No regional association of CSDs has more members, or more complicated regulatory challenges, than ECSDA. As a result, managing member priorities and compliance demands is less like dealing with a single conflagration than keeping a series of smaller blazes under constant control. Anna Kulik, secretary general of ECSDA, says she is currently focusing on a new settlement discipline regime, corporate actions harmonisation initiatives, helping CSDs to enhance their risk management practices and compliance framework, cyber-resilience and helping members to monitor new digital technologies.
Business, like economics, is the art of allocating scarce resources. With more work to be done than there is time or money to do it, business runs the constant risk of letting the urgent crowd out the important. Anna Kulik, secretary general of the European Central Securities Depository Association (ECSDA), knows this better than most. She leads an association of central securities depositories (CSDs) with more members and associate members (40) drawn from almost as many jurisdictions (36) and a greater geographical span (they extend from Portugal in the west to Kazakhstan in the east) than any other regional association of CSDs.
Keeping up with the priorities of this large and diverse membership is an important aspect of the work of ECSDA, and Kulik says she holds multi-lateral and bi-lateral conversations with members all the time, in addition to the regular surveys of members and working group calls and meetings that the organisation conducts. “We are a participatory democracy,” she explains. “I start each year by discussing our objectives for the next 12 months and listing the possible deliverables with the ten-person executive committee, but we have 30 directors on our board, and I am always very much in listening mode towards my members.”
The CSDR regulation is the top priority for European CSDs
And what Kulik hears about the most at the moment is regulation in general and one regulation in particular. Since the majority of her members are operating within the European Union (EU) or the European Economic Area (EEA), and 19 of them are established within the eurozone, they are affected by the Central Securities Depositories Regulation (CSDR). First circulated in draft by the European Commission in 2012, CSDR has proved a slow-burning measure, but it is now approaching the point at which it is very combustible. Furthermore, it is serving as an example for some non-EU jurisdictions.
ECSDA has helped European CSDs continuously to comply with CSDR, through the interpretation of its requirements and their clarification by policy-makers; advising them how to set up new processes and enhance existing ones – such as risk management – and how to get authorised. Ten CSDs are already authorised under CSDR. Others have completed their filing and now await authorisation (fortunately, until the decision of their competent regulatory authority is made, they continue to operate under a “grandfathering” rule).
As it happens, the first obligation laid on market participants by CSDR was accomplished relatively comfortably. All European Union securities markets switched from settling on T+3 to settling on T+2 without incident in a single day in October 2014. One of the major challenges which CSDR now sets for CSDs and their users – namely, settlement discipline – is proving much more challenging. The ambition of the settlement discipline regime laid down by CSDR is obvious enough – to deter settlement failures by imposing fines for late settlement on those responsible – but the process by which the penalties for late settlement are initiated, calculated, imposed and collected is fiendishly complicated. And CSDs play a crucial role in the process.
CSDs play a crucial role in the CSDR settlement discipline regime
Essentially, from September 2020 the counterparty responsible for failing to deliver cash or securities on T+2 will pay a cash penalty equivalent to a 1 basis point ad valorem charge on the settlement consideration for liquid securities, half of a basis point for illiquid securities and a quarter of a basis point for small and medium-sized enterprise (SME) growth market securities. In addition, missing liquid securities must be delivered within four business days of the contractual settlement date, and illiquid securities within seven days, or a mandatory “buy-in” process will be initiated by which the wronged party instructs an agent to buy the missing securities in the market and impose any difference between the contract price and the market price on the participant at fault.
At present, CSDs are expected to monitor these processes, and calculate, collect and distribute the fines. This is why ECSDA is working on a harmonised Settlement Discipline Framework to be applied by all European CSDs. “Settlement discipline is one of the bigger topics we are dealing with right now,” says Anna Kulik. “We need the agreement of our members on how the cash penalty process will work so that, ideally, a market participant using any CSD in Europe will face the same process and cross-CSD collection and distribution processes will function smoothly. In effect, we are creating a harmonised market standard for the settlement discipline process that will apply to all European CSDs and CSDs willing to follow equivalent legislation.”
European CSDs are making progress on harmonising corporate actions processes
Another major harmonisation project ECSDA is pursuing is the standardisation of corporate action practices across Europe. This is a bold initiative, since standardisation of corporate action notifications and instructions is an area of conspicuous failure for the securities industry, stretching back nearly 20 years. In its first report, published as long ago as November 2001, the Giovannini Group labelled the different laws and rules governing corporate actions in European member-states as one of the 15 major barriers to a single European capital market.
The obvious solution, then as now, is the harmonisation of the securities laws of the member-states of the EU. After multiple attempts with its ill-fated Securities Law Directive, the European Commission concluded that this is an idea which has no political support. It is not surprising. A single European securities law would mean harmonisation of securities ownership rights, a single definition of who is an owner, serious repercussions over multiple domains of private law and even potential impact on company laws governing the issue and status of shares.
As a lawyer by background herself, Kulik understands how differently even adjacent jurisdictions are still liable to answer the question, “What is a security?” Coming up with a single answer almost certainly awaits a United States of Europe, so it is encouraging that Kulik thinks the stalemate in harmonising European corporate actions processes, if not legal principles, is now coming to an end. “It is taking a big step forward,” she says. “The end-state will only be achieved when laws are fully harmonised, but if 75-90 per cent of processes are harmonised, it is already great.”
She points to the work of the Corporate Actions Joint Working Group, which is made up of CSDs, issuers, investors and custodians, and the Corporate Actions Sub-group (CASG) of the ECB, which is made up of CSDs and their users. The industry has now also created a steering group which is concentrating on the EU Shareholder Rights Directive, by which issuers are obliged to engage with their investors more often and more fully. These groups and the Eurosystem Collateral Management System (ECMS) project run by the European Central Bank (ECB) have imparted political momentum to solving this long-running issue, says Kulik.
Progress is still slow, but she is convinced the momentum for change is now unstoppable. “Corporate actions are extremely technical because each market has a set of practices derived from their national securities laws,” she explains. “So they are extremely complicated to harmonise, but we are in a good phase right now in terms of progress towards actually delivering harmonised standards in European corporate actions processing, thanks to the drive for change of the ECB.”
Collateralisation of central bank credit is helping harmonise corporate actions
One little known driver of the ECB enthusiasm for more efficient processing of corporate actions is the need to service the collateral pledged by banks to the central bank in return for credit. Like every central bank the ECB advances credit against eligible collateral only. Even securities pledged as collateral still pay interest, or face redemption, and the work of collecting and paying such entitlements still has to be done. Inevitably, CSDs are densely involved both in the movement of collateral (borrowers mobilise collateral both in their domestic market and across borders through their accounts at the CSDs) and in servicing it (where it is pledged to the account of the central bank).
“CSDs provide a range of services which support the implementation of monetary policy by the ECB,” explains Anna Kulik. “We now see that it is not only collateral management practices that need to be harmonised but also large parts of corporate actions processing as well. In fact, there is no other way to service assets posted as collateral across borders to the ECB than by harmonising corporate actions processes – or at least most of them, and substituting collateral with unharmonised practices. As a result, the advances we are making in harmonising the processing flows of different event types in different markets are extremely significant.”
CSD links have prompted standardisation of settlement processes across borders
One way in which CSDs can move collateral across borders in Europe is via direct links between them. In practice, they frequently used to work in partnership with the sub-custodian banks which hold accounts on behalf of their clients at the CSDs, but the ECB and local regulators have encouraged the use of direct links. European CSDs are currently operating no less than 318 direct, indirect and relayed links to other CSDs. “The density of the links in Europe is much greater than in any other region,” says Kulik. “90 per cent of European CSDs have an `outbound’ CSD link and hence hold foreign securities for participants. It is an exceptional case when a European CSD has no links at all.”
These links are captured by CSDR. It insists CSDs maintain the same standards whether they are settling securities issued into their own system or securities issued into another CSD which it is settling via a link. To check compliance, CSDR has required all European CSDs to perform thorough due diligence not only of their links with other European CSDs but also the links they have to CSDs outside Europe. For this purpose, ECSDA developed a Single Link Assessment Questionnaire. Based on CSDR, it asks probing questions about governance, technology, processing capacity and risk management. “The aim is to ensure that securities settled via links to foreign CSDs are settled as safely as securities settled in a European CSD,” says Kulik.
CSDs offer safety and security as they adapt their services to new digital technologies
But, even as an association facing direct, complicated and contentious regulations, ECSDA cannot concentrate all its efforts on compliance. The members of ECSDA, like CSDs everywhere, are concerned about the impact on their activities of new digital technologies such as artificial intelligence, machine learning, robotic process automation and blockchain. “In Europe, CSDs understand that we will shortly be living in a very different world,” says Kulik. “Hence they need to see how they will adjust themselves to this new world.”
To help them adjust successfully, ECSDA hosted a one-day conference dedicated to the impact of new technology on CSDs on 27 November last year. The ECSDA New Technology Day showcased user case studies in liquidity management, e-voting, small company share trading and settlement, and crypto-asset custody. Among the companies presenting was ID2S, the Paris-based CSD recently authorised under CSDR to support the commercial paper market.
Funded by French telecommunications business Orange, large parts of the business of ID2S are based on blockchain technology designed and built by blockchain technology firm SETL. “It is interesting to explore whether a CSD can run its settlement engine on blockchain technology,” says Kulik. “It must of course operate to the highest standards of safety and compliance.” ECSDA has recognised that ID2S has obtained a CSD licence, and is open to new participants: the start-up joined the association on the day the conference took place and its CEO, Andrea Tranquillini, joined the ECSDA board simultaneously.
His experience of applying blockchain technology to the work of a CSD will be interesting for all CSDs. ECSDA members are taking an increasingly close interest in the new technology. In fact, ECSDA recently became a founding member of the International Association of Trusted Blockchain Application Providers (INATBA), which came into being last month. “CSDs are well-placed to adapt to this new technology,” concludes Kulik. “The most important responsibility for any institution, when transferring cash or securities, is to ensure the assets of end-investors are safe. That is exactly what European CSDs guarantee today. The underlying technology they use may be a secondary matter, but it is an important one.”
Tuesday 9 April 2019
Regional associations: Burning platform issues
Moderator: Byungrhae Lee, Chairman, WFC
Mohamed Abdel Salam, AMEDA
Arman Melkumyan, AECDS
Shariq Naseem, ACG
Jorge Hernan Jaramillo, ACSDA
Anna Kulik, ECSDA
 See “ECSDA, Overview of CSD links in Europe, 26 January 2015, at https://ecsda.eu/wp-content/uploads/2015_01_26_CSD_Links_Overview.pdf