What is it?
Following the financial crisis, the Central Securities Depositories Regulation (CSDR) became a part of the EU regulatory reform agenda. The purpose of the CSDR is to harmonize the settlement process and ensure consistency across the EU in relation to the regulation of Central Securities Depositories (CSDs). It aims to increase confidence in the financial markets and provide a safer and more efficient environment for the settlement of securities.
Who will it affect?
The CSDR applies to all CSDs in the EU, together with those in Norway, Iceland and Liechtenstein. In addition, Switzerland is subject to certain provisions via bilateral agreement. Whilst the regulation, as its name suggests, primarily affects CSDs, it also has an impact on CSD customers and other market participants such as central counterparties and trading venues.
CSDs are platforms for the holding and settlement of transactions involving financial instruments such as shares and bonds. CSDs may be structured in a variety of forms, however the CSDR defines a CSD as an entity which (i) operates a securities settlement system (“settlement service”); (ii) records newly issued securities in a book-entry system (“notary service”); and (iii) provides and maintains securities accounts at the top tier level (“central maintenance service”). With the development of technology and the opening of markets in financial services, we are seeing an increase in the number of CSDs coming to market allowing for greater competition and delivery of a wider range of services.
What does it do?
Perhaps the most important change, and the one that we are most familiar with, is the requirement that settlement must occur no later than the second business day after trading takes place for trades executed on a regulated market, multilateral trading facility (MTF) or an organised trading facility (OTF). However, the scope of the CSDR extends much further than this.
Impact on CSD customers
- The CSDR introduces a number of “settlement discipline measures” to act as a deterrent for participants that cause settlements to fail. It establishes a penalty mechanism, whereby a fee will be payable by the failing counterparty to the counterparty that did not receive the settlement. This penalty will apply for each business day that a transaction fails to settle following the intended settlement date.
- If settlement continues to fail and does not occur within a set period then, unless the participants bilaterally cancel the transaction, a mandatory buy-in process will be initiated to effect the settlement. This period is dependent on the asset type and liquidity of the financial instrument concerned (up to four days for liquid securities, up to seven for illiquid securities and up to 15 days for trades on SME growth markets). All buy-in costs must be borne by the failing participant.
- Any Issuer established in the EU that issues or has issued transferable securities which are admitted to trading or traded on a regulated market, MTF or OTF will be required to arrange for such securities to be represented in book-entry form.
- Any institution that executes transfer orders on behalf of clients or on its own account, other than through a securities settlement system, (known as a settlement internalizer) will have to report to their local competent authority on a quarterly basis the aggregated volume and value of all securities transactions that they settle outside securities settlement systems.
- The CSDR gives CSD customers the right to demand segregated accounts. However, in return, the customer must offer its own clients the choice between omnibus client segregation and individual client segregation and inform them of the costs and risks associated with each option. Both the CSDs and their customers must publicly disclose the levels of protection and the costs associated with the different levels of segregation they provide.
Impact on CSDs
- The CSDR requires CSDs to obtain authorization from a national regulator. Only CSDs that are authorized are able to operate a securities settlement system. CSDs must also meet certain minimum capital requirements.
- CSDs shall take appropriate measures to verify that the number of securities making up an issue is equal to the sum of securities recorded on the accounts of the participants of the securities system operated by the CSD. These reconciliation measures must be conducted at least once a day.
- CSDs, together with central counterparties and trading venues, are placed under a new obligation to establish procedures to identify and suspend, in consultation with their respective competent authorities, any participant that consistently fails to deliver securities.
- The CSDR requires CSDs to have robust governance arrangements in place, including a clear organisational structure. CSDs will be subject to regular and independent audits and must comply with certain record keeping requirements.
- New transparency rules have been introduced for CSDs. They must publicly disclose the prices and fees associated with core services that they provide, including discounts and rebates and the conditions that have to be satisfied in order to benefit from those reductions. In addition, CSDs are required to have a publicly disclosed criteria for participation which allows fair and open access to their services. At the same time, it is essential that CSDs ensure their customers do not expose one another to undue risk.
The CSDR entered into force across all member states in September 2014, however a number of provisions apply at a later date. The upcoming implementation timeline is as follows:
- In July 2019 the first settlement internalizer’s report will be due to their local competent authority.
- The settlement discipline measures come into force in September 2020.
- The obligation to record securities in book-entry form applies from 1 January 2023 for transferable securities issued after that date.
- All transferable securities must be in book-entry form by 1 January 2025.
Martin Bartlam is experienced in complex capital markets transactions, securitisation and derivatives.