European Commission publishes draft CSD regulation

Proposals to regulate central securities depositories in Europe have today been adopted by the European Commission to bring more safety and efficiency to the region’s settlement system. 

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Proposals to regulate central securities depositories (CSDs) in Europe have today been adopted by the European Commission (EC) to bring more safety and efficiency to the region’s settlement system. 

The proposal will introduce, in line with the EC’s international partners, common standards across the European Union for securities settlement and CSDs to ensure a single market for the services provided by national CSDs.

The proposed regulation aims to reduce settlement fails and the risks and costs of cross border settlement of transactions in Europe, which are up to four times as much as those for national markets, by enabling passporting of CSDs in various markets. 

The regulation recognises the importance of having a harmonised set of measures across Europe for settlement as well as for the CSDs responsible for settlement, particularly as the importance of cross border transaction in Europe continues to increase, with different types of trades including securities transactions to collateral transfers. In a statement the EC said CSDs are becoming increasingly interconnected with the importance of these transactions. As such, it noted that CSDs, which are currently regulated at national level, needed a common set of prudential, organisational and conduct of business standards at European level. 

Europe’s 30 CSDs and two ICSDs collectively settled about €920 trillion worth of transactions in 2010 and were holding almost €39 trillion of securities at the end of 2010. Euroclear and Clearstream, the two ICSDs, represent about 37% of total settlement volumes in the EU. The specific objectives of the proposal are hence to increase the safety of settlements, in particular for cross-border transactions, by ensuring that buyers and sellers receive their securities and money on time and without risks; increase the efficiency of settlements, in particular for cross border transactions, by introducing a true internal market for the operations of national CSDs and to increase the safety of CSDs by applying high prudential requirements in line with international standards.

Moreover, as part of the G20 initiative to improve the safety and efficiency of Europe’s financial markets, with MiFID addressing the trading environment and the European market infrastructure regulation addressing the clearing landscape, this latest post trade regulation, would complete the picture, said the EC.

The need to address the fragmented settlement landscape in Europe is expected to accelerate with the advent of Target2Securities (T2S), a project launched by the Eurosystem to provide a common technical platform for securities settlement in Europe, which is scheduled to start in 2015 and with which the proposed regulation is consistent, said the EC. There have, however, been two delays to the platform, with industry sources expressing doubt about whether it will go ahead and whether the projected costs of the project – around €1.4 billion to date – would outweigh the benefits.

In the short term, the EC expects the proposed regulation is likely to create more competition between CSDs, with expected benefits for the quality and price of cross-border services. In the medium to long term, the CSD market could become more consolidated and less fragmented. There could be less intermediation for cross-border holding of securities and CSD services, and cross-border settlement will become safer and cheaper. This would translate into lower costs for investors along the whole post trading chain.

The proposals of the regulation are as follows:

- The settlement period will be harmonised and set at a maximum of two days after the trading day for the securities traded on stock exchanges or other regulated markets (currently two to three days are necessary for most securities transactions in Europe).

- Market participants that fail to deliver their securities on the agreed settlement date will be subject to penalties, and will have to buy those securities in the market and deliver them to their counterparties, referred to as the so-called “buy in procedure”.

- Issuers and investors will be required to keep an electronic record for virtually all securities, and to record them in CSDs if they are traded on stock exchanges or other regulated markets.

- CSDs will have to comply with strict organisational, conduct of business and prudential requirements to ensure their viability and the protection of their users. They will also have to be authorised and supervised by their national competent authorities.

- Authorised CSDs will be granted a 'passport' to provide their services in other member states. 

- Users will be able to choose between all 30 CSDs in Europe.

- CSDs in the EU will have access to any other CSDs or other market infrastructures such as trading venues or central counterparties (CCPs), whichever country they are based in.

In further setting out the benefits of the regulation the EC said a harmonised settlement period – T+2 as opposed to a combination of T+2 or T+3 in various markets across Europe – will reduce operational inefficiencies and risks for cross-border transactions, while reducing funding costs for investors (for instance, for those that have to deliver cash or securities at T+3 but can only receive them at T+2). A shorter settlement period would have an important advantage of reducing counterparty risk, it added.

The EC believes the passporting function of the regulation – where CSDs would be able to provide their services in the EU without the need for further authorisation – would enable CSDs to consolidate their operations in a much more efficient way. In a press briefing following the announcement of the proposals, Michel Barnier, EU internal markets commissioner, said he did not foresee fewer depositories as a result of the proposals, adding that the EC has been consulting with the Council and the debate has gone well.

“People have not been concerned. We are talking about €600,000 billion of derivatives traded – we think we have come up with balanced proposals to manage the market. Some things have been introduced and it has gone down well. I want to promote a level playing field and single financial market. Passporting will make things easier but it is not to say CSDs need to merge. I am not expecting a rush to concentration but we’re creating passporting to allow them to do business in other countries.”

The European Securities and Markets Authority (ESMA) will have an important role in ensuring cooperation between national competent authorities and developing technical standards for the application of certain provisions of the proposed regulation. A CSD from a third country can provide its services in the EU if it is recognised by ESMA. 

The regulation is also proposing that the provision of banking services by CSDs is done in another legal entity than the CSD, given that they are operating systemically important infrastructures for the securities and the payments markets. Their resilience needs to be strengthened in line with international efforts, said the EC. “Since some of them provide banking services to their participants related to the settlement service, they are exposed to more risks and, therefore, to a greater likelihood of suffering a default or being subject to severe stress with dramatic consequences for the securities and payments markets.”

The EC feels the possible mitigation measures of the related credit and liquidity risks, such as for instance full collateralisation of credit and stringent liquidity measures, do not completely eliminate these risks associated with CSD's banking functions given their significant amounts of intraday lending and deposit taking.

The requirement to provide banking services in a separate legal entity (acting as a so called ‘settlement agent’) would therefore prevent the spillover of risks from the banking services to the CSD services, it said. “In addition, if the banking entity were to default, the activities of the CSD could continue, particularly if the CSD retained the IT infrastructure for settlement. Therefore, the CSD and its authorities would have more options to develop back-up solutions that enable a quick substitution of a failing settlement bank."

The proposal now passes to the European Parliament and the Council of the European Union for negotiation and adoption under the co-decision procedure.

Reporting by: Janet Du Chenne, Global Custodian, an Asset International publication