A second requirement - which is linked to the first one - relates to the objective of reducing clearing and settlement costs, especially the costs of cross-border securities operations. As discussed in the 4 Giovannini report mandated by the EU, domestic clearing and settlement arrangements within member countries seem to have reached a level of cost efficiency, which is - by and large comparable to what DTCC (Depository Trust & Clearing Corporation) in the US has achieved. By contrast, the whole cross-border domain is far from being cost-efficient, mainly due to fragmentation in terms of market infrastructures and practices, as well as differing legal, tax and accounting frameworks. The obvious question is, therefore, how to realise efficiency gains in the cross-border context. One way - and probably the most appealing one - is to consolidate market infrastructures. Within the European Union, there are currently more than 20 Central Securities Depositories. Although consolidation seems unavoidable, it is less clear how to achieve it and which model best suits integrated financial markets. Should priority be given to vertical or to horizontal integration? On the one hand, vertical integration presents some advantages. Since trading, clearing and settlement occur within the same organisation, this reduces legal and operational risks. On the other hand, vertical integration may entail cross-subsidies, which disguise the effective costs of trading, clearing and settlement. In addition, this model may also tend to rely on rents, as it is impossible for users to switch between providers.

To see why, imagine a bank whose expected future profits, and hence market capitalisation, have slumped. If this erosion of profits is sufficiently material, conversion at the highest trigger occurs. Upon triggering, a chunk of that bank’s debt converts into equity, automatically recapitalising the bank and providing it with an extra equity cushion. This equity infusion ought to help restore market confidence in the bank’s soundness. If the first conversion does not do the trick, or if the profits shock is sufficiently large, there are other rungs in the ladder. Lower triggers provide a graduated safety net. As these triggers are pulled, converting CoCos offer progressively greater stuffing for the cushion. This is a double boon. It confers the benefits of (contractually pre-agreed contingent) equity. But knowledge of the graduated safety net ought also to help stabilise investors’ confidence in the bank. Under this capital structure, banks’ insurance contract would be fundamentally different than at present. Instead of equity being provided at haste under stress, the safety net would extend automatically in advance. And instead of being provided by the state ex post, insurance would come from private creditors ex ante. Timely self-insurance would replace laggardly public insurance. There would be prompt corrective action. But it would operate on autopilot, using a contractual, market-based navigation system. 12  For example, Flannery (2010), Flannery and Perotti (2011), Duffie (2011), Calomiris and Herring (2011). 13  Alternatively, there could be graduated tranches of CoCos operating with a single trigger.