Viewpoint : Post-trade : CSDR Reform : Alex Merriman

SECURING THE FUTURE.

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Europe prepares to harmonise its Central Securities Depositories. Alex Merriman, Head of Market Policy at SIX Securities, looks at the issues.

The primary driver of change in the financial services sector today is without doubt regulation. Since the financial crisis of 2008, regulators have sought to tighten processes, improve reporting and avoid any reproduction of the factors that led to the collapse of global financial institutions and brought the world´s financial markets to their knees. In Europe, many of the new regulations such as the European Market Infrastructure Regulation (EMIR) and the CSD Regulation (CSDR) have focused on introducing a more stringent regulatory regime for CCPs and CSDs.  These measures, and infrastructural projects such as the ECB’s Target 2 Securities (T2S) Project, have also assisted in the harmonisation of post-trade activities across the continent in an effort to reinforce the stability of financial markets.

As we emerge from the crisis, post-trade reform has continued in Europe unabated. While reduction of systemic risk is still key, many are now looking to regulation to make Europe more competitive, especially in comparison to the US. Where US issuers and traders only have to deal with the DTCC for their clearing and settlement requirements, European trading activities can be, to some extent, routed through a number of post-trade operators. Having a settlement system with mainly domestic players, working under their own local jurisdiction and therefore following multiple sets of rules is not conducive to setting up a best-in-class, continent-wide financial market. As such, the European Union is now seeking to ensure harmony across the full value chain, so that trading partners can effectively compare benefits. Crucially, this harmonising process is also reinforcing risk management procedures, and thereby reassuring participants along the value chain.

Disciplining the markets

The Central Securities Depositories Regulation (CSDR) will be the next addition to the regulatory post-trade arsenal as it is due to be formally and finally adopted by European Institutions in July, notably at the new European Parliament´s Plenary session. This regulation takes aim at CSDs, which have only ever been subjected to national regulatory frameworks; the European Commission recognising that they have become a systemically important part of the post-trade infrastructure in the modern European securities markets.

In their role of overseeing the registration, safekeeping and settlement of securities in exchange for cash, CSDs ensure the efficient processing of securities transactions in financial markets, particularly as we have moved from paper-based trading to digital exchanges of securities that exist primarily in book entry form. As Europe moves to the full dematerialisation of securities by 2020, it will require a hyper-efficient post-trade infrastructure to match. In addition, because they are located at the end of the post-trade process, CSDs are unique witnesses to any failures that occur during the settlement period, making them a key element in the harmonisation of settlement discipline.

Levelling the playing field

For all firms along the value chain across Europe, the implementation of the CSDR will bring a range of benefits. By instigating a series of standardised rules, the regulation will level the post-trade playing field and generate a new wave of transparency. Companies will be able to compare prices for the first time, as services and risk management procedures are standardised. This trend will be enhanced by T2S, when it goes live in June 2015, when participants will be able to access T2S via a single connectivity point for all euro-denominated settlement. In addition, CSDs will have the onus of proving that their systems can deal with both market and operational risk. Best practice will be applied to governance as well, with the automation of participant consultation, the restructuring of boards of directors with new independent non-executive directors, and the implementation of mandatory user committees. CSDs will also be encouraged to openly define their goals and objectives, enabling market participants to get strong insight into the intentions and motives of their settlement partners.

Churning away

For these reasons, on the whole the CSDR can be regarded as positive for the stability of the financial system, despite the fact that it will increase burdens on CSDs such as enhanced capital requirements. It has been clear to many that the European Commission would have to introduce the CSD regulation at some point, now that they had already legislated in relation to trading venues, CCPs and Trade repositories.  The CSDR is also important given other structural developments, such as T2S and the shortening of the settlement cycle to T+2.  This will mean that collateral, which has become the lifeblood of the modern financial market, for instance in securing credit exposures, and providing initial and variation margin, will be freed up more quickly, potentially enabling firms to leverage it to their advantage.

The move to T+2 will in particular provide a real-time test of whether there is a sufficiency of collateral in the financial system, and this will be further tested when T2S goes live in June 2015.This will impact on what Manmohan Singh, ‎Senior Financial Economist at the International Monetary Fund, terms ‘collateral velocity’. If collateral velocity decreases, the markets are less liquid and are at risk of ‘seizing up’. The CSDR and T2S are therefore two of the primary drivers for market participants to improve their collateral management systems, which can handle both the heightened requirements for collateral and the higher rate of collateral churn – or turnover.

Battening down the hatches

Given recent media attention, for many market participants it may feel like the introduction of T2S will bring the project of harmonising the European post-trade infrastructure to a close. This is far from true, however, as it is generally recognised that the European market is still top heavy with post-trade infrastructures, both CCPs and CSDs.

Taken together, the creation of a single euro settlement platform, the shortening of the settlement cycle to T+2 and account handling changes will have a transformational impact along the whole value chain. Market participants will need to think carefully about the sorts of business benefits they can derive from the changes if they are to maintain a competitive advantage in servicing their own clients. For the CSD community itself, competition is intensifying but each will have its own approach. Crucially, the creation of a virtual collateral pool across European markets will help eliminate some of the inefficiencies in transferring securities across systems, hopefully making Europe a more competitive place to do business.

© BestExecution 2014

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