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Rapporteur: Kay Swinburne
Explanatory Statement
In the past, the main focus was reducing costs for investors and increasing efficiency, however post-crisis, financial regulators and policy makers have widened their interest in the post trade environment to ensuring that our financial infrastructure mitigates counterparty risk where possible, is resilient, and serves the needs of the end investor.
The completion of the single market is a key priority for all EU institutions as we strive to increase competitiveness, growth and financial stability. In the interests of both risk mitigation and ensuring a competitive environment for post trade services, it is necessary to look closely at existing models for CSDs across the EU. We need to assess whether the existing models are appropriate for the future developments of the single market. One of the most immediate developments is the introduction of the ECB's Target2Securities (T2S) system, due to go live in 2015. While historically there has been a single CSD for each Member State, with the introduction of T2S it is now possible to see how a more streamlined and integrated model may develop.
In this report the Rapporteur has looked closely at the current post-trade settlement systems to assess where improvements can be made to best serve the needs of all investors. Further objectives of this legislation include the encouragement of new entrants so as to foster a competitive environment, a reduction of cross-border settlement costs and the mitigation of counterparty risk which are all addressed in the report.
Settlement Cycles and Settlement discipline
In order for the real benefits of Target2Securities to be felt it is necessary to harmonise settlement cycles. Many Member States and other international markets are already converging around T+2, meaning that the intended settlement date shall be not later than on the second day of business after the trade takes place. This therefore seems an appropriate first step that could perhaps be shortened in the future.
Currently there is no common definition across the EU of what constitutes a settlement fail, therefore it is very difficult to measure what effect this is having upon the market. All settlement fails should be reported to the regulated and disclosed publicly in an aggregated format on a regular basis.
In order to reduce the problems caused by settlement fails it is appropriate that sanctions be imposed upon offending market participants and for receiving parties to be able to initiate a buy-in procedure four days after the intended settlement date should their counterparty have failed to deliver the securities. Further to this.
SME Growth Markets
All EU markets legislation should be properly tailored for SME Growth Markets, so as to encourage more SMEs into the capital markets, particularly so as to reduce companies' reliance upon bank lending. Given the often less liquid nature of SME securities it is therefore appropriate to allow venues to exclude SME Growth markets from the sanctions for settlement fails for a period up until 15 days after the intended settlement date when a buy-in procedure can also be initiated to ensure delivery. While T+2 should still be the expectation, some flexibility should be allowed by the operators of these markets.
Supervision
Responsibility for authorising and supervising CSDs should remain primarily with the Member States. However, in order to facilitate the efficient development and then coordinate the supervision of a single European post-trade infrastructure, ESMA should conduct a specialised peer review of the national competent authorities of CSDs offering cross border services regularly. Information concerning the operation of CSDs should be shared upon request with all competent authorities.
Banking Services
In order for CSDs to be as resilient as possible, and maintain a level playing field across the entire EU, if it seems appropriate that a CSD wants to provide banking services to perform its primary function, it is required to establish a separate legal entity constituted under the relevant banking legislation (CRD IV) to provide these services. As more stress is being put on market infrastructure via central counterparties and increased collateral management needs, it is important that institutions providing these services are regulated to the highest possible standard. Should the settlement arm of a CSD fail due to the collapse of one of its intraday liquidity providers for example, then it should be possible for another settlement agent bank to be able to take its place without the complete failure of the CSD.
Separation of the activities within a group should ensure it is simpler, in an emergency situation, to ensure client access to their securities at all times. A similar situation in an integrated model would require legal resolution by administrators. The CPSS IOSCO guidelines and the recent consultation document released by the Basel Committee on Banking Supervision, Consultative Document, "Monitoring Indicators for Intraday Liquidity Management" July 2012 show the concerns of international regulators in this regard. It would seem that any loss of efficiency by operating the cash and securities businesses of a CSD as separate legal entities is fully compensated by a reduction in systemic risk to the end investor by avoiding more complex resolution procedures.
If a separation of the banking services from the settlements services were not to be included in this regulation, a specialised regime would need to developed to encompass the activities of the International CSDs (ICSDs) given their role as systemically important financial institutions.
CSD Links
In order to achieve a more integrated post trade landscape across the EU, it is appropriate to reduce the administrative burden of CSDs linking to one another in the case of standard links that do not involve the transfer of risk. Target2Securities will make these links safer and more useful to market participants. While other types of links should also be encouraged, they require closer supervision and should be subject to explicit authorisation procedures.
Internalisation
There are no indicators for the proportion of settlement activities taking place outside of the settlement systems operated by CSDs and Central Banks in the EU. While this activity could provide positive competitive pressure upon market infrastructure and reduce costs for investors, the Rapporteur believes that all settlement should take place in a regulated environment. Given the lack of information on this kind of activity it is important that this regulation set up a framework for the reporting of internalised settlement so it can be better understood and the regulation can be tailored if necessary.
Segregation
Investors should be able to choose the level of protection required for their assets throughout the entire chain of trade to post trade. This should entail CSDs offering fully segregated client accounts and omnibus type accounts, should this be an investor preference, at a reasonable cost. National law that prevents this should be modified so costs can be reduced for the end investor choosing this level of segregated account.
Rehypothecation
As regulations such as EMIR and CRD IV place higher collateral demands upon financial institutions it is very important that regulators are able to monitor how collateral is being reused and rehypothecated. While detailed guidelines will be developed for work on Shadow Banking, the key role that is played by CSDs via securities lending activities as well as their notary function means they are well placed to provide evidence to regulators of how best to proceed in this area. Notwithstanding this, end investors should always be required to give their informed consent should their assets be used by anyone else in the chain of post trade services for other purposes, and any fees earned in relation to rehypothecation should be transparent.
Dematerialisation
Those Member States that have not fully dematerialised should be given a deadline to do so in order to ensure that the benefits of the single market in financial services can be felt by all investors. Retail investors should be given comprehensive information regarding the process from certificated shared to dematerialised ones and be made aware of the benefits and safety of electronic records as opposed to paper share certificates. In order for shareholders to play a more active role exercising their rights over companies it is necessary that central registers be kept that will facilitate the use of these rights. Given the need to change investor culture, a suitably long period of adjustment needs to be allowed, although the transition to dematerialisation at the point of settlement of trade, rather than at the point of trade itself, should aid the transfer to electronic formats.
Securities Law and Conflict of Laws
A common understanding to overcome the conflicting laws of different Member States governing securities is required to make the provisions of this regulation fully operational. Tying each issuer to the CSD of their own Member State is not inline with the single market, therefore it is important that this issue is solved. Above all else legal certainty for all market participants should be guaranteed in this regulation and should be further strengthened by Securities Law legislation as soon as practical.