Competition at CSDs, for better or worse

The European obsession with competition and free market has arrived in the CSD space. It is an unfamiliar concept in this space and will bring with it both positives and negatives for CSDs. There will be a change in approach, of the philosophy of the CSDs and also of the services that they provide. These are entities that stood up resolutely in the recent financial turmoil, so it would appear obvious to argue that if it’s not broken, then why try to fix it?

As we looked into last week with Soraya Belghazi, secretary general of ECSDA, (http://ds.thomasmurray.com/opinion/regulations-csd-space-%E2%80%93-are-they-all-necessary) the raft of regulation on a global scale has impacted upon CSDs, financial market infrastructures with no history of failure and an exemplary record through times of strife. Where regulation is increasingly defining CSDs, it has also opened the door to competition, as is the European Union’s wont. This represents a significant change for CSDs, so what will the effects be?

“One intended consequence of the regulations is that there will be much more competition amongst CSDs,” begins Soraya. “The aim is, although the regulations are not final, to allow market participants and also issuers of securities to be able to freely appoint a CSD of their choice, whether or not the CSD is operating in their domestic market. There will be for the first time a European passport for CSDs, making it easier in principle for a CSD to develop and market services in different countries in the EU. For example, there will be the explicit possibility for CSDs to open branches and this is something that we are expecting to happen. There is no precedent for this in the CSD space, as the ones that do operate in other jurisdictions today do so via subsidiaries. The idea is to really allow CSDs that are active in other countries to be so in a more integrated way. That could raise the possibility of consolidation between operations in multiple countries.”

The argument is still valid, that since CSDs have such an exemplary history as market infrastructures, they should be left as they were. “CSDs performed well through the crisis and represented a haven of stability,” says Jim Micklethwaite, director of capital markets at Thomas Murray Data Services. “They had a certain security in their national monopolies and were able to act responsibly within this framework. They were, essentially, risk averse entities as opposed to money-generating entities. With the introduction of competition into the landscape comes a shift in philosophy, the introduction of new risks and an increase in pricing as they move to a commercial model.”

Other areas of regulation have left CSDs competing not just with other CSDs, but with banks as well; see the entrance of BNY Mellon into the CSD market. The latest draft of UCITS V may, counter to its intentions, encourage custodians to establish CSDs in order to keep all of their assets, and thus their liabilities, in-house. “The good thing about CSDR is that it creates a level playing field,” says Soraya. “One of the things that we were keen to see avoided was the rise of entities providing CSD-like services but not subject to the same rules as existing CSDs. The good thing is that the rules are clear and new players will be required to apply for authorisation and respect the same rules. I think this is a positive development and this is why we wanted a clear definition of a CSD in the law, to make sure that all those entities that operate recognised securities settlement systems for their clients in Europe have to apply for a CSD license.”

Another major catalyst for competition amongst CSDs is T2S. The technology platform will bring settlement processes together in Europe, with the original business case revolving around decreasing settlement costs in Europe. This now will not happen and could even see settlement costs rise. The one benefit will be a centralised collateral pool that will increase efficiency at a time when collateral is at a premium with it being required for margining under the wave of regulations and their various components. Collateral efficiency will also be helped by a move to T+2 settlement.

T2S otherwise looks like increasing competition at the expense of weakening CSDs. “It is a political tool designed to increase competition and consolidation amongst European CSDs by removing their core revenue base,” says Jim. T2S was dreamt up in 2006, before the financial crises struck. It is a solution to a market with volumes that simply no longer exist.

“The goal is to consolidate the CSD landscape in Europe since voluntary consolidation never occurred,” continues Jim. “The system and operational changes require huge investment and will drive up costs. Harmonisation is a painful process and will be so in Europe.”

The very notion of competition implies the presence of winners and losers. “The winners will be the larger players who are currently commercially driven and ready for competition: Clearstream and Euroclear. We will move from national monopolies to a regional oligopoly. The losers will be the smaller, national CSDs; entities that have done nothing wrong nor posed any systemic risk.”

“It is difficult to guess, but there will be parallel trends between CSDs in Europe as a combined effect of T2S and CSDR,” says Soraya. “This will clearly provide an incentive for some CSDs to consolidate their services, or to integrate and even merge. What I am also expecting, however, is the development of new partnerships between CSDs, not necessarily mergers. I think that, a bit like we have seen in the trading and clearing space with new regulations leading to the entry of new players, we could end up with even more CSDs in the first instance than we have at present. After this initial phase, however, I think that you can expect to see a lot more consolidation and integration of services at CSDs.”

How seamless this process of mergers, consolidation and harmonisation is, remains the key question. Questions about the past successes of CSDs are redundant now, since the change is coming. It is too late. “What’s happening in Europe must be viewed by those outside as a golden opportunity,” concludes Jim. The European CSDs are not prepared for competition and are having it forced upon on them. It is plausible that non-European infrastructures will win business in picking up the pieces that will be created by an increasingly fragmented space.

For this to be avoided, the European obsession, or gamble, on competition must be proved right.

Tags: CSDRCSDECSDAT2ST+2EuroclearClearstreamEuropean CommissionEuropean UnionCollateralRegulationUCITS V