As the Czech CSD approaches its fifth birthday, there are still concerns around the safety of securities. CSOB’s Marek Za?al explores why
It is often overlooked, deemed too small or even uninteresting, but the Czech securities market is not about to stand aside. This year, it will be five years since the market finally introduced its first central securities depository (CSD), but it’s not time to celebrate yet. In terms of record keeping and asset safety, questions and concerns still remain, even after such an anniversary.
In 2010, the local CSD came into existence with the typical enthusiasm and related expectations. However, despite the fact that securities—except T-bills—are finally settled under one roof, Czech legislation did not shed much light on the safekeeping side of the matter. After the introduction of so-called ‘two-tier registration’, one could argue that there is no cause for discussion about segregation and asset safety. Unfortunately, this discussion still persists today, and it seems it will continue.
When one and one is not always two
There is a two-tier registration of securities held in the local CSD, as defined by the Capital Market Act. Beneficial ownership must be recorded either at the CSD level (tier one), or in a sub-custodian’s books (tier two). For this purpose, Czech legislation introduced two types of accounts: the owner account and the account of customers.
To clearly distinguish between these, the owner account is defined as one where book-entry securities are registered for the person for whom the account was opened. Additionally, it is deemed that the owner of book-entry securities is the person in whose owner account the securities are registered.
In the account of customers, there will be various registered book-entry securities of many persons who will entrust their securities to one person, in whose name the account of customers has been opened. The person for whom the account of customers has been established is not the owner of book-entry securities registered.
Moreover, the CSD maintains the central register of book-entry securities on both owner accounts and accounts of customers. More importantly, the person who maintains the follow-up register linked to the central register of book-entry securities, ie, the person who holds the account of customers in the CSD, maintains this follow-up register only, and entirely, on owner accounts. Therefore, two-tier registration of securities should be assured.
Read between the paragraphs
So what is the point? The problem lies in Czech legislation, or rather, in its interpretation.
This is mainly due to the legal definition of an owner account, which states: “It is deemed that the owner of book-entry securities is the person on whose owner account the securities are registered”. The word “deem” amounts to a rebuttable presumption that the holder of an owner account is the owner of securities. But there are two different interpretations to this presumption on the market.
The first stream refers to this rebuttable presumption and says that registered ownership of securities may be rebutted, or proven otherwise. This stream claims that it is possible, if needed, to prove that a holder of an owner account is not the beneficial owner of securities held on this account, although this holder is deemed to be the owner by all local authorities and issuers.
The second stream claims that the idea of rebuttable presumption is not to create the nominee concept for the owner account, but to allow corrections of mistakes in ownership registration. For example, omitted changes in ownership records in cases of marriage, inheritance and other similar situations. This stream also stresses that the very existence of statutory nominee accounts, or accounts of customers, proves that an owner’s account is not meant by the legislator to be used as a nominee. As we can see, a full nominee concept is not applied simply because the holder of an account of customers in the CSD can only open owner accounts of final beneficiaries in its books.
Low cost or risk-free?
Some foreign investors still feel that the situation in the Czech Republic is unclear. This is due to the fact that some Czech sub-custodians are of the opinion that it is possible to use an owner account in the CSD as a nominee account, or even that this is an acceptable market practice. The secret as to why this solution became a market practice for some local providers is hidden. To open and fully manage an account of customers, local providers are obliged to implement a particular communication interface, which brings with it costs and time pressures. If you ask your Czech sub-custodian whether it is able to open a true account of customers in the Czech market, its reply will most likely indicate what its attitude to account management really is.
Although some Czech sub-custodians do call it a ‘market practice’, it can also be said that it is a practice of many foreign banks, which might not be fully informed of all implications. Many foreign banks do use owner accounts as nominee accounts in the Czech CSD. However, there are still two key questions: are these foreign banks aware of the fact that an owner account is not a nominee? And, are they aware of the related risks?
If we consider a foreign bank using an owner account as a nominee for holding the securities of its underlying clients, then clients of this bank are exposed to a risk that their securities may be blocked, if an order for blocking of foreign bank property is released by authorities or an insolvency administrator. This could be, for example, in case of the foreign bank´s insolvency. Considering this indisputable risk, the opinion that it is a market practice to use an owner account as a nominee account is misleading, at best. However, the question remains whether foreign banks are fairly informed by Czech sub-custodians about this risk, or if this risk is trivialised.
The whisper of a regulator
At a meeting of the Association for Capital Markets held in October last year, the Czech CSD representatives confirmed that the CSD will block owner accounts belonging to foreign banks if instructed to do so by authorities or an insolvency administrator. There is no need to further describe how long it would take to reverse this action, or, in the language of Czech law, to ‘prove otherwise’ that the actual owner of securities on such an account is different from the named account holder.
Also, the local regulator, the Czech National Bank, has already confirmed that final beneficiaries must be informed on such a risk. What’s more, the Czech National Bank supports the second-stream opinion, saying that the statutory owner account is not meant to be used ‘as standard’ as a nominee account. One could say that this resolution is the end of the story. But this statement from the regulator would not be complete if we did not include one additional remark. It will not be Czech National Bank that would, in the case of a dispute, decide the ownership of any securities. The final word in this matter would be uttered by a court of law, and the Czech National Bank claims that it cannot anticipate a court decision with any certainty.
Out of sight, out of mind
All in all, it still looks like we do not have a winner. The reason is, perhaps, truly hidden in the last paragraph.
The truth is that the market still lacks any real praxis. Since the establishment of the CSD as there has been no real evidence of a court’s decision, and a dispute could prove lengthy. However, one example can be found beyond Czech boundaries. It is not more than a few months since UK regulator the Financial Conduct Authority (FCA) imposed a significant penalty on Barclays Bank, fining it nearly £38 million for failing to properly protect clients’ custody assets, worth £16.5 billion.
Because of ‘significant weaknesses’ in the systems and controls in Barclays’s investment banking division between November 2007 and January 2012, clients risked incurring extra costs, lengthy delays or losing their assets if Barclays had become insolvent. In addition to these failings, account naming or incorrect data suggested that the account assets belonged to Barclays, instead of its client.
The Czech market could learn a lesson from this, but the numbers are unrelenting. The fine imposed by the FCA in this case was £38 million. On the other hand, according to the latest statistics from the Czech National Bank, it has imposed record penalties totalling only £500,000 since the beginning of 2015.
Is the cost for keeping assets safe in the Czech Republic really so high? In any case, if usage of a Czech account of customers was more supported and widely practiced, many clients, as well as network managers, might sleep better.
