Europe to Unveil Securities Settlement Regulation

Terry Flanagan

Proposals call for settlement in central bank money.

The European Commission will unveil proposals for a new regulatory framework for central securities depositories (CSDs) on March 7.

CSD regulation, together with Markets in Financial Instruments Directive (MiFID) and European Markets Infrastructure Regulation (EMIR), form the triumvirate of legislative actions in Europe that will transform the functioning of the securities markets.

CSDs are systemically important institutions for the financial markets because they operate the infrastructures that enable the settlement of virtually all securities transactions worth over 900 trillion euro per year.

CSDs are also involved in the issuance of securities involving the public and private sectors.
In the United States, National Securities Clearing Corp. (NSCC), a subsidiary of DTCC, functions as the central counterparty for the nation’s major exchanges and markets, clearing virtually all broker-to-broker equity, listed corporate and municipal bond trading in the U.S.

In Europe, Euroclear Bank and Deutsche Börse’s Clearstream Banking Luxembourg operate the two international CSDs, known as international CSDs used by securities professionals for cross-border transactions. Both Euroclear and Clearstream also operate national CSDs in Europe.

The regulation stipulates that national CSD settlement takes place in central bank money–i.e., in accounts held at the central bank for transactions denominated in the currency of the country where settlement takes place—whenever practicable and feasible.

Euroclear and Clearstream have emphasized that while it’s understandable that the EC would prefer settlement to take place in central bank money, settlement by the inerrnational CSDs in commercial bank money is a perfectly feasible alternative, provided that the settlement provider adhere to strict risk parameters.

“Existing CSDs have to look for new areas because of T2S and the flexibility to change business models is boxed in as the draft EU law increases operational complexity as currently written,” Clearstream told Markets Media in a statement. “The CSD regulation is disproportionate and it’s increasing operational risk versus the objective of the regulation which is to increase the level of safety in the system.”

Another important aspect concerns the harmonization of settlement periods, i.e. the time between the conclusion of a transaction and settlement. Currently, all European securities markets do not follow a common settlement period (e.g. for equities, regulated markets either settle two days or three days after trade (T+2 or T+3).

The European Central Bank’s Target2Securities (T2S), scheduled to go live in 2015, will centralize settlement in central bank money, primarily in euros.

This differs from the current situation where CSDs settle the cash component of their clients’ trades with their local central bank. When T2S is launched, CSDs are expected to outsource the settlement of both the securities and cash components to T2S.

Settlement across borders presents unique risks and higher costs for investors. For example, cross-border trades do not settle on the intended settlement date far more frequently than domestic trades, although still less than 1%. Meanwhile, cross-border transactions in Europe continue to increase.

The CSD regulations are a long time coming. The Giovannini Group, in a 2001 report, had identified several barriers to efficient clearing and settlement systems, including national differences in settlement periods.

The new CSD regulatory framework will distinguish between core and ancillary services. Core services include maintaining a central register of securities, central safekeeping and accounting of securities, and settlement.

Ancillary CSD services could include banking-like services that a CSD renders in order to facilitate settlement, such as securities lending.

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