One of the more interesting developments in the CSD space in recent years has been the evolution of competition. In line with the response to the post-2007 financial crises, CSDs have not been exempt from the wave of new regulation that has swept through financial markets and financial market infrastructures. Whilst this has posed challenges, it has also created opportunities. The CSD space is undergoing a transformation in Europe with the switch to T+2 settlement, the advent of T2S and the introduction of new players to the market.
One of these new players is BNY Mellon. The custodian bank has made the move into the CSD space in response to changes in the markets in which it was operating. “Back in 2010, under Tim Keaney’s leadership, we looked at the European environment – what was changing, what the latest trends were and whether they were positive or negative to our established business model as a group,” explains Chris Prior-Willeard, CEO of BNY Mellon CSD. “We came to the conclusion that a lot was evolving in respect of regulation, market infrastructure, client behaviours and our competitors; we were also seeing new competitors.
“What came of that was that we identified five key drivers behind establishing a CSD. We’re going back three years now, so some of this may seem odd or irrelevant now, but it certainly wasn’t at the time:
- T2S changes everything. The great thing from our perspective is that we’ve engaged with T2S in a number of ways. We took a position on T2S after consulting clients and the industry to ensure that people were viewing this in the right way. From the point of view of what it meant to our own business at the time, however, there was still a great deal that was unknown in terms of exactly how it would affect our existing franchises.
- At that time, Deutsche Börse had made its bid for the New York Stock Exchange and Eurex. This didn’t particularly interest us from a cash perspective, but it interested us greatly from the perspective of bringing LIFFE and Eurex together. We took the view that Eurex Clearing would become the dominant CCP, changing the way assets flow into CCPs.
- Another factor, one that seems obvious now but was an issue at the time, was that we saw that the population of CSDs in Europe was going to change. This affects any business that relies upon a network to deliver services to clients.
- More competition was emerging as the markets reacted to these trends in areas where we had developed a market leadership. So we saw increased entrants into the issuer services layer. From a strategic point of view, this demanded some sort of response.
- The final driver was that US$600 trillion of OTC derivatives were going to be forced through central clearing and this would have a huge impact on the additional requirements for margin. Everyone has since come to the same conclusion: there is a shortfall in eligible collateral for this. Given our collateral management capabilities, this was going to have an impact.
"New regulation – not necessarily confined to the CSD space – and the impact upon BNY Mellon’s existing business lines pushed the company in the direction of establishing a CSD. “Achieving CSD status was one of the responses from our analysis,” continues Chris. “Achieving this would have given us access to the system that the Eurozone central banks were then developing for the movement of central bank collateral, CCBM2 (central bank collateral management). CCBM2 has subsequently been cancelled, but nonetheless, the important issue was that, given our commercial bank status, we were not going to get access to CCBM2. Only central banks and regulated financial market infrastructures would.”
It made sense, therefore, that the company should look to establish its own CSD, given its established interest in the collateral management space. “What we are looking to do is give our clients the choice as to whether they want to receive their services via a commercial bank, or via a regulated financial market infrastructure,” says Chris. “We always look to service our clients to the best of our abilities. We did an awful lot of analysis. It wasn’t a case of identifying the five drivers and getting on with it, we spent a great deal of time through the entire business in Europe and working out what effect those five drivers would have on the rest of the business. We therefore knew where the CSD would fit and the impact that it would have on our other business areas.”
Regulation for CCPs under EMIR states that CCPs must post their non-margin collateral at a CSD. This means that significant amounts will be posted to CSDs. Was this a factor for a company with a strong interest in collateral management? “EMIR 47.3 hadn’t actually become an issue then,” says Chris. “We knew what EMIR was getting at and the regulatory background for CCPs was becoming increasingly clear. The actual detail, however, hadn’t become clear as regards collateral posting. In a sense, that was one of the happy results of us taking a bold and emphatic step in acquiring CSD status in Europe. We’d decided upon that route then along came EMIR 47.3 and all of a sudden here we are as a CSD enabled to hold the non-margined assets of a CCP. In hindsight it looks like great wisdom and we’ve had a lot of interest from CCPs in performing this function for them.”
Once the reasoning for establishing the CSD becomes clear, the next concern is the type of CSD that you wish to establish. Given BNY Mellon’s established issuer business, it is no surprise that the company has set up as, at least initially, an Issuer CSD. “We worked with our national regulator in Belgium, which made it clear it wanted us to apply for Issuer CSD first, then as we developed our strategy that Issuer CSD would migrate quite quickly into an Investor CSD so that we would become both an Issuer and an Investor CSD,” explains Chris.
Yet, is there a lot of difference between issuer and investor CSDs? “This has invited some understandable, if, we feel, incorrect, analysis that the two are entirely separate,” says Chris. “They’re not. It’s the way that T2S sees the engagement of CSDs that you can be an Issuer CSD for an ISIN, but any other CSD that wants to settle that ISIN has to, by definition, be an Investor CSD. From a connectivity point of view, I believe that all CSDs will be both – but International CSDs cannot.
“If you are an Issuer CSD and a listing comes through from your national listing entity, this issuer status is very important from a connectivity and notary perspective. Then what the Investor CSD does is prescribe how the other CSDs can connect. It is all about the safety of corporate action – to ensure that there are not multiple sources of corporate action coming from that initial action by the issuer.”
So, in the first instance at least, BNY Mellon will be an Issuer CSD, meaning that it will be competing on issuer instruments with other CSDs – but which? “All - if it has got an ISIN, we can accept it,” states Chris. “We’re talking bonds, securities, funds, structured assets; the whole lot. This is the beauty of it. Because we are presenting quite an unusual CSD with our background, we have the technologies and infrastructure in place to deal with all of those classes. This is one of our opportunities, we’re happy to accept anything with an ISIN.”
The move to becoming a CSD almost seems inevitable for a company such as BNY Mellon. With all of the upheaval in recent times and new regulations that have emerged, the only question left is why it has taken so long for this movement in the market? “I am surprised that it has taken so long, that there wasn’t a move from within our original market to do what we have done sooner,” concludes Chris. “There has been an overlap there for a while now. It makes sense.”
Later this week we will explore the regulatory landscape directly impacting CSDs from the perspective of a new entrant to the space. You can read the thoughts of ECSDA on this here: http://ds.thomasmurray.com/opinion/regulations-csd-space-%E2%80%93-are-they-all-necessary