Global Custodian attended a recent post trade event to hear about current moves to harmonize and make more efficient the European post trade environment.
Kicking off the event, European Securities and Markets Authoritys (ESMA) Verena Ross noted that the main focus for the EU independent regulator in 2012 will be EMIR, where it will draft technical standards for OTC derivatives, CCP and trade repositories. With the 2013 deadline to implement the regulation looming, ESMA will this month issue a discussion paper on EMIR (looking at less controversial areas where agreement at level 1 has already been reached) as it awaits the final text from the EU legislative process. As part of that we are likely to also hold a public hearing in March / early April, said Ross.
Confirming that indications were that the deadline for technical standards has been pushed back from June 30 to September 30, Ross added that the discussion paper will include some draft technical standards depending on whether there is a final text to refer to. I am grateful that we have indication that the deadline for ESMA work under EMIR might have moved to something slightly more realistic. We will also have a formal consultation paper in any case later on which will include the legal text and the cost benefit analysis, said Ross.
ESMA is also awaiting the CSD regulation, expected next year as opposed to this year while negotiations and the legislative process un-folds. The draft regulation is expected in two to three weeks. We are working with the national competent authorities to pull together some common data on settlement fails and working towards harmonizing approaches of data streams and to get to something that is more consistent as well as ensure there is a proper exchange of information to ensure robustness of the post-trading systems.
Euroclears Jol Mrre, who is also chairman of the European Central Securities Depository Association (ECSDA), noted that CSDs could be facing considerable consolidation of their infrastructure with T2S asking them to outsource settlement to a common model, which would be owned and operated by the Eurosystem.
Commenting on the potential reduction of cross-border settlement costs under T2S, he said: If we reduce by a certain amount the number of infrastructures for settlement, this will produce some savings. He also noted that T2S will, in effect, force CSDs to compete as they become investor CSDs, meaning that they will pursue business opportunities currently provided by CSDs outside their home market. Under T2S, Euroclear France, for example, could give its clients access to all securities processed by T2S. This is also where custodians and CSDs could compete, the major difference being that CSDs will be able to settle in central bank money whereas ICSDs and custodians settle in commercial bank money. But, not all CSDs are likely to develop that business and move up the value chain.
Mrre said T2S will not be able to trigger a lot of savings in the short term because CSDs will not de-commission any processing platforms and will have to invest to connect their systems to T2S. We are working very hard to prepare ourselves for T2S and have already invested a lot of money, but in the end the cost/benefit analysis of T2S will be assessed on its long-term benefits or some form of infrastructure consolidation. The question remains whether there will be further consolidation or not.
Mrre also noted moves towards greater harmonization on the asset servicing side. High costs relating to the burdens that intermediaries must manage for having to deal with different tax codes, market practices and regulation in Europe remains a problem that T2S alone will not resolve. Harmonization of public and private sector rules and regulations is key or we will end up with the same levels of post-trade costs. The benefits of consolidation are not about CSD A buying CSD B; rather its when the operations of CSD B can be transferred to the operations of CSD A.
While the ECB is putting a lot of emphasis on harmonization, we can wonder whether the interest to harmonize isnt fading due to other priorities. And, since harmonization has a cost attached to it, the commitment to spend, given current market conditions, is diminishing, he added. I am convinced that some parts of the harmonization process will only be achieved through legislative changes. We have seen some elements in the draft CSD regulation in that it covers settlement fails and penalty regimes.”
Florence Fontan of BNP Paribas Securities Services noted that collateral issues in the post trade environment and regulators moves to replicate the level of organization in the cash market were key parts of the upcoming regulation. She observed that regulatory initiatives such as EMIR or the future CSD regulation are pushing two critical components in relation to market structure: a market infrastructure in the center and a tiered market organization around the market infrastructure where banks as users of the market infrastructure, are intermediating the financial market. The intermediary provides a link to the infrastructure and serves as risk absorber between the buy side and the infrastructure.
To ensure a well-functioning market you need an organization with the appropriate risk management and in particular, ensure market infrastructures which are systemic by nature are not taking undue risk. This is why EMIR and CSDR are absolutely critical in terms of making sure you have proper risk management requirements in terms of CCPs and CSDs. The CSDR for example, is supposed to limit the function of CSD to only infrastructure functions and in particular limit or even prohibit CSD to take credit risk. This may question the business model of ICSDs. The issue is that if an ICSD such as Euroclear wants to develop connectivity in direct competition with custodians, then you should have some firewalls between the infrastructure and the risk absorber area to ensure the safety of the infrastructure on which the market is relying on.
Fontan acknowledged that business models need to be adapted to ensure the infrastructure is safe and agreed with Mrre that harmonization makes things more efficient. T2S is not just a question of costs – its a major step towards building the single market and harmonization. For us thats not having to adapt to 27 systems and that should bring costs savings. There should also be cost savings at CSD level that they should pass to their users. I understand that those cost savings may take some time, however I dont want to see increases in CSD fees to finance the T2S adaptation. T2S is the catalyst to harmonization. Its going to cost us to adapt in the short term but its a major step towards harmonization.
As markets become more organized around post trade infrastructure, Fontan called for an improved user governed framework and where users opinions are counted. Taking the example of EMIR and CCPs, where there is considerable risk involved, Fontan said the CCP risk committee should be mainly user governed with the complement of independent directors given that it is the users who are going to be paying the margins and who have a direct interest in the CCP and the potential default thereof.
Fontan noted that the way in which collateral would be issued and circulated in the new regulatory environment will likely lead to the evolution of some market organizations. How we manage and circulate that collateral going forward is a big issue, she said. Change and significant constraints under AIFM or potentially the future UCITS V could affect some fiduciary and safekeeping responsibilities. EC rules on whether collateral is given or received by the fund may trigger a specific organization. For example if the depository is mainly responsible for the collateral whether giving or receiving – there is no way that that depository, given the high level of responsibility they have, will accept that those securities go somewhere else where they have no control over them. Depending on the level of responsibility of the custodian or depository going forward, this may change current market practice where collateral is held today at prime broker or clearing member. New set-ups may be required and depositories that can provide collateral management services and clearing services such as BNP Paribas Securities Services, may have a competitive advantage.”
(JDC)