A central securities depository (CSD) provides the global financial system with essential services that facilitate the issuance, safekeeping, and settlement of securities. They are a cornerstone of market infrastructure, enhancing the efficiency, security, and integrity of financial markets.
A custodian of securities
The primary function of a CSD is to act as a custodian of securities. These tend to be held in electronic form, which is vital now that physical certificates are largely obsolete in most financial markets. By maintaining electronic records of ownership, a CSD simplifies the process of transferring securities between parties. This electronic bookkeeping ensures that securities can be traded quickly and accurately, reducing the risk of errors and fraud that were more common when physical certificates were the norm.
Facilitating the settlement process
Another critical function of a CSD is to enable the settlement process. Settlement is the finalisation of a securities transaction, where the buyer receives the securities, and the seller receives payment. CSDs ensure that these exchanges occur simultaneously, a process known as ‘delivery versus payment’ (DvP). This mechanism minimises counterparty risk – that is, the risk that one party in a transaction may default on their obligations. By guaranteeing that the transfer of securities and the corresponding payment happen concurrently, CSDs uphold the stability and trustworthiness of the financial system.
Issuance of new securities
When companies or governments issue new stocks or bonds, CSDs help manage the process by recording the issuance in their systems. This means that the securities are correctly accounted for and are available for trading in the market. This function supports the smooth operation of primary markets, where new securities are created, and secondary markets, where existing securities are traded.
CSDs also provide various corporate action services, such as the distribution of dividends, interest payments, and the execution of corporate events like mergers and acquisitions. By efficiently handling these processes, CSDs ensure that investors receive their due entitlements without delay, thus maintaining investor confidence and market integrity.
Market liquidity and systemic risk
The importance of CSDs extends to their role in maintaining market liquidity and reducing systemic risk. Because CSDs facilitate the swift and secure transfer of securities, they enhance market liquidity by enabling buyers and sellers to execute transactions promptly. This liquidity is essential to the proper functioning of financial markets, as it allows investors to enter and exit with ease. Additionally, by reducing settlement times and ensuring the accurate recording of securities ownership, CSDs mitigate systemic risks that could arise from unsettled transactions or discrepancies in ownership records.
CSDs also contribute to the standardisation and harmonisation of market practices, particularly in the context of cross-border transactions. In an increasingly globalised financial system, where securities from one country are frequently traded in another, CSDs facilitate international trade by adhering to global standards and cooperating with other CSDs around the world. This cooperation helps overcome the complexities and legal challenges associated with cross-border securities transactions, promoting smoother and more efficient global market integration.
Transparency and oversight
CSDs maintain comprehensive records of securities transactions and ownership, which provides regulators with the critical data needed to monitor market activities, detect irregularities, and enforce regulations. This transparency is essential for preventing market abuse, fraud, and ensuring that markets operate fairly and efficiently.
As financial markets continue to evolve and expand, the significant role that CSDs play in supporting these developments and ensuring smooth market operations will evolve in response.
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