Vertical Integration and Regulation in the Securities Settlement Industry
The European Securities Trading and Post-trading (Clearing and Settlement) Industries have recently experienced a vast movement of consolidation. This was encouraged by the European Commission, seeking to establish a single market for the trade of financialsecurities across the European Union, and reduce the cost of cross-border transactions. For the regulator, the issue as a whole hinges on the need to allow for the achievement of economies of scale, while avoiding the possibility that an upstream monopolistic position might thwart competition in the downstream market, i.e. banking activities or securities trading activities. After long discussions with the industry, the European Commission considered that there was no need for regulation, provided that platforms adopted and implemented a "Code of Conduct". The present article challenges this view by showing that such a "Code of Conduct" may not be enough. We consider a model where custodians are competing to provide both custody services and banking services to investors. There is only one Central Security Deposit (CSD) where all the net orders must be in the end settled. Custodians have omnibus accounts in the CSD, for which they pay a fixed fee, and must pay an additional fee for each transaction. The CSD is directly competing with other custodians for the provision of custody and banking services. A key assumption is that because of economies of scale it would be socially inefficient to let several CSDs compete for the provision of depository and settlement services for a given security. Different types of regulator may be considered, such as the European commission, or those in place in other industries (telecom, energy). While the former may only impose external constraints on actors such as non-discriminatory access pricing or forbidding of integration, the latter may resort to a combination of monitoring and incentive regulation in order to extract information and impose a cost-based regulation.
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