removal  of  all  the  remaining  barriers  identified  in  the  Giovannini 
reports.  The  removal  of  the  technical  or  market  practice  barriers,  the  barriers  related  to  tax 
procedures  and  the  legal  barriers  is  a  necessary  element  for  achieving  the  integration  of 
clearing  and  settlement  in  the  EU.  For  this  reason,  the  Commission  endorses  the  general 
approach  taken  in  the  two  Giovannini  reports.  The  Commission  is  also  in  favour  of  the 
specific  suggestion  of  the  Giovannini  group  that  the  removal  of  barriers  should  be  effected 
through the combined efforts of the private and public sectors and according to an appropriate 
sequence. 

Another important barrier to cross-border clearing and settlement that needs to be addressed 
by  public  authorities  relates  to  the  settlement  of  the  cash  leg  of  securities  transactions. 
Currently, remote participants in the Euro-system national central banks do not have access to 
the  intra-day  credit  facilities  provided  by  those  central  banks  to  domestic  participants.  This 
does not constitute a problem to securities settlement during TARGET10 operating hours, as 
TARGET  participants  can  easily  move  funds  from  one  account  to  another.  However,  it 
becomes  a  problem  outside  TARGET  operating  hours,  particularly  in  those  cases  in  which 
Securities Settlement Systems operate overnight settlement processes. 

The  Commission  considers  that,  generally  speaking,  the  cross-border  settlement  of  the  cash 
leg of securities transactions should be made as easy as is compatible with the objectives of 
the  Euro-system  and  the  other  EU  central  banks,  e.g.  by  making  it  possible  for  banks  to 
centralise liquidity in one central bank account  and then transfer the funds during securities 
settlement  systems  operating  hours  or,  alternatively  to  use  one  single  account,  as  will  be 
possible  with  the  envisaged  enhanced  release  of  TARGET  (TARGET  211),  to  support  their 
settlement activity in the EU12. 

Although  the  liberalisation  and  integration  of  markets  are  essential  elements  of  the  whole 
process,  they  will  not  be  sufficient  to  ensure  efficient  securities  clearing  and  settlement 
systems  in  Europe.  The  competent  authorities  would  also  need  to  ensure  the  full  respect  of 
competition  law  by  Clearing  and  Settlement  service  providers.  Integration  of  existing 
Securities  and  Clearing  Settlement  Systems  has  the  potential  to  increase  efficiency;  this 
potential  should  not  be  hindered  by  the  adoption  by  Securities  Clearing  and  Settlement 
Systems  of  anti-competitive  practices,  such  as  unfair  denial  of  access  or  the  imposition  of 
excessive and/or discriminatory prices. 

In  addition  to  the  actions  mentioned  above,  the  Commission  considers  that  a  common 
regulatory and supervisory framework needs to be introduced in the EU. Such a framework 
will enhance the safety of Securities and Clearing Settlement Systems and permit their mutual 
recognition. In fact, the safe functioning of all post-trade arrangements is vital to the safety of 
the  financial  markets  and  the  stability  of  the  financial  system  as  a  whole.  Participants  in 

10 
11 

12 

TARGET is the European network of Real Time Gross Settlement payment systems. 
ECB, "TARGET 2: Principles and Structure", 16 December 2002. TARGET 2 offers the possibility to 
consolidate  the  technical platforms  of  the national  systems  "to  those  central  banks which… decide  to 
give up their individual platforms". Such consolidation will no doubt facilitate cross-border settlement. 
The  CESR/ESCB  consultative  report  addresses  a  similar  recommendation  to  central  banks  inviting 
them  ''to  enhance  the  mechanism  for  the  provision  of  central  bank  money  by,  e.g.,  extending  the 
operating hours of the cash transfer system and by facilitating access to central bank cash accounts.'' 

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Securities  Clearing  and  Settlement  Systems  are  confronted  with  a  variety  of  risks13.  If  one 
participant's  failure  to  settle  renders  other  participants  unable  to  meet  their  obligations,  a 
Securities  Clearing  and  Settlement  System  could  become  a  major  source  of  financial 
instability. 

As  Securities  Clearing  and  Settlement  Systems  hold  the  assets  that  are  used  to  secure 
payments  in  large-value  payment  systems  and  as  collateral  in  monetary  policy  operations, 
their  safety  and  efficiency  is  also  of  the  utmost  importance  for  the  efficiency  of  payment 
systems and monetary policy. 

It  is  also  necessary  that  securities  transactions  are  finalised  speedily  and  efficiently  in 
accordance  with  the  terms  of  the  trade.  If  investors  perceive  a  Securities  Clearing  and 
Settlement Systems as unsafe, they will not be willing to enter into financial transactions that 
are  cleared  and  settled  in  that  Securities  Clearing  and  Settlement  Systems.  In  such  a  case, 
there will be a direct impact on financial market liquidity and indirectly on the cost of capital. 

For these reasons, under the present regulatory framework regulators can deny access to, or 
oppose the use of, foreign systems if they are not confident that the smooth operation of the 
markets  for  which  they  are  responsible  can  be  maintained  and  the  overall  financial  stability 
guaranteed. 

The  Commission  considers  that  this  concern  should  be  addressed  and  that  the  liberalisation 
and  integration  of  Securities  Clearing  and  Settlement  Systems  should  be  coupled  with  a 
common regulatory and supervisory framework system, which will increase the safety of the 
overall  clearing  and  settlement  environment  in  the  EU  while  also  leading  to  the  mutual 
recognition of systems.  

The  adoption  of  measures  intended  to  liberalise  access  and  to  establish  a  common 
regulatory/supervisory  framework  will  also  create  a  level  playing  field  by  eliminating  the 
existing  disparities  as  regards  access  rights  and  capital  requirements  between  clearing  and 
settlement service providers that are licensed as banks and those that are not. In fact, the same 
activities should be subject to the same treatment (the "functional approach") regardless of the 
institutions that perform them. This approach implies the adoption of common definitions for 
the activities involved in the Clearing and Settlement process. It does not however imply the 
segregation of functions at this stage. Nonetheless, parties are invited to comment on such an 
approach  in  the  light  of  arrangements  which  exist  in  some  European  domestic  markets  and 
which differentiate between infrastructure and banking functions. 

Some of the public authorities' concerns regarding the safety of Securities Settlement Systems 
and  Central  Counterparties  and  their  possible  adoption  of  anti-competitive  practices  can  be 
also  addressed  ex-ante  through  reliance  on  effective  governance  arrangements.  Such 
mechanisms must be considered as complementary to the policies mentioned above, namely 
competition policy and effective regulation and supervision. 

The Commission's policy regarding clearing and settlement will therefore focuses on (a) the 
liberalisation and integration of existing Securities Clearing and Settlement Systems, (b) the 
application  of  competition  policy,  (c)  the  adoption  of  a  common  regulatory  and 

13 

Such risks include liquidity risk, credit risk, custody risk, operational risk and legal risk. See the CPSS-
IOSCO Recommendations for a thorough discussion of these issues. 

10 

 
 
  
 
                                                 
supervisory  framework  including  the  question  of  definitions,  and  (d)  the  adoption  of 
appropriate governance arrangements. 

* * * 

Once  all  required  measures  have  been  adopted,  consolidation  among  Securities  Settlement 
Systems  and  Central  Counterparties  is  expected  to  accelerate.  The  Commission  agrees  with 
the  conclusions  of  both  the  Lamfalussy  and  Giovannini  reports  that  the  process  of 
consolidation needs to be market-led.  

The  Commission  considers  that,  as  long  as  the  appropriate  regulatory/supervisory  and 
competition policy safeguards are established, it should be neutral as regards such structural 
issues as (a) the degree and form of consolidation (either horizontal or vertical), and (b) the 
opportunity  for  Securities  Settlement  Systems  and  Central  Counterparties 
to  offer 
Intermediary  and/or  Banking  services.  Provided  these  safeguards  are  established,  the 
Commission will refrain from proposing or imposing any specific market and/or institutional 
structure; it will also refrain from proposing or imposing any segregation of the Intermediary 
and  Banking  activities  eventually  offered  by  Securities  Settlement  Systems  or  Central 
Counterparties.  Market  forces  will  determine  the  "final"  structure  of  the  Clearing  and 
Settlement industry. Markets, not the regulators, are best placed to decide on the structure of 
the  industry  and  on  the  combination  of  consolidation  and  integration  that  best  meets  their 
needs. 

The  general  aim  of  the  authorities  should  be  to  facilitate  this  process,  encouraging  market 
forces  whilst  ensuring  that  public  policy  objectives  are  addressed.  Such  public  policy 
objectives  will  have  to  be  addressed  through  the  envisaged  common  regulatory  and 
supervisory framework, through the full respect and implementation of existing national and 
community competition law provisions and finally through the implementation of appropriate 
governance arrangements. 

THE COMMISSION'S PRACTICAL INITIATIVES 

Achieving the objective set out above – that is, the creation of efficient and safe EU Securities 
Clearing  and  Settlement  Systems  which  ensure  a  level  playing  field  among  the  different 
providers  of  Clearing  and  Settlement  services  –  will  be  a  lengthy  and  complex  process  and 
require  the  combined  efforts  of  market  infrastructures,  market  participants,  regulators  and 
legislators. The Commission considers that it will need to play a major role in providing the 
necessary  political  impetus,  in  co-ordinating  actions  and  in  proposing  specific  legislative 
measures in order to establish the necessary legislative framework.  

On the basis of the above, the Commission intends to:  

(a) 

(b) 

Set  up  an  Advisory  and  Monitoring  group:  The  Commission  intends  to  set  up  an 
advisory  and  monitoring  group  in  order  to tackle  all  Giovannini Barriers  for which 
the  private  sector  has  sole  or  joint  responsibility,  and  to  promote  the  overall 
integration and liberalisation project.  

Propose  a  Directive  on  Clearing  and  Settlement:  The  Commission  considers  it 
necessary to complement the market-led removal of the relevant Giovannini barriers 
with  a  secure  legal  framework  ensuring  the  freedom  to  provide  securities  clearing 
and  settlement  services  throughout  the  EU  on  the  basis  of  common  requirements. 
Such a framework will ensure that restrictions and barriers as regards the location of 

11 

 
 
  
 
(c) 

(d) 

clearing  and  settlement  are  lifted.  It  will  also  ensure  the  mutual  recognition  of  the 
various national systems based on the home country principle. The Directive should 
be  a  framework  Directive,  in  that  it  should  only  set  out  general  principles  in 
conformity with the Lamfalussy process. 

Address  legal  and  tax  issues:  The  Commission  intends  to  set  up  expert  groups  to 
consider the legal and tax-related barriers to integration, to evaluate the situation and, 
if needed, suggest methods of harmonisation of national law and/or procedures. 

Ensure  the  effective  implementation  of  competition  law:  The  Commission  and 
national competition authorities will address anti-competitive market practices, such 
as  unfair  denial  of  access  and  the  imposition  of  excessive  and/or  discriminatory 
pricing,  and  at  the  same  time  monitor  existing  monopoly  positions  and  further 
industry consolidation intervening when necessary. 

The setting up of the Advisory and Monitoring group and the expert groups on legal and tax 
issues is to be considered as a priority action. 

1. 

The setting up of the "Clearing and Settlement Advisory and Monitoring Group" 

Among  the  measures  and  policies  to  be  pursued  in  order  to  achieve  the  Commission’s 
objectives, the  integration  of existing  Securities Clearing and Settlement Systems is the one 
that  requires  more  coordination  between  private  and  public  sector  bodies.  In  order  to 
overcome  barriers  to  integration,  action  by  such  bodies  will  be  called  for  and  the  relevant 
synergies will need to be established.  

The launching of these private and public sector-led actions will have important repercussions 
on  the  way  clearing  and  settlement  functions  are  performed  throughout  the  EU.  Processes, 
policies  and  attitudes  will  have  to  change  as  a  result.  The  Commission  is  also  aware  that 
market participants' interests may not coincide, depending on their functions and the services 
they provide. For some of  them, participation in an open and integrated market will require 
substantial  investments  while  for  others  the  risk  of  losing  particular  areas  of  business  to 
competition  will  be  important.  This  may  cause  delays  and  frictions  in  the  adoption  and 
acceptance of measures tackling the different barriers.  

For  these  reasons,  all  bodies  concerned  by  this  process  must  be  convinced  of  the  need  for 
particular action. Strong political leadership is required. In addition, monitoring of the results 
of the whole process is needed to ensure that the efforts will be sustained and that the general 
purpose and direction of the process will not be diverted.  

In order to obtain the required results, the Commission favours the setting up of an informal 
advisory  and  monitoring  group.  This  proposal  echoes  recommendations  made  by  the 
Giovannini group of experts, which considered that the establishment of a co-ordination and 
monitoring mechanism would be advisable for the success of the whole operation. 

In particular, it is envisaged that this group will, together with the Commission: 

(a) 

(b) 

promote  the  overall  project  and  provide  the  public  with  all  necessary  explanations 
and reports of the state of reform, ensuring transparency at all times; 

operate as a forum for both public and private sector bodies with a view to ensuring 
their confidence that progress is being made; 

12 

 
 
  
 
(c) 

(d) 

(e) 

liaise  with  the  groups  of  experts  that  will  tackle  the  legal  barriers  and  the  barriers 
related to tax procedures (see section 3). 

informally assist the Commission; 

interface between the private and public sector bodies involved in the process with 
the aim of: 

•  defining interdependencies among the different barriers; 

•  coordinating  detailed  action  plans  and  ensuring  the  consistency  of  the  overall 

implementation process; 

•  monitoring progress and sequencing of actions; 

(f) 

liaise with the Group of 30 and other international bodies to ensure the consistency 
of initiatives in the EU with those developed at international level. 

This "Clearing and Settlement Advisory and Monitoring Group" should be composed of high 
level  representatives  of  various  private  and  public  bodies  involved  in  this  project,  including 
the ESCB and CESR.  

The Group will be chaired by the Commission. It is expected that the Group will meet at least 
twice  a  year  and  that  it  will  also  appoint  specialised  subgroups  responsible  for  particular 
aspects of the process. 

A  Framework  Directive  for  efficient  and  safe  pan-European  Clearing  and 

2. 
Settlement 

The removal of  technical  and  market  practice barriers for which the private sector has been 
attributed  some  responsibility  is  a  necessary  but  not  sufficient  condition  for  achieving  a 
liberalised,  integrated  and  competitive  post-trading  market  in  the  EU.  The  Commission 
considers that meeting this objective will require the adoption of a framework Directive which 
will address the following issues: 

•  comprehensive rights of access and choice; 

•  common regulatory framework; 

•  appropriate governance arrangements. 

2.1 

Rights of access and choice 

The  achievement  of  an  integrated  Securities  Clearing  and  Settlement  System  will  largely 
depend on Clearing and Settlement service providers' enjoying effective freedom of access to, 
and choice of, their preferred clearing and settlement location on non-discriminatory terms. It 
is clear from the responses the Commission received to its first Communication that certain 
access and choice restrictions still remain today. In many cases, these stem from national law 
provisions or their interpretation. Examples of these are laws that require that stock exchange 
transactions  be  settled  in  an  affiliated  system  and  laws  that  give  special  privileges  to  local 
banks  for  the  settlement  and  servicing  of  securities  portfolio.  The  most  efficient  way  to 
remove these or similar direct or indirect restrictions, incorporated in a multitude of national 
legal  instruments,  is  likely  to  be  the  adoption  of  a  framework  Directive,  introducing 

13 

 
 
  
 
comprehensive  rights  of  access  and  choice  and  the  conditions  for  their  exercise.  The 
alternative, namely to rely on voluntary action by the national legislators or regulators, would 
be much less certain and might not guarantee EU-wide liberalisation for a long period of time.  

Although  the  EU  has  begun  to  tackle  this  issue  through  Community  legislation,  more  will 
need to be done in order to create a truly liberalised and integrated cross-border post-trading 
environment.  The  current  Investment  Services  Directive  (ISD)14  provides  that  authorised 
firms,  namely  investment  firms  and  banks,  have  the  right  of  direct  or  indirect  access  to 
clearing and settlement facilities provided for to members of regulated markets throughout the 
EU. Under that rule, authorised firms with remote access to regulated markets must also be 
allowed access to the clearing and settlement systems of that market under conditions that are 
non-discriminatory when compared to the access conditions granted to local participants. 

The new ISD15 extends this right, in the sense that authorised firms may now directly access 
clearing and settlement systems in another Member State even when they are not members of 
a regulated market or a Multilateral Trading Facility in that Member State. The new ISD also 
grants elements of choice to both markets and authorised firms in routing trades for clearing 
or settlement. Thus the proposal grants to: 

a) 

b) 

c) 

authorised  firms:  the  right  to  access  Central  Counterparties  and  Securities 
Settlement Systems located in other Member States; 

authorised  firms:  the  right  to  choose  the  settlement  location  of  their  transactions, 
provided that: 

– 

– 

the necessary links are in place for their system of choice to be used; 

there is agreement by the regulated market authority that the system of choice 
allows for the smooth and orderly functioning of financial markets. 

regulated  markets:  the  right  to  make  use  of  the  services  of  Central  Counterparties 
established  in  another  Member  State  for  some  or  all  transactions;  however,  the 
competent authority of that regulated market has a right of opposition when the use 
of a foreign Central Counterparty demonstrably endangers the orderly functioning of 
the regulated market16. 

The access rights granted under the new ISD are not comprehensive and, therefore, they do 
not  allow  for  the  integration  of  systems  at  all  levels.  They  only  apply  to  authorised  firms; 
Central Counterparties and Securities Settlement Systems do not have a corresponding right 

14 
15 

16 

Directive 93/22 of 10 May 1993, OJCE1993 L141/27 
Directive of the European Parliament and of the Council on markets in financial instruments, markets, 
amending  Council  Directives  85/611/EEC  and  93/6/EEC  and  Directive  2000/12/EC  of  the  European 
Parliament  and  of  the  Council  and  repealing  Council  Directive  93/22/EEC  of  7  April  2004.  The 
Directive provides in its Article 34 that “Member States shall require that investment firms from other 
Member States have the right of access to central counterparty, clearing and settlement systems in their 
territory  for  the  purposes  of  finalising  or  arranging  the  finalisation  of  transactions  in  financial 
instruments.  Member  States  shall  require  that  access  of  those  investment  firms  to  such  facilities  be 
subject  to  the  same  non-discriminatory,  transparent  and  objective  criteria  as  apply  to  local 
participants. Member States shall not restrict the use of those facilities to the clearing and settlement of 
transactions in financial instruments undertaken on a regulated market or MTF in their territory 
The  new  ISD  proposal  clearly  recognises  public  authorities'  concerns  relating  to  the  use  of  foreign 
systems when they do not operate on the basis of a common regulatory framework. 

14 

 
 
  
 
                                                 
to  become  members  of  other  systems.  This  limits  authorised  firms'  ability  to  exercise  their 
corresponding right to choose the settlement location. 

The  right  to  choose  the  settlement  location,  granted  under  the  new  ISD,  is  intended  to 
eliminate  the  need  for  authorised  firms  to  maintain  multiple  memberships  in  Securities 
Settlement Systems. Such a right will enable them to decide where to settle transactions and 
hold  securities  on  the  basis  of  their  own  business  needs.  They  may  therefore  choose  to 
centralise holdings in a single system or combination of systems, selecting freely on the basis 
of  cost,  efficiency,  access  to  funding,  level  of  service  or  other  considerations  important  to 
them. This reduces complexity and allows for much more efficient management of collateral. 

However,  authorised  firms  will  not  be  able  to  exercise  their  right  of  choice  unless  the 
preferred  settlement  location  has  access  to  the  "Issuer-Securities  Settlement  System". 
Therefore,  Securities  Settlement  Systems  should  have  the  right  of  access  to  Securities 
Settlement  Systems  located  in  other  Member  States.  Moreover,  the  right  to  choose  as 
provided  for  in  the  new  ISD  does  not  include  Clearing.  The  Commission  considers  that 
authorised firms should be given the option of choosing not only the settlement location, but 
also the clearing location. By choosing the settlement location, market participants would be 
able  to  settle  cross-border  through  the  Securities  Settlement  System  of  their  choice.  In  the 
same way, by choosing the clearing location, market participants would be able to clear cross-
border  in  the  Central  Counterparty  of  their  choice.  For  the  right  to  choose  the  clearing 
location  to  be  effective,  Central  Counterparties  must  have  the  right  to  access  to  Central 
Counterparties located in other Member States.  

Central  Counterparties  typically  interpose  themselves  between  the  counterparties  to  trades, 
acting as the buyer to every seller and the seller to every buyer ("novation"); in order to be 
able to settle the novated transactions, Central Counterparties must also have direct or indirect 
access  to  the  Securities  Settlement  Systems  where  transactions  are  ultimately  settled  and 
securities  held.  Consequently,  Central  Counterparties  must  also  have  the  right  of  access  to 
Securities Settlement Systems located in other Member States. 

Providing access rights to Central Counterparties and Securities Settlement Systems not only 
makes authorised firms' rights of choice effective, it also ensures a level playing field among 
clearing and settlement service providers. 

The  right  to  make  use  of  the  services  of  Central  Counterparties  established  in  another 
Member  State,  granted  to  regulated  markets  under  the  new  ISD,  aims  at  increasing 
competition in the provision of clearing services in the EU. 

The  right  of  choice  granted  to  regulated  markets  is  not  comprehensive  in  that  regulated 
markets should also have the right to choose the services of a Securities Settlement Systems 
located  in  other  Member  States,  along  with  the  right  to  choose  the  services  of  a  foreign 
Central Counterparties. Moreover, the same rights should be extended to Multilateral Trading 
Facilities17. 

The  Commission  considers  therefore  that  the  framework  Directive  on  Clearing  and 
Settlement, combined with the new ISD Directive, should "together" provide for the following 
set of rights of access and choice: 

17 

The political agreement reached by the Council on October 7th 2003 on the draft new ISD overcomes 
both  limitations  by  granting  to  both  regulated  markets  and  Multilateral  Trading  Facilities  the  right  to 
choose the services of foreign Central Counterparties and Securities Settlement Systems.  

15 

 
 
  
 
                                                 
•  investment firms and banks: the right to access Securities Clearing and Settlement Systems 

located in other Member States; 

•  Central  Counterparties:  the  right  of  access  to  Central  Counterparties  and  Securities 

Settlement Systems located in other Member States; 

•  Securities Settlement Systems: the right of access to Securities Settlement Systems located 

in other Member States; 

•  Regulated markets and Multilateral Trading Facilities: the right to enter into appropriate 
arrangements  with  Central  Counterparties  and  Securities  Settlement  Systems  located  in 
other Member States. 

In  all  these  cases,  access  should  be  governed  by  transparent  and  non-discriminatory  rules, 
based on objective criteria. In order to avoid discrimination, where standard service levels or 
pricing apply, any variation from these should also be justified on objective grounds. It is also 
important to note that the existence of comprehensive rights of access in favour of Securities 
Settlement  Systems  and  Central  Counterparties  does  not  imply  that  these  entities  should  be 
obliged  to  request  and  maintain  access  to  other  systems.  However,  if  a  link  between  two 
Securities Settlement Systems exists and is operational, it should not be possible for them to 
deny the use of the link for the purpose of settling transactions in those securities for which 
either of the two Securities Settlement Systems represents the final point of settlement. 

2.2.  Common regulatory/supervisory framework 

process 

National restrictions on access and choice may reflect historical conditions, but they may also 
reflect the legitimate interest of national regulators/supervisors and overseers to safeguard the 
safety of systems and overall financial stability. As stated above, CESR and the ESCB are in 
the 
common 
regulatory/supervisory/oversight  framework  that  will  provide  a  basis  for  addressing  such 
concerns  in  the  EU.  It  is  expected  that  regulators,  supervisors  and  overseers  ("national 
authorities") will integrate these standards into their respective assessment frameworks and in 
this  way  assess  compliance  with  them.  These  standards  will  not  be  mandatory  and  will  not 
supersede any conflicting national legal provisions. 

developing 

standards 

defining 

aimed 

of 

at 

a 

As  cross-border  mergers  and  links  between  Securities  Clearing  and  Settlement  Systems 
develop, there will also be an increased demand for cooperation among national authorities to 
achieve  effective  cross-border  regulation  and  supervision.  In  this  context,  it  is  important  to 
have  clarity  over  the  applicable  regime,  i.e.  which  authority  is  competent  for  the  regulation 
and  supervision  of  a  particular  set  of  cross-border  clearing  and  settlement  activities.  In  the 
absence  of  a  common  framework,  current  cross-border  co-operation  between  national 
authorities  with  an  interest  in  a  system  or  its  participants  is  agreed  directly  between  these 
authorities  as  and  when  market  developments  make  such  cooperation  necessary.  Again,  the 
CESR-ESCB  draft  standards  provide  for  an  appropriate  scheme  for  the  division  of 
responsibilities among the national authorities concerned. However, the relevant standard will 
not supersede public authorities' responsibilities under national laws. 

These inherent shortcomings of the standards demonstrate that although standard setting may 
provide some level of common framework for securities clearing and settlement, they may not 
replace  a  proper  legislative  framework.  The  Commission  considers  therefore  that,  as  is  the 
case with the introduction of comprehensive rights of access and choice, reliance on voluntary 
action  by  the  national  legislators  or  regulators  to  provide  a  common  regulatory/supervisory 

16 

 
 
  
 
framework, will provide less legal certainty and may not guarantee a level regulatory playing 
field for a long period of time. 

These shortcomings will be avoided through the adoption of a Directive which will establish a 
common  set  of  high-level  principles  for  the  authorisation,  regulation  and  supervision  of 
Securities  Clearing  and  Settlement  Systems.  However,  the  specific  rules  to  be  applied  by 
Securities  Clearing  and  Settlement  Systems  should  be  flexible  and  should  closely  reflect 
market  and  supervisory  practices.  For  this  reason,  the  Commission  considers  that  the  high-
level  principles  should  be  further  concretised  by  specific  measures  to  be  adopted  under  the 
four-level  approach  embodied  in  the  Lamfalussy  procedure.  The  CESR/ESCB  standards 
might  then  form  the  basis  of  any  level  2  implementing  measures  to  be  developed  in 
accordance with the enabling provisions of the framework Directive. 

It is envisaged that the Directive should provide for: 

•  A functional approach; 

•  Initial and on-going prudential and investor protection requirements; and  

•  Supervisory co-operation. 

Functional approach: In line with the work undertaken recently by the CPSS-IOSCO and the 
ESCB/CESR working groups, the Commission considers that the Directive should be based 
on the functional approach. This will ensure consistency of action and avoidance of regulatory 
conflicts.  

In this context, the Directive should introduce common functional definitions of Clearing and 
Settlement activities. Such definitions might cover, but not necessarily mirror, a broad range 
of  post-trading  activities,  such  as  trade  matching  and  confirmation,  clearing,  settlement, 
custody and the notary function. In any case, they should be based on appropriate segments of 
the value chain, not on the “Intermediary” or “Infrastructure” status of the service provider, 
even  though  such  dichotomy  may  still  be  relevant  for  the  sake  of  deriving  the  level  of  risk 
associated to the different functions. Parties are invited to comment on the relevance of such a 
dichotomy  in  this  context.  The  Commission  considers  that  the  degree  of  detail  in  the 
definition of functions will depend on how the different activities relate to the prudential and 
investor protection requirements that will be considered appropriate, in particular with respect 
to  the  various  categories  of  risk  –  credit  risk,  operational  risk,  custody  risk,  etc  –  that  such 
requirements are intended to tackle. It should also be considered whether definitions and the 
scope  of  application  of  the  Directive  should  be  extended  as  to  cover  further  post-trading 
activities, such as collateral management or asset servicing.  

The Commission is conscious of the fact that current market practice has sometimes resulted 
in the use of the same term to denote different and/or complementary functions. The Directive 
should tackle this issue by adopting definitions which unambiguously relate to functions, even 
though  they  might  not  necessarily  encompass  the  totality  of  current  uses  of  a  term.  In  the 
present  Communication,  the  Commission  has  purposely  used  two  broad  categories  of 
functions  only,  that  is  Clearing  and  Settlement.  Clearing  is  defined  as  the  activities,  e.g. 
novation, that have as effect to guarantee counterparties from the replacement cost risk, while 
Settlement  is  defined  broadly  to  include  Pre-settlement,  Settlement  and  Custody.  These 
definitions will have to be made more narrow and precise in the envisaged Directive, taking 
into  account  their  relation  with  the  appropriate  prudential  and  investor  protection 
requirements. 

17 

 
 
  
 
Initial  and  on-going  prudential  and  investor  protection  requirements:  The  aim  of  the  new 
legislative framework embodied in the envisaged Directive on Clearing and Settlement is to 
enable Securities Clearing and Settlement Systems to provide services freely in other Member 
States.  At  the  same  time  these  entities  represent  an  important  source  of  counterparty  and 
systemic  risk  to  other  market  participants.  For  these  reasons,  the  Commission  considers  it 
necessary, if mutual recognition within the framework of the internal financial market is to be 
achieved,  to  establish  common  initial  and  on-going  prudential  and  investor  protection 
requirements, plus further requirements relating to governance (see section 2.3). 

Therefore,  the  Directive  should  establish  appropriate  initial  and  on-going  capital  adequacy 
requirements  applicable  to  Securities  Clearing  and  Settlement  Systems  in  the  EU.  Capital 
requirements for Clearing and Settlement activities need to be clearly linked to functions, as 
appropriately  defined,  and  to  the  level  of  risk  associated  to  those  functions  ("functional 
approach").  The  Commission  considers  that  such  capital  requirements  should  take  into 
account those at present applicable to banks, notably with respect to credit risk. However, to 
the extent that the current and foreseeable capital adequacy framework applicable to banks is 
not  considered  appropriate  to  cover  risks  specific  to  Clearing  and  Settlement,  the  capital 
adequacy  framework  for  Securities  Clearing  and  Settlement  Systems  should  be  adapted 
accordingly. Further prudential requirements are at this stage not excluded. 

The  Directive  should  also  establish  high  level  principles  on  risk  management,  such  as 
Delivery Versus Payment, along with some further principles on investor protection, such as 
those aimed at preserving the integrity of the issue and at protecting customers' securities. In 
particular, it is fundamental that the reliability of book-entry holdings through all layers of the 
intermediary  chain  is  ensured.  Proper  accounting  practices  and  reconciliation  procedures  of 
book-entry holdings throughout the chain of intermediaries are necessary companions of any 
effort to clarify the legal effects of indirectly held securities (on the efforts to harmonise these 
legal  effects  please  see  section  3.1  below).  The  Commission  considers  that  such  high-level 
principles  on  risk  management  and  investor  protection  should  further  be  concretised  by 
specific measures, such as those being developed by CESR/ESCB.  

Supervisory  co-operation:  The  introduction  of  comprehensive  access  rights,  the  removal  of 
existing  barriers  to  cross-border  clearing  and  settlement  and  the  introduction  of  a  common 
regulatory  framework  are  likely  to  bring  about  a  greater  degree  of  integration  and 
consolidation  in  the  Clearing  and  Settlement  industry.  For  this  reason,  the  regulatory 
framework  needs  to  incorporate  a  model  for  supervisory  co-operation,  to  avoid  Securities 
Clearing  and  Settlement  Systems  operating  cross-border  being  subject  to  the  supervision  of 
multiple supervisors, which would increase the cost of regulation and its complexity. 

The supervisory model applied in the EU harmonised sectors of banking, investment services, 
etc, is based on the principle of home country control. This principle, enshrined in several 
EU  Directives,  provides  that  the  supervision  of  an  entity  for  the  activities  carried  out  in  its 
home  country  or  abroad  through  a  branch  or  by  way  of  provision  of  services,  is  the 
responsibility  of  the  home  country  authorities.  It  also  provides  that  foreign  subsidiaries  of 
these  entities  are  supervised  by  the  authorities  of  the  Member  State  where  the  subsidiary  is 
established.  The  host  country  authorities,  on  the  other  hand,  retain  responsibility  for  certain 
issues, such as the supervision of the liquidity of branches, monetary policy implementation 
measures etc. This supervisory model also provides a framework for the regular exchange of 
information and cooperation between supervisors.  

18 

 
 
  
 
The  Commission  considers  that  a  similar  model,  adapted  as  necessary  to  address  the 
specificities  of  the  clearing  and  settlement  sector,  should  be  introduced  to  coordinate  the 
supervisory responsibilities of national authorities. 

This supervisory co-operation framework will also have to take into account, and adapt to, the 
fact that certain entities may already be subject to an existing supervisory regime (such as the 
banking regime). The Directive should avoid the duplication of supervisory requirements.  

On  the  basis  of  these  provisions,  Securities  Settlement  Systems,  Central  Counterparties, 
Custodians and Clearing Members would acquire an EU passport that, in turn, would allow 
them  to  operate  cross-border.  Currently  only  custodians  have  such  a  passport,  based  on  the 
ISD provisions. The clearing and settlement passport will ensure a level playing field among 
all providers of clearing and settlement services. 

2.3.  Governance 

Securities Settlement Systems and Central Counterparties enjoy a very high degree of market 
power. They also have the potential to become a source of instability for the financial system 
as  a  whole.  To  the  extent  that  the  process  of  integration  brings  about  a  higher  degree  of 
consolidation  in  the  EU,  the  potential  for  any  individual  Securities  Settlement  System  and 
Central  Counterparty  to  become  a  source  of  financial  instability  is  greatly  increased. 
Governance arrangements can be used to reduce these concerns. 

The  Commission  considers  it  extremely  important  that  Securities  Settlement  Systems  and 
Central  Counterparties  implement  appropriate  governance  arrangements.  Accordingly,  it 
believes that some high level principles should be included in the framework Directive.  

Governance  arrangements  encompass  the  relationship  between  owners,  board  of  directors, 
management  and  other  interested  parties,  including  users  and  authorities  representing  the 
public  interest.  The  various  categories  of  stakeholders  have  different  interests.  Owners  of 
Securities  Settlement  Systems  and  Central  Counterparties  are  legitimately  interested  to 
maximise  profits.  Users  are  interested  in  receiving  the  services  that  meet  their  needs  at 
reasonable  prices.  Public  authorities  are  interested  that  Securities  Settlement  Systems  and 
Central Counterparties: (i) do not engage in anti-competitive practices; and (ii) have in place 
adequate  safeguards  against  risk.  Such  interests  may  conflict  with  each  other.  For  example, 
profit maximisation must not come at the expense of increasing risk, which could be the case 
if a Securities Settlement System or Central Counterparty did not make the necessary level of 
investments, both in terms of information system and personnel. 

Key  components  of  governance  include:  (i)  the  ownership  and  group  structure;  (ii)  the 
composition of the board of directors; (iii) the reporting lines between management and the 
board  of  directors;  and  (iv)  the  management  incentives  and  the  process  that  makes  it 
accountable for its performance, e.g. audit committees18. 

One  major  distinction  is  between  two  stylised  governance  structures:  (i)  user-owned/user-
governed entities; and (ii) for-profit entities. In the first case, users own the company; what is 
relevant,  however,  is  the  fact  that  ownership  shares  are  allocated  according  to  usage. 
Moreover, the same ownership shares should be reflected in the composition of the board. In 
this way, the company would not just be user-owned, but also user-governed. Because usage 

18 

See the CPSS-IOSCO Recommendations and the CESR/ESCB standards. 

19 

 
 
  
 
                                                 
by  users  can  vary  overtime,  a  mechanism  is  needed  in  order  to  reconcile  ownership  shares 
with usage. In the second case, shareholding is not connected with usage. Between these two 
stylised forms of governance, there is ground for intermediate solutions. 

The Commission considers that an appropriate governance structure is particularly important 
in order to address potential problems in this area. However, it does not intend to enter into 
the  debate  about  what  form  of  governance  structure  -  user-owned/user-governed  entities  or 
for-profit entities – is preferable. The important thing is that whichever model is chosen, the 
requirements set forth are fully respected.  

* * * 

Governance arrangements should be clearly specified and transparent. This implies that, inter 
alia,  owners  of  Securities  Settlement  Systems  and  Central  Counterparties  should  disclose, 
subject  to  a  given  threshold,  their  ownerships  shares;  moreover,  directors  and  management 
salaries and any incentive schemes, should be made public, or at least disclosed to their users. 
In this way, it would be possible to know to whom profits are distributed, how much directors 
and management are remunerated and what their incentives are. Transparency of governance 
arrangements also implies that objectives and major decisions are disclosed to owners, users 
and public authorities. 

Moreover, Securities Settlement Systems and Central Counterparties should have one or more 
independent committees, such as an audit committee, composed of a majority of independent 
directors. The audit committee's responsibilities will be to make sure that public authorities' 
concerns  and  users'  interests  are  properly  addressed  on  the  following  issues:  (a)  internal 
organisation and the overall adequacy of human and technological resources; (b) accounting; 
(c)  information  system  reliability;  and  (d)  risk-management  policies.  Some  of  the  tasks 
attributed  to  the  audit  committee  can  be  handed  over  to  external  companies,  due  to  their 
highly technical nature. Such a committee should also identify and manage potential conflicts 
of interests between owners and users and between owners and/or users, on one side, and the 
public authorities, on the other. Independency of directors is usually assessed with respect to 
management and controlling shareholders. Because of the inherent public authorities interests 
over  the  well  functioning  of  Securities  Settlement  Systems  and  Central  Counterparties,  an 
appropriate  number  of  directors  should  also  be  independent  with  respect  to  users  and  non-
controlling shareholders. 

The  question  of  the  governance  arrangements  which  should  apply  to  Intermediaries  in 
particular  in  relation  to  their  securities  services  activities  also  needs  to  be  addressed.  The 
Commission  considers  that  the  regime  applicable  to  them  should  be  consistent  with  the 
governance arrangements envisaged for qualified shareholders and management of Securities 
Settlement Systems and Central Counterparties, which are important to ensure transparency, 
fitness and propriety and the containment of risks. 

* * * 

These measures are broadly in line with the policy orientations set forth in the Commission 
Communication  on  Company  Law  and  Corporate  Governance19.  However,  the  Commission 
considers  that,  because  of  the  public  authorities  interests  that  Securities  Settlement  Systems 
and  Central  Counterparties  do  not  engage  in  anti-competitive  practices,  further  governance 

19 

COM(2003) 284(final) of 21.5.2003 

20 

 
 
  
 
                                                 
measures could be appropriate, having regard to the current and foreseeable development of 
the industry. Increased integration will mean that different categories of institutions will likely 
be  in  competition  in  the  provision  of  cross-border  Clearing  and  Settlement  services.  For 
instance,  Central  Securities  Depositories,  International  Central  Securities  Depositories  and 
custodians will likely be in competition in the provision of cross-border Settlement services. 
For this reason, it is envisaged that Central Counterparties and Securities Settlement Systems 
keep segregated accounts of, and provide for the unbundling of, the services they offer in their 
Intermediary  capacity.  The  same  provisions  should  apply  to  any  non-core  activity,  such  as 
Banking,  eventually  performed  by  Securities  Settlement  Systems  and/or  Central 
Counterparties. Although these further measures may be considered more intrusive than other 
disclosure requirements - for instance, accounting separation may imply discretionary choices 
on how to attribute costs – they increase the degree of transparency of Central Counterparties 
and  Securities  Settlement  Systems.  In  this  respect,  the  present  Communication  follows  the 
approach  proposed  in  the  Communication  on  Company  Law  and  Corporate  Governance, 
according  to  which  “preference  should  be  given  whenever  possible  to  disclosure 
requirements, because they are less intrusive in corporate life and because they can prove to 
be a highly effective market-led way of rapidly achieving results" (p. 11).  

Accounting separation: In order to achieve accounting separation, a separation of costs and 
revenues  is  needed.  The  requirement  that  specific  services  be  priced  separately,  as  further 
discussed below, would allow separation of revenues. As Securities Settlement Systems and 
Central  Counterparties  are  characterised  by  large  economies  of  scope  with  respect  to  the 
performance  of  core  activities,  on  one  hand,  and  the  non-core  activities,  on  the  other, 
separation of costs will involve discretionary choices. 

For  instance,  by  allocating  a  very  low  percentage  of  costs  to  the  non-core  activities,  any 
Securities Settlement System or Central Counterparty would be able to show that it is making 
a profit on such activities, which would be a sign that no cross-subsidisation is taking place. 
Such evidence would be misleading: if the “right” percentage of fixed costs was allocated to 
the non-core activities, they would be found to be less profitable or, in the extreme case, to 
effectively run a loss. Cost allocation is therefore an issue to be dealt with very carefully if the 
desired  results  are  to  be  achieved.  To  this  end,  the  envisaged  Directive  could  refer  to 
internationally accepted standards on cost allocation, which may provide a solid starting point 
for  these  entities  to  meet  their  obligations.  In  any  event,  as  discussed  above,  the 
Communication  foresees  that  accounting  issues,  including  cost  allocation,  will  have  to  be 
responsibility of an Audit Committee to be composed by a majority of independent directors. 

Unbundling: It is also envisaged that non-core services, such as those offered in Intermediary 
capacity  and  the  Banking  activities,  be  priced  and,  on  demand,  supplied  separately.  Such 
requirement  might  adequately  address  concerns  that  Central  Counterparties  and  Securities 
Settlement Systems are tempted to force their users upon buying any "monopoly" service they 
might offer, on condition that they also buy other, unwanted, services from the same provider. 
Such practice will raise competition law concerns and will inhibit users' ability to move their 
activities to the most efficient supplier, thus potentially reducing efficiency.  

The supply of Banking services (including receiving of deposits and provision of credit) poses 
specific problems. Generally speaking, Securities Settlement Systems’ participants may need 
credit  to  overcome  temporary  shortages  in  their  cash  position  when  settling  securities 
transactions.  They  would  need  credit  in  the  same  asset  type  (central  bank  money  or 
commercial  bank  money)  used  for  the  settlement  of  the  cash  leg  of  securities  transactions. 
Securities  Settlement  Systems  settling  in  their  own  (commercial  bank)  money  will  also 
provide credit to their participants. 

21 

 
 
  
 
There  are  several  ways  to  deal  with  the  issue  of  supply  of  Banking  services  by  Securities 
Settlement  Systems  under  monopoly  conditions.  One  is  to  make  settlement  in  central  bank 
money compulsory. The second is to oblige Securities Settlement Systems to offer the option 
to settle in central bank money. A further alternative would be to oblige Securities Settlement 
Systems settling in commercial bank money to allow other banks to provide for the settlement 
of the cash leg of securities transactions. In each of these alternatives, Securities Settlement 
Systems’ participants would not be obliged to use the banking services offered by the Issuer-
Securities Settlement System. 

The  Commission  considers  that  Securities  Settlement  Systems  settling  in  commercial  bank 
money should at least provide a choice for their participants to settle in central bank money as 
well.  This  is  the  approach  adopted  in  the  ESCB/CESR  draft  standards  on  clearing  and 
settlement. 

* * * 

Finally,  in  order  to  achieve  a  level  playing  field  in  this  respect,  management  and  qualified 
shareholders  of  Securities  Clearing  and  Settlement  Systems  should  meet  the  fitness  and 
propriety  requirements  and  the  suitability  requirements  respectively  applicable  to  the 
management and the qualified shareholders of banks or investment firms.  

For  all  the  reasons  mentioned  in  the  preceding  sections,  the  Commission  considers  that  the 
adoption of a framework Directive will be necessary to introduce (a) comprehensive rights of 
access and choice, (b) a common regulatory framework, and (c) appropriate  governance 
arrangements. 

The envisaged directive is only a first step. It should ensure an appropriate balance between 
ex  ante  legislation  and  ex  post  intervention  of  the  competition  authorities  to  enforce 
competition  rules.  The  Commission  will  continue  to  monitor  closely  and,  where  necessary, 
adapt  its  approach  to  developments.  In  case  of  further  market  developments  it  may  be 
necessary  to  review  the  approach  set  out,  including  via  further  measures  to  ensure  that  the 
legal  framework  in  place  ensures  a  level  playing  field  for  the  different  operators  and 
adequately addresses the potential problems which may arise. 

3. 

Addressing legal and tax law discrepancies 

3.1 

The Legal Certainty project  

The  safety  of  any  securities  clearing  and  settlement  system  ultimately  depends  on  the 
soundness of the legal system on which it is built. General laws, such as property, securities 
and  insolvency  laws,  as  well  as  more  specific  rules,  including  systems'  operating  rules,  all 
influence the way securities clearing and settlement systems work and their overall efficiency. 
In order for Securities Clearing and Settlement Systems to fulfil their function adequately, the 
legal  framework  should  be  clear,  reliable,  coherent  and  predictable  in  its  interpretation  and 
implementation.  In  this  way,  legal  risks  to  participants  and  to  the  system  as  a  whole  are 
greatly reduced. 

Cross-border  clearing  and  settlement  involves  multiple  legal  jurisdictions,  representing 
differing  legal  traditions  and  approaches.  While  each  of  these  jurisdictions  may  adequately 
address  issues  arising  in  a  domestic  context,  when  providing  cross-border  clearing  and 
settlement  services  there  is  a  need  to  identify  clearly  the  national  law  applicable  to  the 
contractual  and  proprietary  aspects  of  the  whole  operation  (the  conflict  of  laws  issue). 

22 

 
 
  
 
Additionally, even if the identification of the applicable substantive national laws is properly 
addressed through the harmonisation of national conflict  of law provisions, discrepancies in 
the national substantive laws of the various jurisdictions concerned may still adversely affect 
the whole process. These particularly complex legal issues add considerably to the costs and 
uncertainties of cross-border clearing and settlement. 

The two Giovannini reports provided a clear description of the problems raised by legal issues 
in  this  context.  They  identified  as  important  barriers  to  further  integration,  the  uneven 
application of national conflicts of law rules, the national difference in the legal treatment of 
bilateral  netting  and  the  absence  of  an  EU-wide  framework  for  the  treatment  of  interests  in 
securities. The reports also found as an important barrier existing national law differences as 
to  the  moment  a  purchaser  is  considered  to  be  the  owner  of  a  security  for  the  purposes  of 
corporate actions.  

The current EU legal framework already addresses some of these issues. Thus, differences in 
the  legal  treatment  of  netting  and  conflicts  of  law  issues  have  been  addressed,  to  a  large 
extent, by the Directives on Settlement Finality20 and on Financial Collateral Arrangements21. 
These two Directives also contain special provisions as to the application of insolvency laws 
to  Securities  Clearing  and  Settlement  Systems  and  financial  collateral  arrangements,  which 
aim at increasing the safety of systems and the security of financial collateral arrangements.  

The Settlement Finality Directive minimises the disruption caused to a settlement system by 
insolvency  proceedings  and  ensures  that  transfer  orders  and  netting  are  legally  enforceable 
and  binding  on  third  parties.  Consequently,  the  unwinding  of  netting  will  not  be  possible 
where transfer orders have been entered into the system. Moreover, settled transactions may 
not  be  reversed  on  the  basis  of  the  so-called  "zero-hour  rule",  sometimes  incorporated  in 
insolvency  laws.  The  Directive  also  provides  that  transfer  orders  be  irrevocable  after  a 
moment specified by the system. Finally, collateral provided to central banks or in connection 
with participation in a system is insulated from the effects of insolvency law.  

The  Directive  also  addresses  the  issue  of  conflicts  of  law  in  relation  to  such  provision  of 
collateral in cases where the rights of the collateral taker are recorded on a register, account or 
a  CSD.  The  Directive  adopts  the  place  of  the  relevant  intermediary  approach  (PRIMA), 
namely that the determination of the rights of the collateral holders shall be governed by the 
law of the Member State where the register, account or CSD is located. 

The  Financial  Collateral  Directive,  which  is  in  the  process  of  implementation  by  Member 
States, has a much broader scope of application since it covers (almost) all financial collateral 
transactions  performed  by  systems  and  "financial  intermediaries"22.  It  reduces  formal 
requirements for financial collateral agreements and protects their validity and irrevocability 
against  certain  insolvency  provisions,  such  as  "zero-hour"  rules.  It  recognises  close-out 
netting even when its enforcement is triggered by the commencement or the continuation of 
winding-up  procedures  or  reorganisation  measures.  The  Directive  adopts  the  same  PRIMA 
approach  to  address  conflicts  of  law  issues  in  relation  to  the  legal  nature  and  proprietary 
effects  of  book  entry  securities  collateral23,  the  requirements  for  perfection  and  validity 

20 
21 
22 
23 

Directive 98/26 of 19 May 1998, OJ 1998 L166/45 
Directive 02/47 of 6 June 2002, OJ 2002 L168/43 
Financial collateral transactions carried out with natural persons are not covered by the Directive. 
Collateral which consists of financial instruments, title to which is evidenced by entries in a register or 
account. 

23 

 
 
  
 
                                                 
against  third  parties,  the  conflict  of  competing  titles  and  interests  in  such  collateral  and  the 
requirements for its realisation.  

The  conflict  of  laws  issues  arising  in  the  context  of  book-entry  securities  have  been 
subsequently re-addressed by the newly adopted Hague "Convention on the law applicable to 
certain rights related to securities held with an intermediary".  

Under the Convention, the law applicable to certain rights related to securities held with an 
intermediary  will  be  the  law  agreed  by  the  account  holder  and  the  relevant  intermediary, 
provided  the  law  in  question  meets  a  so-called  "reality  test"  intended  to  ensure  that  the 
intermediary’s  securities  business  has  some  connection  to  that  jurisdiction,  though  not 
necessarily in relation to the account in question.  

The implementation of the Hague Convention in the EU will enable participants to determine 
in  advance  of  any  action,  with  certainty  and  with  only  reasonable  effort  what  national 
substantive  law  governs  their  rights  to  indirectly-held  securities.  In  the  context  of  its 
responsibilities, the Commission will make the necessary arrangements for the signature and 
subsequent  accession  to  the  Convention  by  the  European  Union  and  its  ratification  by  the 
Member  States.  The  Commission  will  also  take  the  necessary  steps  to  bring  the  Settlement 
Finality and the Financial Collateral Directive in line with the conflicts of law provisions of 
the Hague Convention. 

In spite of the improvements that these measures will bring in terms of legal clarity and to the 
overall soundness and efficiency of cross-border clearing and settlement in the EU, they have 
not addressed a number of other important legal barriers. 

The most prominent of these is the absence of an EU-wide framework for the treatment of 
interests  in  securities  held  with  an  intermediary.  This  absence  has  been  identified  by  the 
Giovannini Group as the most important source of legal risk in cross-border transactions.  

Securities  are  increasingly  held  and  transferred  on  the  basis  of  book  entries.  For  instance, 
dematerialised securities are exclusively represented by a book entry in an account held by an 
intermediary. When securities are held as book entries in intermediaries’ accounts, it is first of 
all necessary to have clarity as to the legal nature of the rights that investors have with respect 
to such book entries. In fact, legal interpretations of these rights vary considerably from one 
Member State to another.  

Equally important are the legal framework of transfers of rights in respect of indirectly-held 
securities. While in practice dispositions of such rights are effected by mere book entries, it is 
claimed  that  not  all  national  jurisdictions  have  appropriately  adapted  their  legal  system  for 
such  dispositions.  It  is  also  important  to  ensure  clarity  as  to  the  determination  of  the  exact 
time at which indirectly-held rights are transferred.  

Other  issues  that  need  be  addressed  are  the  determination  of  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 than where such right is actually 
recorded or constituted ("upper-tier attachment"). As securities are usually pooled in omnibus 
accounts,  an  upper-tier  attachment  would  have  the  effect  to  freeze  all  securities  recorded  in 
the account where the attachment is made, not just those of the investor concerned.  

The  absence  of  a  coherent  approach  across  the  EU  on  these  issues  seriously  affects  cross-
border clearing and settlement efficiency and safety. The Commission considers that this issue 

24 

 
 
  
 
should  be  tackled  as  a  matter  of  priority,  although  it  may  take  sometime  to  bring  forward 
concrete proposals. 

Another  issue  that  needs  to  be  addressed  concerns  differences  in  national  legal  provisions 
affecting corporate action processing, such as discrepancies in Member States' laws as to the 
determination  of  the  exact  moment  when  a  purchaser  is  considered  to  be  the  owner  of  a 
security, e.g., for the payment of dividends. National laws may provide that such moment is 
the trade date, the intended settlement date or the actual settlement date. As noted in the two 
Giovannini reports, such discrepancies may inhibit the centralisation of securities settlement 
and, for this reason, constitute a barrier to further integration. As a consequence, there might 
be a need for harmonisation of the relevant rules. 

Finally, the Commission wants to consider in more detail the issue of securities location. It 
has been suggested that restrictions relating to the issuer's ability to choose the location of its 
securities act as a further barrier to Securities Settlement Systems consolidation. The basis for 
these restrictions can be found either in national law linking listing in a particular market with 
the use of the local CSD or in company law. The Commission intends to consider this issue 
further, taking into account the differences between the various types of securities, as well as 
the company law implications of such requirements. 

In view of the importance of these issues, the Commission, supported by the recommendation 
of the Giovannini group of experts, considers that a specific exercise should be launched to 
address these issues. The Commission proposes to set up a group, composed of experts from 
academia, public authorities and practising lawyers. It will be tasked with undertaking further 
analysis  of  these  issues,  proposing  solutions  and,  eventually,  helping  to  draft  specific 
legislative proposals. The composition of the Group will need to reflect the legal traditions of 
current  and  future  Member  States.  However,  a  core  secretariat  will  provide  the  necessary 
impetus  for  the  project.  The  group  will  also liaise  with  other  bodies,  such  as  UNIDROIT24, 
that might have undertaken similar work at the wider global level. 

In view of the complexity of the subject and its intricate connexion with national property and 
company  law,  the  Commission  expects  this  project  to  be  long-term.  Its  exact  scope  will  be 
defined at the time the Group is created; however, it should address issues such as: 

•  the nature of the investor's rights in relation to securities held in an account with 

an intermediary; 

•  the transfer of these rights; 

•  the finality of book-entry transfers; 

•  the treatment of upper-tier attachment; 

•  investor protection from insolvency of the intermediary; 

•  the acquisition of these rights in good faith by third parties; 

24 

UNIDROIT  (the  “International  Institute  for  the  Unification  of  Private  Law”)  is  an  independent 
intergovernmental  organisation  whose  purpose  is  to  study  needs  and  methods  for  modernising, 
harmonising and co-ordinating private and in particular commercial law as between States and groups 
of States. 

25 

 
 
  
 
                                                 
•  differences in the rules relating to the transfers of ownership for the purposes of 
corporate actions, to the extent that these differences are incorporated in national 
laws; 

•  the choice of securities location. 

For  each  of  these  issues,  differences  in  national  laws  should  be  evaluated  and,  if  needed,  a 
proposal for harmonisation should be made. 

3.2 

Taxation issues 

Member  States  have  entered  into  bilateral  agreements,  under  which  both  the  state  where 
income is sourced and the state where the recipient is resident for tax purposes claim the right 
to impose tax on income generated by an investment. Relief from potential double taxation is 
granted in one of two ways. Either one state exempts the income from tax altogether (unusual 
and  mainly  confined  to  so-called  "direct  investors:"  those  with  a  minimum  shareholding  of 
perhaps 10%); or the state of residence gives credit for any tax deducted in the source state. 
These are generally known respectively as the "exemption" and "credit" methods. 

However,  the  normal  tax  rate  in  the  source  state  may  be  broadly  comparable  with  the  rate 
charged by the state of residence. Using the credit method would result in very little tax being 
paid  in  the  state  of  residence  because  the  source  country's  tax  would  fully  (or  almost  fully) 
cover  any  tax  liability.  Yet  it  is  in  the  state  of  residence  where  the  owner  is  more  likely  to 
benefit from services that are paid from taxation. Thus, the agreements usually provide for a 
reduction  in  the  normal  rate  of  withholding  tax  in  the  source  state,  so  as  to  leave  some  tax 
payable in the state of residence. 

The Giovannini reports identified and invited public authorities to tackle a number of practical 
problems that arise from the procedures whereby only certain intermediaries are permitted to 
apply  a  reduction  of  the  normal  rate  of  withholding  tax.  In  particular,  some  Member  States 
only  permit  institutions  established  within  their  territory  to  operate  withholding  tax 
procedures.  Other  Member  States  allow  foreign  intermediaries  to  apply  reduced  rates  of 
withholding  tax  but  only  on  condition  that  they  appoint  a  local  fiscal  representative.  The 
Giovannini  reports  suggest  that  such  a  situation  effectively  prevents  the  possibility  for  an 
intermediary  to  operate  on  a  cross-border  basis  or  to  use  the  Intermediary  services  of  a 
Securities  Settlement  System,  thus  greatly  limiting  competition  in  the  provision  of  cross-
border  Settlement  services.  Therefore,  market  participants  are  prevented  from  choosing  the 
most  efficient  way  to  operate  cross-border,  which  in  turn  increases  the  inefficiency  of  the 
whole process.  

Moreover, differences exist in the procedures used in the various Member States to collect, or 
grant relief from, withholding tax. Even if total or partial relief is granted, eligible investors 
may be required first to suffer the tax and subsequently reclaim it. Procedures applicable to 
repayment of withholding  tax can be  very complex and may also differ considerably across 
Member  States.  Such  complexities  and  differences  significantly  increase  the  cost  of  cross-
border Settlement. 

The relevance of these barriers to efficient cross-border Settlement was also argued during the 
consultation  to  the  first  Commission  Communication  on  Clearing  and  Settlement.  Indeed, 
some  respondents  considered  that,  while  substantive  tax  harmonisation  is  not  currently 
necessary,  harmonisation  of  the  different  procedures  involved  in  tax  processing  should  be 
pursued, while at the same time ensuring equal treatment for domestic and foreign investors.  

26 

 
 
  
 
The Commission notes that there is an increasing tendency to move away from withholding 
taxes towards a greater reliance on information exchange. This enables tax authorities to have 
the proper information available to them in order to charge the right amount of tax on the right 
person.  Information  exchange  on  as  wide  a  basis  as  possible  underpins  Council  Directive 
2003/48/EC dealing with taxation of income in the form of interest received across national 
frontiers25.  Moreover,  there  is  now  a  Directive  for  Mutual  Assistance  on  Recovery26,  under 
which  the  competent  authorities  of  one  Member  State  can  assist  those  of  another  with  the 
collection  of  both  direct  and  indirect  taxes  due  in  the  first-mentioned  state  from  a  debtor 
located in the second. In addition, the original Directive on Mutual Assistance27 is currently 
undergoing  modernisation  with  a  view  to  strengthening  it.  Therefore,  Member  States  will 
have  better  possibilities  for  controlling  taxpayers  who  are  located  outside  their  territorial 
jurisdiction. 

Given this new context, it is an opportune moment to explore the additional possibilities that 
are now available to see whether changes in some of the existing rules might be introduced in 
order to simplify matters for business, while still safeguarding the rights of Member States in 
relation to tax collection. 

The  Giovannini  group  also  suggested  that  the  integration  of  the  system  for  collection  of 
transaction taxes, within the functionality of existing Securities Settlement Systems in the EU, 
constituted  a  further  tax  barrier.  In  such  circumstances,  the  reports  suggested  that  using  a 
different  Securities  Settlement  System  could  mean  paying  higher  transaction  taxes.  Should 
that prove to be the case, other Securities Settlement Systems may be de facto prevented from 
offering Intermediary services in cross-border Settlement, thus reducing the efficiency of the 
system. The Giovannini group of experts invited public authorities to consider this barrier and 
to propose appropriate solutions. 

The Commission proposes the creation of a group of experts to examine, in more detail, the 
taxation issues identified by the Giovannini group and by respondents to the first Commission 
Communication  on Clearing  and Settlement as constituting barriers to efficient cross-border 
Settlement. The expert group should further consider and analyse such issues, with a view to 
reporting on their relevance and on whether alternative ways might be found to secure the tax 
receipts  to  which  Member  States  are  entitled,  while  still  permitting  all  financial  institutions 
across the European Union to compete on an equal footing.  

The remit of the expert group would also include the undertaking of a study of the different 
procedures  in  place  across  Member  States,  with  a  view  to  seeing  whether  these  might  be 
capable of being more closely aligned, so that the existence of a multiplicity of rules, which, 
among  other  things,  raise  the  cost  of  cross-border  Settlement,  could  be  eliminated  or 
substantially reduced.  

The Commission will consider the findings of the expert group and will use them as a basis 
for  discussion  with  the  tax  authorities  of  the  Member  States,  in  accordance  with  the 

25 

26 

27 

Council  Directive  2003/48/EC  of  3  June  2003  on  taxation  of  savings  income  in  the  form  of  interest 
payments, OJ 2003 L175/38 
Council Directive 2001/44/EC of 15 June 2001 amending Directive 76/308/EEC on mutual assistance 
for  the  recovery  of  claims  resulting  from  operations  forming  part  of  the  system  of  financing  the 
European Agricultural Guidance and Guarantee Fund, and of agricultural levies and customs duties and 
in respect of value added tax and certain excise duties, OJ 2001 L175/17 
Council  Directive  77/799/EEC  of  19  December  1977  concerning  mutual  assistance  by  the  competent 
authorities of the Member States in the field of direct taxation, OJ 1977 L336/15 

27 

 
 
  
 
                                                 
established  policy  of  prior  consultation  on  tax  issues.  If  subsequent  action  at  a  Community 
level is considered appropriate, the Commission will endeavour to bring forward appropriate 
proposals. 

4. 

Competition policy 

Consistent  application  of  competition  policy  is  part  of  the  Commission  overall  approach  to 
Clearing  and  Settlement.  Measures  intended  to  promote  liberalisation  and  integration  of 
existing systems and competition policy are complementary in achieving efficient Securities 
Clearing and Settlement Systems in the EU.  

In  fact,  the  financial  sector,  including  all  post-trading  activities,  is  subject  to  the  same  EU 
competition  rules  as  all  other  industry  sectors.  The  Commission  works  closely  with  the 
national competition authorities on cases when both domestic and cross-border issues are to 
be  assessed,  e.g.  in  cases  of  alleged  discriminatory  access  towards  domestic  and  foreign 
participants. Furthermore, the implementation, in May 2004, of Council Regulation 1/200328 
will  further  strengthen  the  cooperation  between  national  competition  authorities  and  the 
Commission  in  the  enforcement  of  competition  rules.  This  will  enhance  the  effective  and 
coherent application of Articles 81 and 82 of the EC Treaty and be beneficial to the promotion 
of competition in the financial sector. 

Together with the extension of the scope of their activities, there have been recent instances of 
cross-border  consolidation  of  Securities  Clearing  and  Settlement  Systems,  which  have 
historically consolidated within Member States. This has included for example the merger of 
national  infrastructures  (such  as  Central  Securities  Depositories)  with  companies  having  a 
genuine cross-border focus (such as International Central Securities Depositories).  

Whilst  the  Commission  is  neutral  on  the  question  of  vertical  or  horizontal  consolidation  as 
well  as  on  the  issue  of  multiple  or  single  infrastructure  and  ownership  profiles,  as  in  any 
industry  sector,  where  consolidation  results  in  a  possible  creation  or  reinforcement  of  a 
dominant market position, this will be a cause of concern. To date, most mergers in this sector 
have  not  met  the  thresholds  of  Council  Regulation  4064/8929,  the  so  called  “Merger 
regulation”, and therefore have not been notified to the EU Competition authorities.  

The Commission will continue to monitor mergers and acquisitions in this sector carefully In 
addition,  existing  as  well  as  emerging  entities  must  comply  with  the  special  responsibilities 
that  Article  82  of  the  Treaty  imposes  on  them,  should  they  occupy  dominant  positions. 
Moreover,  agreements  among  clearing  and  settlement  service  providers  will  also  be 
monitored in the light of Article 81 of the Treaty.  

As  the  pace  of  systems’  consolidation  increases,  so  do  the  rights  and  responsibilities  of  the 
buyers and providers of services in this sector. Certain specific issues can be mentioned. They 
should  not  however  be  considered  as  an  exhaustive  list  of  competition  concerns  or  an 
anticipation of situations which may arise in the future.  

Supply of services and non-discriminatory access: In the present industry context, particular 
attention is given to the respect of competition rules where agreements or concerted practices 
between  companies,  or  the  exercise  by  a  company  of  its  dominant  position,  restrict 

28 
29 

Council Regulation 1/2003 of 16 December 2002, OJ 2003 L1/1 
Council Regulation 4064/89 of 21 December 1989, OJ 1989 L395/1 

28 

 
 
  
 
                                                 
competition  in  a  specific  market.  In  making  its  assessment,  the  Commission  will  take  into 
consideration the economic context and the effect that any such practices may have either in 
creating or in hampering efficiencies and competition in the single market. 

Pricing: The Commission is not a price regulator. Prices should be determined by the market 
but  this  is  subject  to  certain  limits.  In  particular  a  dominant  undertaking  has  an  obligation 
under Article 82 of the EC Treaty to avoid “directly or indirectly imposing unfair purchase or 
selling  prices  or  other  unfair  trading  conditions”30  and  to  avoid  “applying  dissimilar 
conditions  to  equivalent  transactions  with  other  trading  parties,  thereby  placing  them  at  a 
competitive disadvantage”31.  

Exclusive  arrangements:  The  term  "exclusive  arrangements"  covers  a  variety  of  dissimilar 
legal situations. It can be understood as including legislative acts and self-regulation, as well 
as  industry  agreements.  Exclusive  arrangements  as  such  are  not  prohibited  by  competition 
rules.  However,  they  may  be  subject  to  the  application  of  Articles  81,  82  and  86  of  the  EC 
Treaty, particularly in the context of developing cross-border services. Such provisions within 
the securities clearing and settlement area may include the obligation to clear and settle only 
in  a  specific  infrastructure,  the  exclusive  use  of  a  tied  central  counterparty,  etc.  On  the 
contrary, non-exclusive arrangements to use a specific infrastructure simply reflect the right 
of a market to choose the service of a Central Counterparty or Securities Settlement System; 
therefore,  they  do  not  pose  particular  problems.  Where  companies  that  might  occupy  a 
dominant  position,  whether  by  virtue  of  state  measures  or  consolidation,  benefit  from  such 
arrangements,  particular  attention  needs  to  be  paid  to  compliance  with  Article  82  of  the 
Treaty.  

The Commission is actively monitoring market developments in the Clearing and Settlement 
area. In the meantime, service providers are advised to take a pro-active competition stance in 
their business development, and to seek ways of avoiding possible competition concerns at an 
early stage.  

CONCLUSIONS 

This  Communication  defines  the  key  policy  objectives  that  the  Commission  has  taken  into 
account  in  proposing  future  action  at  the  EU  level.  It  includes  an  action  plan  outlining  the 
various  initiatives  that  need  be  undertaken  to  achieve  an  integrated,  safe  and  efficient 
securities clearing and settlement environment in the EU. 

Comments  from  the  European  Parliament,  the  Council,  the  European  Central  Bank,  the 
European  Economic  and  Social  Committee,  the  Committee  of  the  Regions,  national 
regulatory  and  supervisory  authorities,  other  EU  level  and  national  organisations  and 
federations,  market  practitioners,  institutional  investors,  infrastructure  providers  and  all 
interested parties on all aspects of the Communications are invited by the 30th of July 2004. 
Comments  should  be  sent  to  DG  MARKT  G1,  European  Commission,  B-1049  Brussels  (e-
mail address <Markt-Clearing-Settlement@cec.eu.int>). 

The  Commission  also  invites  the  European  Parliament  and  the  Council  to  endorse  the 
approach outlined in the present Communication.  

30 
31 

Article 82(a) 
Article 82(c ). 

29 

 
 
  
 
                                                 
Annex 1 

Giovannini Barriers 

 Diversity of IT platforms/interfaces 

Restrictions on the location of clearing or settlement 

National differences in rules governing corporate actions 

Differences in the availability/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 settlement system 

National differences in the legal treatment of securities 

National differences in the legal treatment of bilateral netting 

Uneven application of conflict of law rules 

30 

 
 
  
 
 
Annex 2: GLOSSARY 

Central Counterparty (“CCP”): An entity performing the Clearing function.  

Clearing  function:  The  activities  that  have  as  effect  to  guarantee  counterparties  from  the 
replacement cost risk. 

Clearing  and  Settlement  service  providers:  SSSs,  CCPs,  Custodians  and  Clearing 
Members. 

Clearing member: An Intermediary in the provision of Clearing services. 

Custodian: An Intermediary in the provision of Settlement services. 

Intermediary  capacity:  The  provision  of  direct  or  indirect  access  to  the  Issuer-SSS  or  the 
CCP with which a market has entered into appropriate Clearing arrangements.  

Investor-SSS: An SSS acting in an Intermediary capacity. 

Issuer-SSS: The SSS where securities are immobilised or dematerialised. 

Markets: Regulated markets and Multilateral Trading Facilities, as defined in the Directive of 
the European Parliament and of the Council on financial instruments markets. 

Replacement cost: the potential losses arising in the event of default of a counterparty to a 
trade. 

Securities  Clearing  and  Settlement  System  (“SCSS”):  The  full  set  of  institutional 
arrangements required to finalise a securities transaction.  

Securities  Settlement  System  (“SSS”):  All  institutions,  in  particular  Central  Securities 
Depositories,  performing  the  Pre-settlement,  Settlement  and  Custody  functions,  except  the 
Custodians. 

TARGET:  Trans-European  Automated  Real-Time  Gross  Settlement  Express  Transfer 
System,  composed  of  the  national  RTGS  payment  systems  of  the  EU  countries  that  have 
adopted the Euro plus the ECB payment mechanism. 

31