Regulatory changes taking place in the CSD space

Of the several changes taking place in the European central securities depository (CSD) space, one of the biggest is the introduction of competition. CSDs have previously largely enjoyed the status of natural monopolies, servicing their own domestic markets. In the aftermath of the global financial crises that struck post-2008, CSDs have been caught up in the regulatory overhaul of the financial system and this is having a profound effect upon the European space in particular.

As we discussed with Alessandro Zignani last week (http://ds.thomasmurray.com/opinion/monte-titoli-and-t2s-%E2%80%93-interview-alessandro-zignani) Target2-Securities (T2S) is bringing about major changes to European CSDs. “It is not just a challenge for Monte Titoli but for the market as a whole - a change of mind-set,” he commented. The biggest change for CSDs is to embrace competition.

“T2S goes along with the new CSD Regulation (CSDR) with the aim of creating a level playing field,” says Alessandro, head of sales at Monte Titoli and CC&G, the Italian CCP, both of which are part of the London Stock Exchange Group (LSEG). “I think the aim of the regulators is clear – on the one side, to strengthen the robustness of the CSDs, as infrastructure, whilst on the other promoting competition to reduce costs, encourage innovation and create much smoother and more reliable capital markets in Europe.

“Of course it is a big change and all the players in the chain need to review their strategies. We will continue to see changes over the next few years as the T2S migration won’t be complete until March 2017, following the fourth wave. Once everything has settled down, the players will start to look towards the opportunities of the new environment. I have, in a previous role, experienced the impact of the Markets in Financial Instruments Directive (MiFID) and I anticipate this being the same. We will see new players emerge but we can also expect a certain level of consolidation. Monte Titoli already has a strong critical mass with a good client base. We are now trying to move up the value chain.

“Other CSDs that do not have the same volumes will probably not be able to pursue this strategy and will remain focused on their domestic market. At that point, I can see consolidation.”

“It is a big change and it will take time to discover who will be the winners and losers. We believe our business model presents a strong opportunity.”

It is the level of consolidation that will see the risk of a CSD failure in Europe – will the larger players be willing to step in and rescue a small domestic CSD? Competition by its definition implies the presence of winners and losers, a previously alien concept in the CSD space. “I can only talk from Monte Titoli’s perspective and we do not foresee any such events occurring,” says Alessandro about the possibility of a CSD failure. “As an infrastructure, we always act as an agent and we do not take any risks; therefore we do not pass these on to our clients. We do not give any credit whatsoever and we do not manage cash in respect of the settlement being done in central bank money.

“We also offer a very low risk profile to our clients and this is supported by our AA rating, which we have had since 2007. The new regulations around CSDs might consider that you can apply for a banking license, but we are not going to do that. By doing this we do not compete with our clients. Through Monte Titoli and the new Lux CSD, we will maintain this profile.”

The new Lux CSD, an LSEG ICSD, is part of the company’s plan to globalise in the wake of the new regulations. “LSEG’s strategy is to provide another entry point into the post-trade world through the Luxembourg regulatory framework, leveraging the infrastructure and knowledge at Monte Titoli. The new CSD will provide traditional services from settlement, custody and asset servicing, starting from the most liquid financial markets, which will be operational for 22 hours daily. We believe that by offering this alternative point of entry we can increase the possibility of attracting new customers who can use their assets with great flexibility globally, through the same account.

“The new CSD, which is fully owned by LSEG will be user neutral. JP Morgan will be the first client of this CSD.”

Lux CSD is one new entrant in a market that could well see a few more new faces before the topic of consolidation raises its head. The other high profile entrant into the CSD space has been BNY Mellon. Is this move from a custodian bank into the CSD space a welcome development? “It is difficult to gage at the moment as there are changing boundaries,” says Alessandro. “There are always pros and cons. It depends upon who your clients are, the risk appetite that they have and the type of services that you are offering. We think that, probably, there will be more competition in every respect. 

“It is a big change and it will take time to discover who will be the winners and losers. We believe our business model presents a strong opportunity.”

Another change at the CSDs is the change in the settlement cycle from T+3 to T+2 (This is a topic we have covered in detail previously http://ds.thomasmurray.com/opinion/t2-right-direction-right-time-europe). “We have been through these changes before in Italy; from settling on a monthly basis, to T+5 then to T+3, and for fixed income we offer a settlement cycle of T+0, so we do not see this as being a big problem,” adds Alessandro. “T+2 comes with the introduction of T2S and CSDR and is part of the harmonisation process. The Italian market will transition to T+2 from 6 October 2014, alongside other markets.”

There have been fears that, at least initially, this change could see an increased in the number of failed trades. “Initially, it is likely that the number of failed trades could increase but we do not foresee a big impact. Apart from the initial adoption in the first days, we do not have any particular concerns about this.”

Indeed, T+2 is of very little concern to the CSDs themselves, as Alessandro points out settlement can happen in real time. It might be a concern for market participants who have to adapt to the new cycle, but there is little that the CSDs can do about that.

CSDR is the other big change in the CSD space. “There have been big changes across the post-trade world and regulators are trying to make the whole system more robust,” suggests Alessandro on the topic. “The aim of the regulation is to create a level playing field. We are still waiting to see how CSDR will be implemented and managed; it could create discrepancies in different markets if it is not transposed in the same way by everybody. This is the biggest concern for us. To this extent one of the main topics of discussion is settlement finality.”

In aiming to create more robust, innovative CSDs, the European regulators are risking introducing failure into a space with no track record of failure. Whereas there have been high profile failures at CCPs in Paris and Kuala Lumpur, there has not been one at a CSD. Yet they have been caught in the regulatory crosswinds and Monte Titoli is embracing the changes through its proactive stance. As Alessandro said, it is a change of mind-set that is being brought about. 

Tags: CSDICSDRegulationMonte TitoliCSDRT2ST+2competition