Settlement internalization: the production and distribution of services in the (clearing and) settlement industry

The aim of this paper is to clarify the likely consequences of settlement internalisation by custodian banks with respect to the competitive nature of the (clearing and) settlement industry, regardless of the extent of internalisation that is actually carried out. The intuition of the model presented in this paper is based on the assumption that the CSD knows the investors' final demand of (clearing and) settlement services, even though it is only faced with a fraction of such demand, i.e. the investors' final demand that is not internalised by custodians. As a consequence, the CSD's monopoly power is not constrained by the possibility of custodian banks internalising part of the (clearing and) settlement activity. The model structurally differentiates the (clearing and) settlement activity of the CSD from that of custodians. The difference between the (clearing and) settlement activity of the CSD and that of custodians refers to the fact that the (clearing and) settlement activity of the CSD is the highest or primary level where settlement can be achieved. To the extent that the probability of settlement internalisation is less than one, not all settlements are internalised. As a consequence of this, the CSD can adjust its price to take into consideration the level of settlement internalisation, making it irrelevant from the point of view of its profits. As regards the appropriate market definitions, the paper proposes to apply to the settlement industry the classical distinction between “production” and “distribution” of services. It then tests such a distinction against the Commission Communication on clearing and settlement of April 2004, the industry Code of Conduct – to clarify the extent to which they can be interpreted as promoting competition in the sector – and against the Commission decision on Clearstream.