Regulatory perspectives on CSDs' emerging risks
For Europe’s Central Securities Depositaries (CSDs), the next few years are rich with risks and opportunities. A conflux of multiple new regulations is driving momentous change, which will shrink the number of CSDs but offer new business opportunities for those remaining.
The regulators have triggered this chain of events, ushering in new competition through CSD Regulation (CSDR) and T2S, while creating an urgent need for collateral management through EMIR, Basel III and Dodd-Frank. Yet they are aware of the attendant risks.
“CSDs can capitalise on new business opportunities by stepping up the value chain through offering services such as collateral management,” stated Marcia de Wachter, Executive Director of the National Bank of Belgium, in her keynote speech at Euroclear’s Collateral Management conference in Brussels. But she went on to explain the importance of CSDs retaining the conservative risk profile expected of market infrastructures, saying: “From a regulatory perspective, it is essential the low risk profile of CSDs and ICSDs is preserved, and new risks are appropriately managed.”
Europe’s CSD consolidation is written in the stars. Since CSDR came into force in September 2014, it has challenged the natural monopoly of national CSDs by promoting cross-border activity. The single European settlement system, T2S, which is being introduced progressively from 2015 to 2017, will offer a single gateway to Europe’s settlement system, allowing CSD clients to rationalise the number of CSD relationships. It will also commoditise the settlement function, removing a former source of CSD revenues.
Meanwhile, EMIR, Basel III and Dodd-Frank, have between them made collateral the currency of capital markets, so creating an urgent need for scalable, robust collateral management infrastructure.
All of these new regulations are handing new opportunities to the CSDs that can become pan-European. These opportunities will go largely to CSDs that can contract with issuers from different European countries, as well as those that offer a European gateway to T2S. And, they will also go to those that move up the value chain to offer collateral management.
Seeking to anticipate future systemic risks, Europe’s financial regulators are keeping a close eye on developments. They regard consolidation as inevitable, but are mindful of the dangers of concentrating too much collateral processing in too few organisations.
Economies of scale will be important for CSDs in this new world. In the opinion of many, ICSDs and the largest CSDs in terms of securities deposits are the ones with sufficient scale to compete. However, even among these large organisations there is a need for collaboration in order to provide the market place with the services needed.
As de Wachter and the other regulators look to the future, they are focusing on emerging risks. She told our conference about the dangers of new operational, legal, concentration and counterparty risks. She also alerted delegates to the regulators’ concerns about the danger of possible maturity mismatches during collateral transformation, risk associated with collateral optimisation and the risk of increased demand for high-quality liquid assets when markets are stressed.
What all of this means is that the CSDs and ICSDs emerging from the likely consolidation of the next few years will play an even more essential role in markets. They will be the conduits of collateral that will by then be the lifeblood of derivatives, futures and financing markets.
More than ever, their low risk profile will be not just a competitive differentiator but also a prerequisite to operating. Only the most robust, scalable CSDs and ICSDs will have a place in tomorrow’s world.