Explanatory Memorandum to COM(2012)73 - Improving securities settlement in the EU and central securities depositories (CSDs) - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2012)73 - Improving securities settlement in the EU and central securities depositories (CSDs). |
|---|---|
| source | COM(2012)73  |
| date | 07-03-2012 |
The Central Securities Depositories (CSDs) are systemically important institutions for the financial markets. Any trade of securities on or off a securities exchange is followed by post-trade processes that lead to the settlement of that trade, which is the delivery of securities against cash. The CSDs are the key institutions that enable settlement by operating so-called securities settlement systems. CSDs also ensure the initial recording and the central maintenance of securities accounts that record how many securities have been issued by whom and each change in the holding of those securities.
CSDs also play a crucial role for the collateral market especially for monetary policy purposes. For instance, almost all of the eligible collateral for central bank monetary policy operations in the EU, especially in the Euro area, flows through securities settlement systems operated by CSDs.
Securities settlement systems in the EU settled approximately €920 trillion worth of transactions in 2010, and held almost €39 trillion of securities at the end of 2010. There are over 30 CSDs in the EU, generally one in each country, and two international CSDs (ICSDs – Clearstream Banking Luxembourg and Euroclear Bank), which are a sub-category of CSDs specialised in the issuance of international bonds, commonly known as 'Eurobonds'.
While generally safe and efficient within national borders, CSDs combine and communicate less safely across borders, which means that an investor faces higher risks and costs when making a cross-border investment. For example, the number of settlement fails is higher for cross-border transactions than for domestic transactions and cross-border settlement costs are up to four times higher than domestic settlement costs.
These safety problems are the result of a number of factors, including:
· The length of the settlement cycle. The time between trade and settlement is not harmonised in the EU, creating disruptions when securities are settled cross-border;
· A small but substantial proportion of securities still exist in paper form. These are settled after a much longer settlement cycle, which increases the risk incurred by investors;
· Settlement fails, which are situations where a transaction fails to be settled on the intended settlement date, are not subject to deterrent penalties in all markets and where they exist settlement discipline measures differ widely between markets;
· While Directive 98/26/EC on settlement finality in payment and securities settlement systems (SFD) reduces the disruption to a securities settlement system caused by insolvency proceedings against a participant in that system, it does not address other risks of the system or the resilience of the CSD operating the system. Some CSDs are subject to additional credit and liquidity risks derived from the provision of banking services ancillary to settlement;
· Agreements between CSDs to link-up, while being considered as a first step towards the consolidation of the European settlement markets, raise safety concerns in the absence of specific prudential rules for such links. In addition, they increase the interconnectedness between CSDs, which justifies further the introduction of a common prudential framework.
The absence of an efficient single internal market for settlement also raises important concerns. Important barriers to the European post trading market continue to exist, such as for instance the limitation of securities issuers' access to CSDs, different national licensing regimes and rules for CSDs across the EU and limited competition between different national CSDs. These barriers result in a very fragmented market. As a consequence, the cross-border settlement of transactions relies on unnecessarily complex holding chains often involving several CSDs and several other intermediaries. This has a negative impact on the efficiency, but also on the risks associated with cross-border transactions.
These problems are important as cross-border transactions in Europe, ranging from usual purchases/sales of securities to collateral transfers, continue to increase and CSDs become increasingly interconnected. These trends are expected to accelerate with the advent of Target2 Securities (T2S), a project launched by the Eurosystem to provide a borderless common platform for securities settlement in Europe, which is scheduled to start in 2015.
This proposed Regulation addresses these problems. It introduces an obligation to represent all transferable securities in book entry form and to record these in CSDs before trading them on regulated venues. It harmonises settlement periods and settlement discipline regimes across the EU. It introduces a common set of rules inspired by international standards addressing the risks of the CSDs' operations and services. As CSDs will be subject to identical substantive rules across the EU, they will benefit from uniform requirements for licensing and an EU wide passport, which will help remove the existing barriers of access.
The proposed Regulation will therefore increase safety in the system and open the market for CSD services, therefore improving the efficiency of securities settlement. The proposed Regulation will complete the regulatory framework for securities market infrastructures, alongside the Directive 2004/39/EC on markets in financial instruments (MiFID) for trading venues, and the proposal for a Regulation on derivative transactions (EMIR) for Central Counterparties (CCPs).
This initiative has received wide political support. The ECOFIN Council of 2 December 2008 emphasised the need to strengthen the safety and soundness of securities settlement systems operated by CSDs and agreed that EU legislation is needed to address legal barriers relating to post-trading, including barriers of access to CSDs. The need for appropriate standards for CSDs is also agreed internationally. As early as 2001 global banking and securities regulators (CPSS-IOSCO) adopted a set of recommendations for securities settlement systems. These were adapted through non-binding guidelines by European regulators (ESCB-CESR) in 2009. In October 2010 the Financial Stability Board re-iterated the call for updated standards for more robust core market infrastructures and asked for the revision and enhancement of existing standards.
Contents
- results of consultations with the interested parties and impact assessment
- Legal elements of the proposal
- Budgetary implications
- 3.1. Legal basis
- 3.2. Subsidiarity and proportionality
- 3.3. Detailed explanation of the proposal
- 3.3.1. Scope of proposal (Title I)
- 3.3.2. Securities settlement (Title II)
- 3.3.3. CSDs (Title III)
- Requirements for CSDs and conflict of law (Chapters II and III)
- Access to CSDs (Chapter IV)
- 3.3.4. Credit institutions designated to act as settlement agents (Title IV)
- 3.3.5. Sanctions (Title V)
- 3.3.6. Compliance with Articles 290 and 291 TFEU
This initiative is the result of an extensive and continuous dialogue and consultation with all major stakeholders, including securities and banking regulators, the ECB and all types of market participants. It takes into consideration the views expressed in a public consultation from 13 January to 1 March 2011, and the input obtained through a broad range of stakeholder groups since summer 2010.
In addition, an external study of costs and prices in the post trading sector was commissioned from Oxera Consulting. Oxera delivered a first report in 2009 and a second one in 2011. These reports provide useful data on the cost gaps between cross-border and domestic post trading costs in Europe.
In line with its 'Better Regulation' policy, the Commission conducted an impact assessment of policy alternatives. Policy options were assessed against the key objectives of increasing the safety, efficiency and level playing field for CSD services in Europe. The assessment was done by considering the effectiveness of achieving the objectives above and the cost efficiency of implementing different policy options.
The draft impact assessment report was submitted on 16 March 2011 to the Commission's Impact Assessment Board (IAB), followed by a resubmission of a revised draft on 8 August 2011. The draft report was considerably improved following the comments of the IAB by strengthening the evidence base underlying the problems found and the analysis of different policy options, in particular with respect to banking services ancillary to settlement and by including an estimation of the overall benefits and of the impact of different policy options on different stakeholder groups and a clearer and more robust monitoring and evaluation framework.
The proposal is based on Article 114 of the Treaty on the Functioning of the European Union ('TFEU') as the most appropriate legal basis in this field. The proposal aims principally at addressing the lack of safety and efficiency of securities settlement 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, which operate securities settlement systems, by introducing a set of common rules concerning certain aspects of the settlement cycle and discipline, as well as a set of common prudential requirements addressing the resilience of and access to CSDs.. In the absence of such common rules and requirements, likely divergent measures taken at national level will have a direct negative impact on the safety, efficiency and competition in the settlement markets in the Union. A regulation is considered to be the most appropriate instrument to ensure that all market participants are subject to uniform and directly applicable obligations regarding the settlement cycle and discipline, and that CSDs are subject to uniform and directly applicable prudential standards in the Union, which should reinforce their resilience and central role in the maintenance of book-entry systems and in the settlement process.
As the main purpose of the proposed Regulation is to introduce a number of legal obligations imposed directly on market operators consisting, inter alia, in the recording of virtually all transferable securities in book-entry form in a CSD and a stricter time frame for settlement and as CSDs are responsible for the operation of securities settlement systems and the application of measures to provide timely settlement in the Union, it is essential that all CSDs constantly comply at all times with uniform and stringent prudential requirements provided in the proposal. It is therefore necessary to include in this proposal a set of uniform and directly applicable rules regarding the authorisation and ongoing supervision of CSDs, as a corollary to the legal obligations imposed on market operators.
According to the principle of subsidiarity provided in Article 5 of the Treaty on European Union, action at Union level should be taken only when the aims envisaged cannot be achieved sufficiently by Member States alone and can, because of the scale or effects of the proposed action, be better achieved by the EU.
This proposal essentially aims at making the European securities market safer and more efficient within the Union, which calls for a coordinated EU action. The Union action is further justified by the systemic nature of CSDs and their increasing interconnection, in particular after the introduction of T2S.
As regards authorisation and supervision of CSDs, the proposed Regulation aims at striking a balance between the competences of national authorities and the interests of other competent authorities. The European Securities and Markets Authority (ESMA) will play a key role in resolving disputes, facilitating the cooperation arrangements between national authorities and developing technical standards in close consultation with the members of European System of Central Banks (ESCB).
Certain issues are already covered by existing Union legislation. For instance, securities settlement systems are already defined by Directive 98/26/EC on settlement finality in payment and securities settlement systems and Directive 2004/39/EC (MiFID) provides for certain rules of access by market participants to the securities settlement system of their choice. The proposed Regulation is consistent with these Union texts.
The proposal also takes full account of the principle of proportionality required in Article 5 of the Treaty on European Union, namely that Union action should be adequate to reach the objectives pursued and should not go beyond what is necessary. The proposed Regulation is compatible with this principle and strikes the right balance between the public interest at stake and the cost-efficiency of the measures proposed. The proposal has taken full account of the need to balance safety, efficiency of the markets and costs for the stakeholders.
The proposed Regulation has two main parts: measures addressing all market operators in the context of securities settlement (Title II) and measures addressing specifically CSDs (Titles III, IV and V). The remaining titles, on scope and definitions (Title I) and transitional and final provisions (Title VI) apply to both parts of the proposal.
The proposed Regulation covers all CSDs, but exempts from the authorisation and supervision requirements the members of the ESCB and other national or public bodies performing similar services, such as the Member States national bodies charged with or intervening in the management of the public debt, that would otherwise qualify as CSDs. These institutions nevertheless remain subject to the full set of requirements for CSDs. They are exempt from Title IV, which imposes the segregation between banking services ancillary to settlement and other CSD services since these institutions, by their very nature, provide such ancillary services.
Regarding financial instruments, the proposal covers all financial instruments as far as the requirements for CSDs are concerned, but it mainly covers transferable securities as defined in point (18) of Article 4 of Directive 2004/39/EC (MiFID) (essentially shares and bonds) for the purposes of Title II on securities settlement.
A key objective of the proposed Regulation consists in increasing the safety of settlement. Title II includes three sets of measures to achieve this objective. First, it imposes the so-called dematerialisation/immobilisation of securities, which is the issuance of securities in book-entry form. This measure is aimed at increasing the efficiency of settlement, facilitating the shortening of settlement periods and ensuring the integrity of a securities issue by allowing for easier reconciliation of securities holdings. Book entry securities do not necessarily need to be recorded in a CSD before they are traded or given as collateral. They may be, for instance, recorded by registrars. However, if they are traded on venues regulated by Directive 2004/39/EC (MiFID), they need to be recorded in a CSD, in order to benefit from the protection for securities settlement systems under Directive 98/26/EC and in order to facilitate reconciliation between securities recorded, on the one hand, and securities traded, on the other hand. The proposed Regulation provides for a sufficiently long transitional period, until 1 January 2018, in order to allow market operators from the Member States where significant amounts of paper securities still exist to comply with this measure.
Second, Title II harmonises the settlement period for the securities transactions across the EU. In Europe most securities transactions are settled either two or three days after the trading day, depending on each market. The settlement period will be harmonised and set at two days after the trading day, although shorter settlement periods will be allowed. Third, Title II harmonises settlement discipline measures across the EU. These consist of ex ante measures to prevent settlement fails, and ex post measures to address settlement fails. The key objective is to reduce settlement fails and to discourage any competition lowering the standards for settlement discipline, for instance between markets that may have different penalties systems in place. The proposed provisions go beyond the level of CSDs and aim to subject market participants that fail to deliver securities on the intended settlement date 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.
Authorisation and supervision of CSDs (Chapter I)
Directive 98/26/EC defines already securities settlement systems as formal arrangements allowing transfers of securities between different participants. However, that directive does not address the institutions which are responsible for operating such systems. In view of the increasing complexity of such systems and risks related to settlement, it is essential that institutions operating securities settlement systems are 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). In addition, CSDs would only be permitted to perform certain ancillary services, which are mostly related to the core services. Where such ancillary services include tax services, CSDs would need to ensure that they comply with the tax legislation of the Member States concerned. In the case of withholding tax relief procedures, CSDs would need to observe any requirements that the Member State of source of the payments subject to withholding tax imposes on financial intermediaries in order to authorise them to apply the withholding and claim withholding tax relief on behalf of the beneficial owners of the payments. This may in particular involve the obligation to report investor information directly to the source Member State (in return for being able to claim relief from withholding taxes at source), which may in turn pass it on to the Member State of residence of the beneficial owner of financial instruments.
CSDs will have to be authorised and supervised by national competent authorities of the place where they are established. However, in view of the increasing cross-border element of their activity, other authorities, related to the securities settlement system(s) operated by the CSD and to other group entities would have to be consulted. ESMA will have an important role in developing draft technical standards to harmonise the authorisation process and to ensure cooperation between authorities.
The proposal grants authorised CSDs a 'passport' to provide services in the Union, either by providing directly a service in another Member State or by establishing a branch in that Member State. A CSD from a third country can be granted access to the Union if it is recognised by ESMA. Such recognition may be granted only when the Commission has ascertained that the legal and supervisory framework of that third country is equivalent to the Union one and that the third country provides for a effective equivalent recognition of the Union regulatory and supervisory framework; the CSD is subject to effective authorisation and supervision in that third country; and cooperation arrangements are in place between ESMA and that third country authorities.
Since CSDs are systemically important and perform critical services for the securities market, they must be subject to high prudential standards to ensure their viability and the protection of their participants. The requirements for CSDs are grouped into several categories in Chapter II: organisational requirements (Section 1), conduct of business rules (Section 2), requirements for CSD services (Section 3), prudential requirements (Section 4) and requirements for CSD links (Section 5).
Section 1 requires 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. Any outsourcing of services or activities should not compromise the responsibility of a CSD towards participants or issuers or the exercise of supervisory and oversight functions by different authorities. An important exception is foreseen for outsourcing arrangements with public entities, such as the T2S project operated by the Eurosystem, which are governed by a dedicated framework agreed by the competent authorities.
Section 2 introduces important requirements for CSDs to have non-discriminatory, transparent and strictly risk-based criteria for participation to securities settlement systems. These requirements are reinforced by the provisions on access set out in Chapter IV. It also introduces important principles on transparency regarding public disclosure of prices and disclosure to the competent authorities of costs and revenues by service provided.
Section 3, in Article 34 on requirements for CSD services, recognises the important role played by CSDs in ensuring the integrity of a securities issue and includes obligations about intraday reconciliation of accounts. In terms of account segregation for the purpose of protecting participants' assets, the proposal goes beyond the requirements provided in Directive 2004/39/EC (MiFID) and requires 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. Regarding cash settlement, the proposal requires CSDs to settle on central bank accounts whenever practical and available. Commercial bank money settlement is allowed, however, contrary to some current practices, it must be done via a separate credit institution that acts as settlement agent.
The prudential requirements for the CSDs themselves in Section 4 include important provisions on the mitigation of operational risk. Since CSDs would not be permitted to perform banking type of services directly, the key risk CSDs will face is operational risk. These provisions include appropriate measures to ensure the continuity of operations, including settlement, at all times. Capital requirements are also set by reference to operating expenses – CSDs should hold capital, retained earnings and reserves to cover at least six months of operating expenses.
As CSDs are increasingly interconnected and this process is expected to accelerate with the advent of T2S, Article 45 provides for important prudential requirements for linked CSDs, including the setting up of identical settlement finality rules.
Chapter III aims at increasing the legal certainty for securities transactions, by proposing a conflict-of-law rule with respect to proprietary aspects for securities held by a CSD.
Opening up the market for CSD services and removing barriers of access is one of the objectives of this initiative. Chapter IV addresses three types of access: (a) between issuers and CSDs, (b) between CSDs, and (c) between CSDs and other market infrastructures.
In many Member States issuers are required by law to issue certain types of securities, most notably shares, in the national CSD. Article 47 introduces the right of issuers to record their securities in any CSD authorised in the Union as well as the right for CSDs to provide services for securities that have been 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.
Sections 2 and 3 lay down the principles on access. A CSD should have the right to become a participant in a securities settlement system of another CSD based on non-discriminatory and risk-based principles. A CSD should also have the right, based on the same principles, to request another CSD to develop special functions, which should be charged on a cost-plus basis. Similarly, a CSD should have the right to receive transaction feeds from CCPs and trading venues and those infrastructures should have access to securities settlement systems operated by CSDs. Any disputes between the relevant competent authorities could be referred to ESMA for dispute resolution.
As described before, 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. This separation between CSDs and settlement agents is an important measure to address and increase the safety of CSDs. Banking services ancillary to settlement increase the risks to which CSDs are exposed and therefore the likelihood of CSDs suffering a default or being subject to severe stress. While the banking services are usually provided by some CSDs on intraday basis and are limited to the services ancillary to settlement, the amounts handled are however significant and any default of such CSDs would have negative consequences for the securities and payments markets. The requirement to provide the banking services in a separate legal entity than the one which provides the core CSD services will prevent the transmission of risks from the banking services to the provision of core CSD services, in particular in case of insolvency or severe stress resulting from the banking services. This requirement will also provide CSDs and public authorities with more options to find appropriate solutions in case of default of the settlement agent providing banking services. For the CSDs which currently provide banking services, the main costs associated with this measure are the legal costs involved in the setting-up a separate legal entity for providing banking services, while CSDs willing to develop such services in the future would not incur significant incremental costs for setting-up of a separate legal entity. There are no less stringent alternatives to the separation of banking services, which would entirely eliminate the danger of transmission of risks from the banking services to the core CSD services.
In order to secure the efficiencies resulting from the provision of both CSD and banking services within the same group of undertakings, the requirement that banking services be carried out by a separate credit institution should not prevent that credit institution from belonging to the same group of undertakings as the CSD. However, if both CSD and banking services are provided within the same group of undertakings, the activities of the credit institution providing banking services should be limited to the provision of banking services ancillary to settlement. The latter restriction aims at reducing the overall risk profile of the group resulting from the presence of a credit institution in that group.
The competent authority should be able demonstrate on a case by case basis the absence of systemic risk incurred by the provision of both CSD and banking services by the same legal entity. In such a case, a reasoned request could be made to the European Commission which may authorise the derogation. In any case, the activities of a CSD licensed as credit institution should be limited to the provision of banking services ancillary to settlement.
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. However, as securities settlement system(s) operated by CSDs should be protected as much as possible against any potential risks caused by settlement agents, such agents should comply with additional requirements to mitigate credit and liquidity risks in respect of each securities settlement system they serve.
Considering that Directive 2006/48/EC does not address specifically intraday credit and liquidity risks resulting from the provision of banking services ancillary to settlement, credit institutions should also be subject to specific enhanced credit and liquidity risk mitigation requirements that should apply to each securities settlement system in respect of which they act as settlement agents. The proposed requirements for the settlement agents are inspired by the international CPSS-IOSCO standards for financial market infrastructures and by current market practices. They include full collateralisation of credit exposures, monitoring of intraday liquidity taking into account the liquidity risk generated by the default of the two largest participants and concentration limits on liquidity providers.
A review of the existing sanctioning powers and their practical application aimed at promoting convergence of sanctions across the range of supervisory activities has been carried out in the Commission Communication Reinforcing sanctioning in the financial services sector. A stock taking of the national regimes in place has, for example, revealed that the levels of pecuniary sanctions vary widely among Member States, that some competent authorities do not have certain important sanctioning powers at their disposal and that some competent authorities cannot impose sanctions on natural and legal persons. As a result, the Commission now proposes that Member States should provide that appropriate administrative sanctions and measures can be applied to breaches of the Regulation. To this end, a minimum set of administrative sanctions and measures should be available to the competent authorities, including withdrawal of authorisation, public warnings, dismissal of management, restitution of profits gained from the breaches of this Regulation where those can be determined, and administrative fines. The maximum level of administrative fines should not be lower than the level provided for by the Regulation – 10% of the annual turnover of a legal entity or five million Euro or 10% of the annual income of a natural person. When determining the type and level of sanctions, the competent authorities should take into account a number of criteria set in the Regulation, including the size and financial strength of the responsible person, the impact of the violation and the cooperative behaviour of the responsible person. The proposed Regulation does not prevent individual Member States from fixing higher standards.
On 23 September 2009, the Commission adopted proposals for Regulations establishing EBA, EIOPA, and ESMA. In this respect the Commission wishes to recall the Statements in relation to Articles 290 and 291 TFEU it made at the adoption of the Regulations establishing the European Supervisory Authorities according to which: 'As regards the process for the adoption of regulatory standards, the Commission emphasises the unique character of the financial services sector, following from the Lamfalussy structure and explicitly recognised in Declaration 39 to the TFEU. However, the Commission has serious doubts whether the restrictions on its role when adopting delegated acts and implementing measures are in line with Articles 290 and 291 TFEU.'
The proposal has implications for the European Union budget related to the tasks allocated to ESMA, as specified in the legislative financial statements accompanying this proposal.