The Central Securities Depositories Regulation (CSDR) (Regulation (EU) 909/2014) was published in the Official Journal of the EU in August 2014 and entered into force 17 September 2014.
Although most of the CSDR is in force, as are many of the technical standards, the settlement discipline rules set out in Commission Delegated Regulation (EU) 2018/1229 which were due to become effective in September 2020 have been postponed and are currently expected to enter into force on 1 February 2021. This is to allow stakeholders to have more time to adapt to new developments such as the envisaged implementation on 21-22 November 2020 of the penalty mechanism and the necessary IT system changes, for the development and update of ISO messages, and for market testing and changes to the contractual arrangements between the parties concerned as set out under the Delegated Regulation (see amending document). However, ESMA has announced that it may possibly delay the entry into force of the CSDR settlement discipline regime until 1 February 2022 due to the impact of the COVID-19 pandemic on the implementation of regulatory projects and IT deliveries by CSDs.
The CSDR aims to harmonise the authorisation and supervision of EU CSDs and certain settlement aspects, such as dematerialisation of financial instruments.
Together with EMIR and MiFID II, the proposed Regulation (CDSR) will form a framework in which systemically important securities infrastructures (trading venues, central counterparties, trade repositories and central securities depositories (CSDs) are subject to common rules on a European level.
The Regulation aims to:
-address the lack of safety of securities settlement, in particular regarding cross-border transactions;
-address the lack of efficiency and the resulting obstacles to the functioning of the internal market resulting from the divergent national rules regulating securities settlement and the activities of the CSDs;
-increase the resilience of and access to CSDs by introducing a set of common rules and prudential requirements.
Due to their size, complexity and systemic interconnectedness, CSDs are deemed to be systemically important and therefore require a comprehensive regulatory framework for supervision and oversight that combines micro- and macro-prudential tools.
The introduction of rules in the form of a regulation, ensures that all market participants are subject to uniform and directly applicable obligations regarding the settlement cycle and discipline. It will also ensure that CSDs are subject to uniform and directly applicable prudential standards reinforcing their resilience and central role in the maintenance of book-entry systems and in the settlement process.
In summary, the CSDR contains the following key elements:
-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.
-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.
A central securities depository (CSD) is an institution that holds financial instruments, including equities, bonds, money market instruments and mutual funds. It allows ownership of those instruments to be transferred in electronic form through updating electronic records which are often known as ‘book-entry records’.
CSDs are systemically important infrastructures in modern securities markets; they perform crucial services that allow at a minimum the registration, safekeeping, settlement of securities in exchange for cash and efficient processing of securities transactions in financial markets.
While securities markets traditionally relied on the physical exchange of paper, CSDs now assume a critical role to guarantee a safe and efficient transfer of securities that exist to a large extent only in book entry form. They have now become a central point of reference for an entire market. Furthermore, being located at the end of the post-trading process, CSDs witness all the settlement fails occurring during the settlement period. They are therefore a key element of any policy of settlement discipline. Given the systemic importance of CSDs and their strategic position at the end of the post-trading process, there is a strong need for an appropriate regulatory framework for CSDs.
Central banks and securities regulators in the Committee on Payment and Settlement Systems (CPSS) and the International Organisation of Securities Commissions (IOSCO) recognised the importance of regulation, supervision and oversight in financial market infrastructures, including CSDs. (See IOSCO-CPSS Principles)
CSDR covers all CSDs, but:
- exempts members of the ESCB and other national or public bodies performing similar services, from the authorisation and supervision requirements
- exempts CSDs from the Title IV provisions imposing the segregation between banking services ancillary to settlement and other CSD services.
CSDR covers all financial instruments (as far as the requirements for CSDs are concerned) but mainly covers transferable securities as defined in point (18) of Article 4(1) of Directive 2004/39/EC (MiFID) (essentially shares and bonds) for the purposes of the Title II provisions on securities settlement.
Title II: Securities settlement
Title II includes three sets of measures to achieve the safety of settlement:
- dematerialisation/immobilisation of securities - the issuance of securities in book entry form;
- harmonisation of the settlement period - set at 2 days with shorter settlement periods allowed;
- harmonisation of settlement discipline measures - ex ante measures to prevent settlement fails, and ex post measures to address settlement fails. Failure to deliver securities on the intended settlement date will be subject to a harmonised 'buy in' procedure, which may be executed by a CCP, in the case of a cleared transaction, or otherwise included in trading venues own rules.
Title III: CSDs
Contains provisions addressing the authorisation and supervision of CSDs and also Requirements for CSDs and conflict of law. Directive 98/26/EC does not address the institutions which are responsible for operating securities settlement systems. Institutions operating securities settlement systems need to be legally defined, authorised and supervised along a set of common prudential standards. A CSD is defined as being a legal person that operates a securities settlement system and at least one other core service (either 'notary' service or central maintenance service).
Authorisation and supervision of CSDs
- CSDs will only be permitted to perform certain 'ancillary' services, mostly related to the core services (Without prejudice to specific requirements of Member States tax law);
- CSDs will have to be authorised and supervised by national competent authorities where they are established but other authorities, related to the securities settlement system(s) operated by the CSD and to other group entities will have to be consulted (ESMA to develop draft technical standards to harmonise this area);
- CSDs will be granted a "passport" to provide services in the EU, either by providing directly a service in another Member State or by establishing a branch in that Member State; and
- provisions for third country equivalence.
Requirements for CSDs and conflict of law
Requirements for CSDs consist of:
- organisational requirements - CSDs to have robust governance arrangements, experienced and suitable senior management, board and shareholders, and to set up user committees representing issuers and participants for each securities settlement system
- conduct of business rules - CSDs to have non-discriminatory, transparent and strictly risk-based criteria for participation to securities settlement systems
- requirements for CSD services -
- CSDs to segregate the accounts of each participant from those of other participants and to enable participants to segregate the accounts of each of the participants' clients.; and
- CSDs to settle on central bank accounts when available, with commercial bank money settlement being allowed but via a separate credit institution acting as settlement agent
- prudential requirements - Articles 40-43 deal with provisions on the mitigation of operational risk. Such provisions include establishing, implementing and maintaining an "adequate business continuity policy and disaster recovery plan" allowing the timely recovery of operations and fulfilment of the CSD’s obligations in the event of disruption to operations;
- CSDs to invest its financial resources only in cash or highly liquid financial instruments with minimal market and credit risk, capable of being liquidated rapidly with minimal adverse price effect;
- capital requirements - Article 44 requires CSDs to hold capital "proportional to the risks stemming from the activities of the CSD" allowing the CSD to cover operating expenses for at least six months under a range of stress scenarios (ESMA to develop technical standards specifying the capital, retained earnings and reserves required);
- requirements for CSD links - Article 45 provides for important prudential requirements for linked CSDs, including the setting up of identical settlement finality rules
- Article 46 proposes a conflict-of-law rule with respect to proprietary aspects for securities held by a CSD. "Any question with respect to proprietary aspects in relation to financial instruments held by a CSD shall be governed by the law of the country where the account is maintained".
Access to CSDs
Articles 47-51 address access between: issuers and CSDs, CSDs and CSDs, and CSDs and other market infrastructures. This Regulation completes the access arrangements laid down in both EMIR and MiFIR between trading venues, CCPs,and CSDs necessary to establish a competitive internal market in post-trade services.
Issuers will have the right to record their securities in any CSD authorised in EU as well as the right for CSDs to provide services for securities constituted under the law of another Member State. National specificities are respected by recognising that this right should be without prejudice to the corporate law under which the securities are constituted.
Title IV: Credit institutions designated to act as settlement agents
When central bank settlement is not practical or available, CSDs may offer commercial bank money settlement to their participants. However, CSDs should not provide the banking services ancillary to settlement themselves but should be authorised by their competent authorities to designate a credit institution to act as settlement agent to open cash accounts and grant credit facilities to facilitate settlement unless the competent authorities demonstrate, based on the available evidence, that the exposure of one credit institution to the concentration of credit and liquidity risks is not sufficiently mitigated.
The credit institution acting as settlement agent should be authorised under the Directive 2006/48/EC relating to the taking up and pursuit of the business of credit institutions, (now CRD IV) and comply with additional requirements to mitigate credit and liquidity risks in respect of each securities settlement system they serve.
Title V: Sanctions
The proposed Regulation provides for a list of minimum administrative sanctions and measures available to competent authorities, for the power to impose sanctions and measures for non-compliance with the rules set out in the Regulation, (Article 60 lists the provisions). NB: The proposed Regulation does not prevent individual Member States from fixing higher standards.
Administrative fines should take into account factors such as any identified financial benefit resulting from the breach, the gravity and duration of the breach, any aggravating or mitigating factors and, where appropriate, include a discount for cooperation with the competent authority. Member States are required to put in place effective mechanisms to encourage reporting of breaches to competent authorities.