The changing legislative landscape will force central securities depositories to reinvent their businesses, says Péter Csiszér of Keler Group
Central securities depositories (CSDs) are the institutions for offering a sound basis for the securities industry, given their core functions. These include notary, central safekeeping and settlement of securities transactions as a book entry. Adding to their importance to the securities industry are their ancillary services, such as corporate actions, proxy voting, and dividend, interest and principal processing, as well as securities lending and borrowing, matching and repo settlement, among others.
As CSDs are fundamental to safe and successful capital markets, they are required to be regulated by comprehensive legislation and internal procedures to ensure they stand firm even in turbulent times such as the recent financial crisis. CSDs proved their preparedness and efficient operation during the course of the crisis and the turmoil it caused to the financial markets, and none of them suffered from severe financial problems.
CSDs are designed to not pose any systemic or counterparty risk. Instead, they help market participants and the market itself to mitigate numerous risks. They have to comply with a number of domestic and international regulations, which have evolved rapidly since the collapse of Lehman Brothers through a massive international legislative effort. The most important development is the upcoming CSD Regulation (CSDR), which will, along with the European Market Infrastructure Regulation and Markets in Financial Instruments Directive, make up the legislative framework and establish a level playing field for all European financial market infrastructures.
Besides CSDR and other regulations, the implementation of Target-2-Securities (T2S) is another compliance challenge ahead for European CSDs. The European Central Bank (ECB) decided in 2006 that it would introduce a pan-European securities settlement system with the purpose of breaking many of the Giovannini barriers and making the European securities post-trading industry more effective and European capital markets more competitive. The development aims to bring cross-border settlements on a par with domestic settlements from the perspective of access and expenses.
All of these changes to the environment in which European CSDs will operate lead to harmonisation and transparency of financial markets, and easier access to cross-border services. T2S is widely seen as the driving force for competition, which is supported by the CSDR, creating a level playing field for European CSDs. Centralising European settlement, T2S might endanger the business model of some CSDs, as it removes part of their principal income base, but at the same time it also forces them to leave their comfort zone, diversify their services and look for additional revenue sources.
What CSDs can do to fill the anticipated gaps in their profit and loss statements is strengthen their presence in their home markets, seek new products and markets, and become international service providers, but most importantly, they must put more focus on clients and increase their sales activity. The latter two are especially important for smaller national CSDs, as they are seen as potential losers of this game against large players that are currently commercially driven and so ready for the competition.
As national monopolies might be threatened when competition evolves, CSDs must strengthen their positions in their home markets. They might look to develop new ancillary services, or invest to step up the value chain and offer services similar to those of sub-custodians, thereby targeting a revenue base that they have left untouched, so far to the benefit of custodian banks and other financial intermediaries.
Many CSDs may also seek opportunities outside of their home base and historic scale of services, which is an obvious opportunity that T2S facilitates. However, becoming an investor CSD and offering cross-border services takes time, requires significant investments and efforts, and is only achievable through choosing the right partnerships.
Service developments will have to be paired with a strong client focus and intense sales activity, which is not obvious in national CSDs today.
Doing nothing is not an option anymore for former monopolies, as it would lead to losing market share and clients, and scaling down sooner or later. The time of local shops has gone and CSDs cannot escape competing with each other and banks. In the competitive arena, being fit and having streamlined operations and processes will be crucial to achieving effciency. Innovation and business development as well as sales activity will also become inevitable, in order to achieve economies of scale and make the organisation profitable.
