EUROPEAN COMMISSION

Brussels, 16.3.2022

SWD(2022) 75 final

COMMISSION STAFF WORKING DOCUMENT

IMPACT ASSESSMENT REPORT

Accompanying the document

Proposal for a

REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL


amending Regulation (EU) No 909/2014 as regards settlement discipline, cross-border provision of services, supervisory cooperation, provision of banking-type ancillary services and requirements for third-country central securities depositories

{COM(2022) 120 final} - {SEC(2022) 160 final} - {SWD(2022) 76 final}

Table of contents

Glossary

1.Introduction: Political and legal context

1.1.Introduction

1.2.Background

1.3.CSDs in the European Union

1.4.Legal and political context

2.Problem definition

2.1.Methodology

2.2.What are the problems?

2.3.What are the problem drivers?

2.4.How will the problem evolve?

3.Why should the EU act?

3.1.Legal basis

3.2.Subsidiarity: Necessity of EU action

3.3.Subsidiarity: Added value of EU action

4.Objectives: What is to be achieved?

4.1.General objectives

4.2.Specific objectives

5.What are the available policy options?

5.1.What is the baseline from which options are assessed?

5.2.Description of the policy options

5.3.Options discarded at an early stage

6.What are the impacts of the policy options?

6.1.Impact of the policy options regarding passporting requirements

6.2.Impact of the policy options regarding cooperation between authorities

6.3.Impact of the policy options regarding provision of banking services related to settlement in foreign currencies

6.4.Impact of the policy options regarding settlement discipline

6.5.Impact of the policy options regarding third-country CSDs

7.How do the options compare?

8.Preferred package

8.1.Summary of preferred aggregated options

8.2.Combined impacts of the package

8.3.REFIT (simplification and improved efficiency)

9.How will actual impacts be monitored and evaluated?

Annex 1: Procedural information

Annex 2: Stakeholder consultation

Annex 3: Who is affected and how?

Annex 4: Analytical methods

Annex 5: Evaluation

Annex 6: Detailed description of identified problem areas

Annex 7: Analysis of all the options

Annex 8: Graphs and figures

Annex 9: description of the buy-in process

Glossary

1.Introduction: Political and legal context

1.1.Introduction

Regulation (EU) No 909/2014 of the European Parliament and of the Council on improving securities settlement in the European Union and on central securities depositories 1 (CSDR) is one of the key regulations adopted after the 2008 financial crisis.

While central securities depositories (CSDs) were resilient, including during the 2008 financial crisis, they were not regulated consistently across the European Union (EU). This led to differences in their safety and raised level playing field concerns. Regulating CSDs was also important to complete the regulatory framework of the trading and post-trading market infrastructures, following the Market in Financial Instruments Directive (Directive 2004/39/EC 2 ), which addressed trading venues, and the European Markets Infrastructure Regulation (Regulation (EU) No 648/2012 3 ), which addressed central counterparties (CCPs) and trade repositories. Moreover, a consistent regulatory approach to settlement systems and settlement processes was important to complement and facilitate the Target2-Securities (T2S) 4 project launched by the Eurosystem. CSDR was also the EU’s response to the call of the Financial Stability Board (FSB), on 20 October 2010, 5 for a revision and enhancement of existing standards to ensure more robust financial market infrastructures, taking into account the global standards. 6

CSDs are financial institutions of systemic importance for financial markets, hence it is essential that their framework remains fit for purpose

CSDs play a crucial role in the primary market, by centralising the initial recording of newly issued securities (‘notary service’). They operate the infrastructure (‘securities settlement systems’) that enables the completion of a securities transaction (‘settlement’). They also maintain securities accounts that record how many securities have been issued by whom and each change in ownership (‘central maintenance service’). Over EUR 53 trillion worth of securities were held in EU securities settlement systems at the end of 2019, handling over 420 million delivery instructions for a total of turnover of over EUR 1 120 trillion. 7 CSDs are essential for the financing of the economy. Apart from their role in the issuance process, securities collateral posted by companies, banks and other institutions to raise funds flows through securities settlement systems operated by CSDs. CSDs are also integral for the implementation of monetary policy as they settle securities in central bank monetary policy operations.

Seven years after its adoption, a review of CSDR is needed to ensure it achieves its objectives while making, where possible, the framework clearer, less costly and future proof.

CSDR has uniform requirements for the settlement of financial instruments and rules on the organisation and conduct of CSDs to promote safe, efficient and smooth settlement. Specifically, CSDR introduced: shorter settlement periods; settlement discipline measures (settlement fails reporting, mandatory cash penalties and ‘buy-ins’ for settlement fails); strict organisational, conduct of business and prudential requirements for CSDs; increased prudential and supervisory requirements for CSDs and other institutions providing banking services that support securities settlement; and a passport system allowing authorised CSDs to provide their services across the EU.

CSDR entered into force in September 2014; however, most of the requirements did not immediately become applicable, as CSDR empowered the Commission to adopt secondary legislation specifying the technical practicalities, leading to a phased-in schedule of certain core requirements. Certain rules, including in particular on settlement discipline, have not yet entered into force.

Article 75 of CSDR requires the Commission to review and prepare a general report on a wide range of issues by 19 September 2019. Article 81(2c) of the European Securities and Markets Authority (ESMA) Regulation 8 also requires the Commission to assess the potential supervision of third-country CSDs by ESMA. From September 2020 to August 2021, the Commission undertook an assessment of the rules in place to prepare a report. This included a targeted consultation with more than 90 contributions from a range of stakeholders, as well as reports required under Article 74 of CSDR from ESMA, in cooperation with the European Banking Authority (EBA) and national authorities.

On 1 July 2021, the Commission adopted the CSDR review report. 9 The report concluded that, in broad terms, CSDR achieves its original objectives to enhance the efficiency of settlement in the EU and the soundness of CSDs. In some areas, targeted changes could improve CSDR’s efficiency and effectiveness. Other provisions have been shown to meet their objective, or changes would be premature considering the relatively recent application of requirements. 

The Commission has assessed the extent to which specific policy requirements in CSDR have met their objectives in an efficient and effective way, while at the same time being coherent, relevant and providing EU added-value. This is supported by an evaluation examining the effectiveness and efficiency of CSDR in specific areas. That evaluation was performed back-to-back with the impact assessment and fed into the problem definition of the impact assessment and is presented in Annex 6.

The evaluation indicates that CSDR may impose in specific areas disproportionate costs and burdens and that certain requirements may be simplified to achieve its objectives more efficiently.

The CSDR review is a key action in the 2020 Capital Markets Union Action Plan 10  for the development of a more efficient post-trading landscape in the EU. Resilient and efficient markets for settlement in the EU should remove barriers to cross-border settlement, ensure adequate powers to monitor risks and reduce administrative burden and compliance costs. As such, the costs of securities transactions should fall and trust in the securities transactions be enhanced, contributing to a better financing of the economy.

Finally, the consequences of Brexit as well as areas where the review of requirements is necessary to ensure the return to long-term growth of the EU economy following the crisis resulting from the Covid-19 pandemic are also considered in the analysis.

This impact assessment report concludes that further action is necessary to address the following issues: (1) burdensome and unclear passporting requirements; (2) insufficient coordination and cooperation between authorities; (3) restrictive requirements for the provision of banking services related to settlement; (4) complicated and unclear requirements for settlement discipline; and (5) insufficient reporting for third-country CSDs. This will ensure that CSDR’s objectives are achieved in a more proportionate, efficient and effective manner. This impact assessment report considers the costs and benefits of different policy options and provides comprehensive evidence that a reduction of costs and burdens can be achieved hand-in-hand with a simplification of CSDR, without compromising financial stability.

1.2.Background

1.2.1.Post-trade services

A crucial element of safe and efficient capital markets is the safety and efficiency of the post-trade arrangements for securities transactions. Though largely invisible to investors, these ensure that after the trade has been carried out the buyer receives securities and the seller is paid. These services that are performed after a trade are commonly referred to as post-trade services. They typically include: 11

·clearing, which guarantees performance by making the CCPs buyer to every seller and seller to every buyer;

·settlement, which allows the discharge of the obligation of the parties to the transaction and the transfer of cash or securities, or both;

·asset servicing which allows the processing and exercise of rights tied to a security over its lifetime;

·post-trade reporting of individual transactions and/ or positions of nominated participants.

Post-trade services are an integral part of the value chain (see Figure I), as they ensure that a securities transaction is completed, including the transfer of legal ownership of a security from one party to another, and transferring cash as payment. Post-trade services are provided by financial market infrastructures, i.e. Central Counterparties and CSDs, trade repositories, as well as by banks (including custodians).

Figure I 12 : Securities industries value chain

Safe and efficient post-trading systems are essential for trust in the financial system, allowing investments to flow into the real economy, increasing competition and thereby further fostering a stronger and more resilient financial system.

1.2.2.Securities settlement

CSDR defines 13 settlement as the completion of a securities transaction after it is concluded with the aim of discharging the obligations of the parties to that transaction through the transfer of cash or securities, or both. Timely settlement is important as it allows market participants to make contingent plans, contributing to the depth and liquidity of the financial markets and to their smooth functioning. The exchange of cash and securities is normally carried out in a Securities Settlement System (SSS) operated by a CSD. In a CSD, the buyer’s and seller’s transactions are matched, verifying the ability of the seller to deliver the securities and the ability of the buyer to pay; after that the transaction is settled discharging the parties from their obligations. However, if both the buyer and the seller of securities have accounts at the same bank, the transaction can also be settled by an internal transfer between those accounts. In such a case, the bank is acting as a settlement internaliser 14 , which executes transfer orders on behalf of clients or on its own account other than through a securities settlement system. 15  

1.2.3.The role of CSDs 

The three ‘core’ services under CSDR are:

·the ‘settlement service’: the operation of a securities settlement system, through which securities are delivered or are exchanged between buyer and sellers; 

·the ‘notary service’: initial recording of securities in a book-entry system; 16  

·the ‘central maintenance service’ – maintaining securities accounts at the top tier level. 17

CSDR defines 18 a CSD as a legal person that operates a securities settlement system 19 (i.e. settlement service) and provides at least one other core service (i.e. notary service or central maintenance service).

As concerns settlement, CSDs hold securities centrally in dematerialised form, i.e. electronically, to speed up settlement. The exchange of cash and securities is normally carried out electronically (although physical delivery is also still used if securities are held in physical form), using a procedure known as Delivery versus Payment (DvP). DvP ensures that neither party can end up with both the securities and the cash, and the other party with nothing. CSDs operating nationally will often have links with other CSDs to allow cross-border settlement and custody 20 facilities. Cross-border securities settlement is sometimes complex, involving at least two CSDs and multiple intermediaries. 21  

CSDs also play a crucial role in the initial recording of newly issued securities (notary function). This generally occurs at the same time as the issuance by the issuer. These securities, once created, are usually recorded and deposited in a single CSD, the issuer CSD. This service is essential as it ensures that there are not more securities circulating than there were actually issued and entered in the account.

Finally, CSDs ensure the maintenance of securities accounts that record how many securities have been issued by whom and each change in who holds those securities. These securities accounts are closely linked to the key mission of CSDs, which is to ensure through their position at the top of the holding chain 22 that no more securities are settled than securities were actually issued.

CSDs also play a crucial role for the financing of the economy. Apart from the issuance process, securities collateral posted by companies, banks and other institutions flows through securities settlement systems operated by CSDs. CSDs also play an essential role for the implementation of monetary policy by central banks as they settle securities in central bank monetary policy operations

In addition to their core services, some CSDs provide ancillary services, 23  e.g. collateral management services, maintaining shareholder registers or supporting corporate actions, 24  that contribute to enhancing the safety, efficiency and transparency of securities markets, without exposing them to credit or liquidity risk. CSDR also allows CSDs to provide banking-type ancillary services 25 related to core or ancillary services, i.e. providing cash accounts and accepting deposits from participants to a securities settlement system, providing cash credit, guarantees and commitments or payment services.

1.3.CSDs in the European Union

1.3.1.Market structure slowly evolving

Historically, CSDs were established along national lines to provide a local venue for the issuance and settlement of securities. Today, this fragmentation remains with 26 CSDs currently authorised in the EU under Article 16 of CSDR. 26  Nevertheless, the EU market structure is slowly evolving; end-2010 there were over 30 CSDs (including two International Central Securities Depositories (ICSDs)) operating in the EU. 27  Most recently, in March 2021, the settlement of Irish securities migrated from UK CREST 28 to Euroclear Bank Belgium. The migration, following the UK’s decision to leave the EU, transferred the settlement of trading activity on Euronext Dublin to a CSD located in the EU. In contrast, the US market is more concentrated and specialised 29 with 2 CSDs.

Included in the 26 CSDs are two ICSDs: Clearstream Banking in Luxembourg and Euroclear Bank in Belgium. 30  ICSDs settle trades in international and domestic securities, usually through direct and indirect links with agents in domestic markets. Originally, ICSDs focused on settling securities transactions denominated in other currencies from where the issuer is based and CSDs focused on national markets. Today, the settlement activities of ICSDs and CSDs are more similar. 31  

CSDs operate different business models, depending on the core and ancillary services they provide. To settle trades in international and domestic currencies, ICSDs are authorised to provide ancillary banking services. The type of instruments a CSD serves does not influence its business model. All but one EU CSD settle equities transactions and all EU CSDs settle corporate debt. A significant majority of CSDs settle government debt. 32  EU CSDs have a variety of corporate structures and ownership models. Only the Croatian, Cypriot and Maltese CSDs are majority owned by the national government, while in Hungary the central bank is the majority owner. In the case of other EU CSDs shareholders include stock exchanges, banks, national governments, central banks and other private institutions. 33  

Although specific data for EU CSDs is not available, there are indications 34 that EU market infrastructures have enjoyed stable conditions, although less favourable than their global counterparts. Market infrastructure providers (exchanges, CCPs, CSDs) globally recovered quickly from the financial crisis with revenues growing 4% annually (2007 – 2012) and then accelerating to 10% post-crisis (2012-1017). EU providers however took longer to recover post-crisis with revenues rising only 1% over the same period. 35  

1.3.2.Size of the market

EU CSDs serve a large securities market. 36  End-2019, EU securities were traded on 430 trading venues, 37  including 135 regulated markets, 223 multilateral trading facilities and 72 organised trading facilities. As of end-2019, 28 000 equity and equity-like instruments were available for trading in the EEA, accounting for annual trading volumes of EUR 27 trillion. 38  Over 170 000 bonds were available for trading in the EEA. Annual bond trading volumes amounted to EUR 101 trillion. 39  

EU CSDs serve the growing EU capital market by handling increasing amounts of trading. In 2019, EU securities settlement systems handled more than 420 million delivery instructions worth over EUR 53 trillion of securities and representing a total turnover of over EUR 1 120 trillion. 40 In 2014, when CSDR was adopted, EUR 43.5 trillion worth of securities were held in EU securities settlement systems, which handled over 330 million delivery instructions for a total of turnover of over EUR 850 trillion. This is a growth of 22% in value of securities held, 27% in number of delivery instructions and 32% in turnover in the period between 2014 and 2019.

Despite the large number of CSDs operating in the EU, in 2019 the three 41 largest CSDs held over 60% of all securities held in EU CSDs. This is however rather a reflection of the size and liquidity of certain EU national financial markets, 42 rather than issues connected to market structure. 43  

1.3.3.Main forces driving market evolution 

In addition to regulatory changes aimed at facilitating cross-border activity, there are economies of scale and scope, driving both consolidation of different types of post-trade services and competition among EU CSDs and the different services they offer.

(a)Consolidation of the sector

First, there is a strong complementary relationship between the various components of securities settlement. Economies of scope may be achieved by integrating along the value chain of securities transaction, i.e. by combining trading, clearing and settlement into one conglomerate. Consolidation between CCPs, CSDs, and stock exchanges has created EU financial market infrastructure conglomerates, e.g. the formation of Clearstream through the merger of Cedel International and Deutsche Boerse in 2012. With the acquisition of the Norwegian and Danish CSDs in 2019 and 2020 respectively, Euronext has also strengthened its presence in the CSD space. This was followed in 2020 with the acquisition of Borsa Italiana (the Italian stock exchange), MTS, where most of Italy’s sovereign debt is traded, as well as the major multi-asset clearing house, CC&G. Economies of scope could also be obtained through horizontal synergies. In 2009 Euroclear brought the Belgian, Dutch and French domestic CSDs onto a single platform, under a harmonised framework, but as separate legal entities. Nasdaq has also consolidated the three Baltic CSDs (Estonia, Lithuania and Latvia) in 2017 and the Icelandic CSD into a single legal entity in 2020. A number of integrated post-trade services groups operate in the EU post-trade market, i.e. Euroclear (bringing together the ICSD Euroclear Bank and national CSDs in Belgium, Finland, France, Ireland, the Netherlands, Sweden and the United Kingdom), Euronext (bringing together national CSDs in Portugal, Denmark, Norway and Italy), Deutsche Boerse (operating the ICSD Clearstream Luxembourg, the German CSD and LuxCSD) and Nasdaq CSD (following the merger of the regional CSDs for Lithuania, Latvia, Estonia and Iceland).

(b)Emerging technological innovation

The rise of new record-keeping technologies also has the potential to alter the landscape. In post-trade, distributed ledger technology 44 (DLT) is currently considered the most promising to simplify processes, reduce costs, and increase efficiency and security 45 . This will potentially lead to lower costs and faster settlement, transform how securities are held and recorded 46  and challenge incumbent settlement systems. 

Most of the realised projects so far point to the potential for financial infrastructures to move towards real-time settlement, flatter structures, continuous operations and global reach. 47 This is reflected 48 in the growing application of DLT in post-trade processes, i.e. issuance and settlement of shares and bonds, data recording or the use of tokens to represent shares. Currently, applying DLT to post-trade processes has the greatest potential with respect to DvP, automation of risk management, settlement and the development of currency-substitutes as means of payment. 49  

(c)Provision of cross border services by CSDs

Fostering competition, greater interoperability and better connectivity among CSDs were some of the main policy objectives of CSDR. Nevertheless, data collected by ESMA does not reflect this. 50  EU CSDs’ cross-border activity, i.e. the CSD services provided in host Member States can be measured by (1) the use of CSD links established between EU CSDs; (2) the measurement of the services provided to participants and issuers from host Member States; and (3) T2S activity.

First, a link allows a CSD to give its clients access to securities recorded and settled in another CSD. The number of links and the volumes handled by established connections measure the cross-border provision of settlement services by CSDs. In this regard, established connections are handling increasing volumes, suggesting growing cross-border activity through this channel. The value of settlement instructions settled through links with other EU CSDs increased from EUR 109 trillion in 2017 to EUR 160 trillion in 2019, 51 a growth of 47%. The total number of settlement instructions through links almost doubled between 2017 (23 278 314 instructions) and 2019 (38 984 805 instructions).  52 The growth in the use of links outpaced the growth in settlement instructions by EU CSDs (32% and 28% in 2014 and 2019 respectively).

However, the number of CSD links 53  has remained stable since 2017. Excluding the ICSDs which both have a very high number of links (31 for Clearstream Banking, 25 for Euroclear Bank), the average number of links per CSD is 5 links with other EU CSDs between 2017- 2020. 54  At the same time, the total number of links for all CSDs, including links with ICSDs, increased by 14% between 2017 (121 links) and 2020 (138 links). Excluding ICSDs, the number of links rose by 28% from 64 to 82 links. 55  The increasing traffic through links shows that such connections serve the development of cross-border settlement, but the limited increase of CSD links demonstrates that barriers to cross-border activities remain.

Second, another measure of use of cross-border services are the type of CSD services, including notary and central maintenance services, provided to participants and issuers from other Member States.

In 2019, the share of central maintenance and settlement services provided to participants from other Member States by EU CSDs was 37%; 56 a slight increase compared to 2018. However, settlement activity shows that only 6 CSDs provide settlement services to more than 75% of participants from other Member States, while two-thirds of EU CSDs settle less than 50% of instructions for participants from other Member States (in value of instructions settled). A similar concentration is noted for notary and central maintenance services provided in relation to financial instruments issued by issuers from other Member States with 3 CSDs (including the two ICSDs) providing more than 80% of their services to issuers from other Member States, while most EU CSDs do not provide or dedicate less than 5% of their notary and central maintenance activity to securities issued by issuers from other Member States. 57  

CSDs can provide all types of services, including of notary and central maintenance services, to participants and issuers from other Member States. In that case, a CSD may become of ‘substantial importance for the functioning of the securities markets and the protection of the investors’ 58 in the host Member State which allows to estimate the progression of cross border services. There was a slight increase in the number of Member States in which the activities of CSDs from other Member States are of substantial importance and to this date, in 19 Member States there is no substantial activity from CSDs from other Member States (Figure II). In line with this trend, there has been a slight increase in the share of EU CSDs providing central maintenance (Figure III) and settlement services 59 to participants in other Member States.

Third, Target2-Securities (T2S), launched in 2015, aimed to address fragmented securities settlement in the EU and the resulting complex cross-border settlement. It offers delivery versus payment settlement in central bank money. It also provides harmonised and commoditised securities settlement to CSDs and applies a single set of rules, standards and prices to all participants. T2S facilitates cross-border settlement, resulting in increased integration of Europe’s financial markets infrastructure by:

·simplifying the purchase of securities in other EU countries; 

·reducing costs of cross-border settlement;

·increasing competition among providers of post-trade services;

·pooling collateral and liquidity;

·reducing settlement risk by using central bank money for transactions on T2S.

It connects 21 CSDs 60  from 18 Member States and Switzerland. It offers settlement in Euro and Danish Krone and processes 687 476 securities transactions worth EUR 672.53 billion per day. 61  T2S has also helped encourage harmonisation of market practices and competition in the EU. 

1.4.Legal and political context 

1.4.1.Legal context: Central Securities Depositories Regulation

CSDR is one of the key regulations adopted by the EU following the financial crisis of 2008 to ensure that securities settlement is safe, stable and efficient. It entered into force on 17 September 2014. 62  

CSDR provides a set of common requirements for CSDs across the EU by introducing:

·shorter settlement periods;

·cash penalties and other deterrents for settlement fails;

·strict authorisation, organisational, conduct of business and prudential requirements for CSDs;

·a passport procedure allowing authorised CSDs to provide services across the EU;

·increased prudential and supervisory requirements for CSDs and other institutions providing banking services that support securities settlement;

·increased cooperation requirements for authorities across Member States with respect to CSDs providing their services in relation to financial instruments constituted under the law of a Member State other than that of their authorisation and to CSDs establishing a branch in another Member State.

The CSDR legal framework also includes Level 2 63 and Level 3 measures (e.g. ESMA guidelines and Q&As).

CSDs may also be subject to other EU legislation depending on their status, e.g. CSDs operating with a banking license are also subject to the relevant banking legislation. Moreover, they may have to comply with certain national laws in the Member State in which they are incorporated, e.g. securities, corporate or civil law. As securities settlement systems, CSDs qualify as systems under the Settlement Finality Directive 64 and are therefore subject to the applicable national transposing laws.

Finally, CSDs should also consider the  International Principles  for financial market infrastructures 65 issued by the Committee on Payments and Market Infrastructures (CPMI) 66 , the International Organization of Securities Commissions (IOSCO) 67 and the FSB 68 .

1.4.2. Political context: Capital Markets Union (CMU), Brexit, Recovery post Covid-19 

The Commission launched its follow-up CMU Action Plan to create a single market for capital across the EU. The aim is to increase investment and savings flowing throughout the EU, benefitting citizens, investors and companies, regardless of where they are located. A fully functioning and integrated market for capital will allow the EU economy to grow in a sustainable way and be more competitive.

The 2020 CMU Action Plan 69  and the 2021 Commission Work Programme announced the Commission’s intention to come forward with a legislative proposal to amend CSDR to improve its efficiency and effectiveness (CSDR REFIT) and contribute to the development of a more efficient post-trading landscape in the EU. This follows from the work of the High Level Forum for the CMU 70  that, amongst others, made recommendations to facilitate the emergence of a common EU CSD market. Resilient and efficient markets for settlement in the EU should remove barriers to cross-border settlement, ensure adequate powers to monitor risks and reduce administrative burden and compliance costs. As such, costs of securities transactions should fall, and trust in securities transactions rise, contributing to a better financing of the economy.

More generally, any forthcoming EU legislative proposal, including on CSDR, will have to take into account, where necessary, the consequences of Brexit as well as to identify how to contribute to the return to long-term growth of the EU following the crisis resulting from the Covid-19 pandemic and to finance the EU’s environmental and digital transitions.

Regarding Brexit, on 25 November 2020, the Commission adopted an equivalence decision determining that, until 30 June 2021, the regulatory and supervisory framework applicable to CSDs established in the UK is equivalent in accordance with CSDR. On 11 December 2020, 71  ESMA announced that Euroclear UK & Ireland Limited, the UK CSD, would be recognised as a third-country CSD. ESMA’s recognition decision applied from 1 January until 30 June 2021. The aim was to give EU issuers, and in particular Irish issuers that used that CSD, sufficient time to transfer their securities to an EU CSD, a project which was completed on 15 March 2021. 72 From its side, the UK introduced a transitional regime 73  under which certain non-UK CSDs can offer CSD services until they are permanently recognised under the UK CSDR. As of 30 April 2021, 15 non-UK CSDs that have notified the Bank of England that they will offer CSD services in the UK under the transitional regime. 74 In addition, the UK Treasury 75 announced that the UK will not implement the CSDR settlement discipline regime.

As concerns the Covid-19 crisis, post-trade infrastructures, and CSDs in particular, have remained resilient and continue to provide their services. Nevertheless, due to the impact of the Covid-19 pandemic on the implementation of regulatory projects and IT deliveries by CSDs and their participants, ESMA proposed postponing the date of entry into force of the Regulatory Technical Standards (RTS) on settlement discipline 76 until 1 February 2022. 77  Stakeholders also noted that market developments during this crisis would have been significantly worse in terms of available market liquidity if the settlement discipline was in place. In this regard, the European Parliament, in its resolution on further development of the Capital Markets Union, 78  also invited the Commission to review the settlement discipline regime under CSDR in view of Brexit and the Covid-19 crisis.

Finally, market infrastructures were also part of two recent packages published by the Commission on digital finance 79  and on fostering openness, strength and resilience of the European economic and financial system. 80  In September 2020, in line with the Commission priorities to make Europe fit for the digital age and to build a future-ready economy that works for people, the Commission published a New Digital Finance Package, 81 which included a legislative proposal on a pilot regime 82 . This proposal seeks to collect experience and to provide legal certainty and flexibility for market participants (including CSDs) who wish to operate a DLT market infrastructure, by establishing uniform requirements for operating these DLT systems. Under this pilot regime trading facilities and CSDs using DLT can develop their businesses and provide a safe environment for market participants and investors. To this end, it provides optional exemptions to certain requirements of CSDR. The New Digital Finance Package also includes a ‘Digital Operational Resilience Act' (DORA) 83 that aims to ensure that all participants in the financial system, including CSDs, have the necessary safeguards in place to mitigate cyber-attacks and other risks. 

Furthermore, in January 2021, as part of a broader set of actions to strengthen the EU’s open strategic autonomy and resilience, the Commission published a communication on ‘The European economic and financial system: fostering openness, strength and resilience. 84 This Communication sets out how the EU can reinforce its open strategic autonomy in the macroeconomic and financial fields by, inter alia, further developing EU financial market infrastructures, including CSDs, and increasing their resilience. 

In conclusion, this REFIT initiative should be viewed within the context of the broader agenda to make the EU markets more competitive, digital and resilient as represented by the CMU, digital and open strategic autonomy initiatives. However, developing internationally competitive CSDs is not a direct objective of CSDR per se. The main objectives of CSDR and this Review are to allow EU settlement markets to become more efficient and secure. However, market players will benefit from efficient and reliable settlement as well as increased competition in the EU capital market. This may drive the emergence of internationally competitive EU post-trade service providers.

1.4.3.Stakeholder consultation

Stakeholder consultation took different forms (see Annex 3), including:

·a Commission targeted consultation between 8 December 2020 and 2 February 2021 85 ;

·ESMA reports - four reports in 2020 and 2021 were submitted to the Commission on internalised settlement, 86 the cross-border provision of services by CSDs and the handling of applications to provide notary and central maintenance services cross-border, 87 the provision of banking type ancillary services 88 and the use of FinTech by CSDs. 89 Such reports also took into account answers to ESMA surveys from national authorities, CSDs and participants;

·Meetings with Member States’ Experts, where the secretariat of the Economic and Monetary Affairs committee of the European Parliament, the ECB and ESMA were also invited, on 22 September 2020 and 15 July 2021;

·Input from the European System of Central Banks (ESCB) to the CSDR consultation process, including an anonymised and consolidated outcome of a survey conducted among CSDs.

·A meeting with Members of the European Parliament on 6 September 2021;

·Bilateral meetings with stakeholders as well as confidential information received from a wide range of stakeholders.

1.4.4. Report to the Council and the Parliament 

Article 75 of CSDR required the Commission to review and prepare a general report on the Regulation and submit it to the Parliament and the Council by 19 September 2019. Furthermore, Article 81(2c) of Regulation (EU) 2010/10 establishing a European Supervisory Authority (European Securities and Markets Authority), required the Commission, after consulting all relevant authorities and stakeholders, to conduct a comprehensive assessment of the potential supervision of third-country CSDs by ESMA exploring certain aspects, including recognition based on systemic importance, ongoing compliance, fines and periodic penalty payments.

Taking into account that some CSDR requirements did not apply until the entry into force of the relevant regulatory technical standards in March 2017 and that some EU CSDs were only recently authorised under CSDR, the Commission report on CSDR was adopted in July 2021. 90  The report identifies specific areas where targeted action may be necessary to ensure the fulfilment of the objectives of CSDR in a more proportionate, efficient and effective manner. The five main areas identified are the following:

·clarifying and simplifying the burdensome requirements related to the provision of services by CSDs domestically and cross-border;

·improving the supervisory convergence amongst authorities involved in CSDs’ supervision;

·facilitating the provision of banking-type ancillary services;

·reducing the disproportionate burdens and costs related to settlement discipline;

·enhancing the framework for third-country CSDs.

In its report, the Commission also invited ESMA to consider whether supervisory convergence tools could be used or amendments to existing regulatory technical standards may be required to facilitate the use of technological innovation by CSDs.

2.Problem definition 

2.1.Methodology 

The main problems assessed in this impact assessment concern areas for which an evaluation has been carried 91 out, as well as input received from various authorities and stakeholders (see section 1.4.3). These indicate that targeted action is necessary to ensure fulfilment of the CSDR objectives more proportionately, efficiently and effectively.

The impact assessment considers the costs and benefits of targeted amendments to CSDR concerning the barriers to cross-border settlement, the disproportionate compliance costs and the insufficient insight into the activities of third-country CSDs. While the definition of the problems is targeted, the impact assessment considers the cumulative impact of targeted changes as presented in section 8.

A key consideration is that the application of CSDR remains work in progress. A sufficient number of EU CSDs was authorised only recently under CSDR, the regulatory technical standards specifying CSDR started applying only as of 2017 and certain core CSDR requirements (including settlement discipline) are yet to enter into application. This limits the availability of data on costs and benefits of the requirements.

First, while the full impact of CSDR is still unfolding, feedback from stakeholders and public authorities 92  indicates that CSDR has contributed to achieving its original objectives of ensuring safety of settlement and financial stability. The impact assessment therefore only considers targeted changes at this point in time.

Second, certain issues raised by authorities and stakeholders are not covered in this impact assessment, because they cannot or should not at present be addressed within the context of CSDR, e.g.:

a)stakeholders noted that CSDs are still subject to Member States’ national laws for issues not regulated in CSDR, such as corporate or civil law matters. This may impact their ability to offer services cross-border as they may need to set up separate operational processes and procedures to comply with the relevant host Member States’ requirements. Nonetheless, harmonisation of the relevant national laws goes beyond the scope of CSDR and therefore is not considered.

b)stakeholders, including the High Level Forum on the CMU, raised concerns about CSDs’ access to central bank money 93  which is subject to conditions set by the central bank in question; e.g. in the Euro area, the ECB sets the access conditions. 94 For CSDs that want to settle in central bank money in a currency other than that of the jurisdiction of their authorisation (or outside of the EU), access to the respective central banks can be challenging 95  and therefore limited. Indeed, very few EU CSDs seem to have direct access to foreign central banks; e.g. one EU CSD has locally incorporated licensed subsidiaries to obtain access to some foreign central banks (e.g. Australian, Canadian, US), however access to others remains impossible (e.g. Russia). 96 This is particularly an issue for smaller CSDs, due to the cost and significant time the process requires. Nonetheless, due to the principle of central bank independence, CSDR cannot introduce obligations on central banks to facilitate CSDs’ access to central bank money within the EU. 

c)digitalisation and new technologies are transforming the EU financial system and the way it provides financial services to EU businesses and citizens. This raised questions of whether existing CSDR provisions ensure technology neutrality. 97 The Regulation for pilot regime for market infrastructures based on DLT (see section 1.4.2), which allows DLT entities to be exempted under certain conditions from complying with certain CSDR provisions, should enable all stakeholders to gain insights into the use of DLT for market infrastructures and the legislation to adapt to the gathered experiences. It therefore seems that any fundamental changes to CSDR to realise the full potential of technology should be postponed until the lessons can be drawn from the pilot regime’s implementation. This is a view that most respondents to the targeted consultation, as well as ESMA, share. Fintech, which is an area related to the existing CSDR framework, is therefore outside of the scope of this impact assessment.

d)Processes for withholding tax are a barrier for efficient EEA market infrastructures and for cross-border settlement. It was identified in the first Giovannini Report 98 and reconfirmed in the 2020 CMU Action Plan. 99  However, as taxation aspects cannot be dealt with in CSDR, and as the Commission plans to propose a legislative initiative for introducing a common, standardised, EU wide system for withholding tax relief at source, accompanied by an exchange of information and cooperation mechanism among tax administrations, this issue is outside the scope of this impact assessment.

2.2.What are the problems?

For a detailed description of the identified problem areas see Annex 6.

2.2.1.Barriers to cross-border settlement

One of the main objectives of CSDR was to facilitate cross-border settlement in order to limit the risks and costs involved. Nevertheless, most stakeholders see limited progress in the provision of cross-border services by CSDs (see point (c) in Section 1.3.3). 100 The evaluation, 101 has identified three main reasons for this: (i) burdensome passporting process; (ii) insufficient cooperation between authorities; and (iii) restrictive requirements for the provision of banking services related to settlement.

First, the passporting process (i.e. the special procedure under which a CSD authorised in a Member State can provide services in relation to financial instruments constituted under the law of another Member State), is burdensome. It requires, where relevant, the agreement of the host national supervisor, regarding the assessment by the CSD of the measures it intends to take to allow its users to comply with the national law referred to in Article 49(1). This partially shifted the burden from the participants to CSDs by requiring the latter to demonstrate that they have the relevant measures in place, rather than relying on users to directly ensure that the CSD they use allows them to comply with the applicable national legislation, despite the fact that it is the users’ responsibility to comply with such national legislation. The objective was to ensure that the provision of cross-border services by a CSD would not affect the application of relevant national laws. The unintended consequence was to make the passporting process burdensome 102 , thereby deterring CSDs from expanding their activities across borders (see sections 1.3.3, 2.2.1 and 2.3.1) or leading others to stop providing cross-border services. The fact that so far there have been no refusals by host national supervisors shows that although passporting is not used as tool to protect national markets, it has added a burdensome and costly level of complexity. Simultaneously, certain third-country CSDs seem to be exempted from these requirements (See section 2.3.5), making it is easier for them to operate cross-border in the EU than for an EU CSD.

Second, cooperation between authorities in home and host Member States and supervisory convergence is insufficient (see section 2.3.2). Despite the existence of provisions enabling the use of cooperative arrangements or voluntary supervisory colleges, there is no evidence of their extensive use (only one college of supervisors has been set up and no information is available to ESMA on whether the other required cooperative arrangements under CSDR have been set up). This means that the same CSD is likely to be subject to different supervisory arrangements and requirements depending on the Member States of operation (see also section 2.3.2).

Third, CSDR contains strict conditions for CSDs to settle a transaction in commercial bank money (see section 2.3.3). A securities trade typically results in an obligation for the seller to deliver securities (securities leg) and a corresponding obligation for the buyer to deliver cash (cash leg). To ensure delivery of the cash, a CSD may use accounts at a central bank 103 or commercial bank (i.e. CSDs may open accounts in their own books or in a commercial bank). Access to central banks depends on the respective central bank, brings cost and therefore requires economies of scale. Consequently, settlement in commercial bank money is sometimes the only option available for CSDs that want to settle in currencies other than that of the jurisdiction in which they are authorised (e.g. because the CSD does not have an account with the central bank of the transaction’s currency). However due to the restrictive nature of the conditions, the percentage of EEA CSDs’ settlement activity in foreign currencies (Figure V) and the level of settlement in foreign currencies remains limited.  104  

Figure V: Settlement in foreign currencies by EEA CSDs

Furthermore, as seen in Figure VI, the vast majority of CSDs settle in only one or two foreign currencies. 105  This means that issuers have a limited choice for multicurrency issuance which prevents genuine cross-border competition (especially since issuers seek one-stop-shop solutions) 106 and the emergence of a single capital market.

Figure VI: Number of CSDs per range of yearly settlement in foreign currencies 107

2.2.2.Disproportionate compliance costs 

Market participants and authorities have identified targeted areas where the CSDR compliance costs are disproportionate, because (a) legal requirements are unclear, and/or (b) they are considered excessively burdensome, and/or (c) the costs of complying with the rules appear to outweigh the potential benefits. Three areas have been identified as generating disproportionate compliance costs: passporting rules; rules on the provision of banking services related to settlement; and the settlement discipline regime.

First, the CSDR passporting rules allow CSDs to provide services for financial instruments constituted under the law of any Members State, thus allowing CSDs to benefit from access to a larger market and issuers to have more choice in where they issue and hold their securities. However, the associated the legal requirements have turned out to be unclear and burdensome (see section 2.3.1).

In addition, the objective difficulty to comply with the legal requirements and the subsequent threat of potential legal action, generate costs that present an unnecessary barrier to the development of CSD activities. A CSD reported confidentially 108 that the associated internal legal support required throughout the passporting process was significant 109 . Even if most CSDs applying for a passport to operate cross-border have been able to obtain it, stakeholders have indicated that this process is difficult, lengthy and demanding (see section 2.3.1). 

Second, the rules around the provision of banking services create disproportionate compliance costs for CSDs. This negatively impacts the provision of cross-border services. The lack of alternatives to settle in commercial or central bank money could undermine the safety of settlement, as transactions could be settled free of payment instead of delivery versus payment, increasing risks for the market as a whole. 110  For a detailed explanation of specific problems faced and/ or risks created by CDS settling in commercial bank money see Annex 6.

Third, certain elements of settlement discipline, 111  although not yet applicable, would potentially create disproportionate compliance costs for CSDs and market participants. To ensure the safety of settlement, any participant in a securities settlement system should settle its obligation on the intended settlement date (ISD); a settlement fail occurs when a transaction does not settle on that date. 112  The settlement discipline regime aims to encourage market participants to avoid settlement fails; its two main elements are the measures to prevent settlement fails (Article 6 of CSDR) and the measures to address settlement fails (Article 7 of CSDR). The latter comprise two main pillars; cash penalties and mandatory buy-ins. CSDs would be required to impose cash penalties on their participants in case of settlement fails. If despite the cash penalties, the original seller fails to deliver the securities, it will be subject to a mandatory buy-in. A buy-in provides the buyer of securities with the right to buy the securities elsewhere, cancel the original transaction and put the costs of the buy-in, as well as any price difference, with the original seller. 113  

The original objective of the settlement discipline regime as contained in the 2012 Commission proposal 114 was mainly to harmonise the diverse market discipline measures across EU capital markets. Hence the proposed measures were general, with detailed technical standards to be set in secondary legislation 115 . The impact assessment could not quantify ex ante the costs and benefits of these general settlement discipline measures relying rather on qualitative assessments. The final set-up of the settlement discipline regime and the associated costs and benefits, became evident to the market participants only when the 2018 regulatory technical standard 116 (RTS) was published. Furthermore, market volatility of spring 2020 triggered reflections about the potential impact of the regime on trading conditions or ability to fulfil certain market functions.

Although settlement discipline rules would incentivise improvements in settlement rates, it would also create high one-off (i.e. connecting to buy-in agents, repapering existing contracts to take account of mandatory buy-in rules) and ongoing costs (i.e. in terms of pricing and reduced liquidity of instruments potentially at risk of being bought-in or trades being abandoned or migrating to non-EU trading venues (see section 2.3.4)).

Evidence provided seems to show that these costs are disproportionate and would stem both from the lack of clarity around the rules governing the process (i.e. what transactions are in-scope or how to use buy-in agents), from the framework’s impact on market conditions (deterioration of liquidity for some instruments, higher bid-ask spreads) and market participants’ trading behaviour (migration of trading from peripheral instruments to liquid instruments, doubts around the viability of the market maker role for less liquid instruments). The costs of applying in particular the rules on mandatory buy-in could outweigh their benefits for three main reasons:

First, the market volatility of March/April 2020 gave stakeholders the opportunity to reflect on how the upcoming settlement discipline regime would have impacted the market. 117  In essence, mandatory buy-ins could have exacerbated the negative impacts linked to the crisis; in particular they could have increased liquidity pressure and increased the costs of securities at risk of being bought-in. 118  

This would affect negatively market makers that take on risk onto their balance sheet to provide immediate execution to clients. They 119 are an important source of liquidity and often offer securities they do not hold, 120 based on the reasonable assumption of sourcing these securities when necessary. For securities not held on their balance sheet, or which cannot be readily sourced, the introduction of mandatory buy-ins would impact the ability of market makers to make markets. To adjust for the expected cost of being bought-in, market makers will have to add a premium to their prices – which will widen the bid-offer spread (which will in turn increase costs to end-investors) – or they may simply not make an offer price on an enquiry thereby deteriorating market liquidity. 

Although these liquidity effects are most pronounced in choices made by market makers, all investors, even in liquid securities, could face similar trade-offs between entering into a trade (providing liquidity), the availability of the instrument and the cost of being bought-in. These impacts are likely to be reflected in behavioural change, rather than a price adjustment. 121  

Periods of market stress could be exacerbated by mandatory buy-ins as participants would have to buy back the securities that already had limited availability adding further liquidity pressure. 122  Investors would have chased a small number of available securities, driving up prices and potentially, further driving volatility in a stressed market. Evidence provided by one bank, showed that the application of mandatory buy-ins to EU government bonds in the current liquidity context could have led to a 50%-100% increase in bid-offer spreads. 123

Second, the settlement discipline regime could also give rise to unintended consequences for the competitiveness of the EU capital markets. Capital markets outside the EU do not have a comparable settlement discipline regime. 124  These markets rather rely on industry-led measures 125 , i.e. the UK announced it is not implementing the CSDR settlement discipline regime and will rely on settlement rules set by CREST, the UK-based CSD. 126  In particular mandatory buy-ins may create an additional cost and risk for EU-settled securities that could disadvantage EU companies. Wider spreads and less liquidity will reduce the investment returns of pension funds, asset managers and, ultimately, end investors, which, according to some stakeholders, could risk driving issuance, trading and investment activity outside of the EU. 127  Furthermore, application of mandatory buy-ins could lead to a potentially loss of counterparties and liquidity for the EU capital market. 128  The potential negative impact on the attractiveness of the EU market would be at odds with the objectives making the EU capital market more attractive by increasing the safety of settlement.

Finally, against the above arguments, it should be noted that despite the dramatic increase in trading (settlement instructions increased by 30% between 2015 – 2019 in EU CSDs 129 ) the settlement fail rate has remained relatively stable in the EU, both as a share of value and number of total transactions (See Annex 8, Figure II ). It experienced a spike for both types of instruments only during March/ April 2020 from which both have recovered (albeit more slowly in the case of equity instruments). This indicates that in normal market circumstances settlement in the EU can be relatively efficient. Quantitative evidence suggests that, in relative terms, the buy-in regime targets a small proportion of the total volume of transactions but will have an impact on the pricing and liquidity of a much larger percentage of overall transactions. 130

Nevertheless, even if settlement efficiency in the EU seems to be stable or improving slightly, fail rates in the EU still remain higher than in, e.g. the US where about 2% of all US treasuries and mortgage backed securities transactions fail. 131  Different levels of settlement efficiency between national capital markets can partly explain the lower overall EU settlement efficiency 132 .

2.2.3.Insufficient insight into the activities of third-country CSDs

Under CSDR, third-country CSDs providing services in the EU provide insufficient insight into their activities in relation to financial instruments constituted under the law of a Member State, in particular when they provide services under the grandfathering clause (see section 2.3.5). This leads to potential risks for the whole settlement ecosystem, and in particular on EU authorities, EU CSDs and issuers.

First, EU authorities are not aware of the activities of third-country CSDs in the EEA, a fact underlined both by ESMA and several respondents to the targeted consultation 133 . Some third-country CSDs operating in the EU are not subject to any notification requirement (see section 2.3.5). EU authorities therefore have no information on which services they provide, their volume or the Member States affected by them. This means that, if needed, neither issuers nor public authorities at national and EU level can assess the impact of these CSDs on the financial stability of the EU.

Second, certain third-country CSDs follow different rules than those EU CSDs are subject to, and provide services in relation to the same financial instruments (see section 2.3.5). The lack of information on third-country CSDs’ activities may create a risk for investors in those cases where the legislation governing them does not offer the same level of protection than EU legislation would.

Third, the lack of information on third-country CSDs’ activities may create a risk for investors. The Commission has not assessed the rules to which CSDs operating under the grandfathering clause are subject, despite the fact that they provide services in relation to the same financial instruments EU CSDs do (see section 2.3.5). The lack of information on those CSDs’ activities may create a risk for investors where the legislation governing them does not offer the same level of protection as EU legislation.

2.3.What are the problem drivers?

2.3.1.Burdensome and unclear passporting requirements for CSDs 

A core objective of CSDR was to dismantle the barriers to cross-border settlement in order for authorised CSDs to enjoy the freedom to provide services within the EU.

To ensure an appropriate level of safety in the provision of services by CSDs in another Member State, CSDs are currently subject to a specific procedure in Article 23 of CSDR. Under this article, when CSDs wish to provide notary and central maintenance services in relation to financial instruments “constituted under the law of another EU Member State” or to set up a branch in another Member State a specific procedure needs to be followed, involving the approval by the host national authority. In particular, they should communicate to the competent authority of their home Member State information including, where relevant, an assessment of the measures the CSD intends to take to allow its users to comply with the national law referred to in Article 49(1).

These requirement of the CSDR passporting process aimed to ensure that the relevant pieces of national legislation would be taken into account and would still be complied with. However, such requirements allow the host competent authority to verify this only once, when assessing the passporting request, and not on a continuous basis. Furthermore, the possibility to refuse the passport does not seem to have been used by host competent authorities 134 .

26 CSDs have been authorised under CSDR, out of which 15 provide cross-border services in the EEA. 135

Further to these first passporting procedures, the majority of stakeholders 136 and Members States 137 now generally agree that the passporting procedure is burdensome (one CSD even noted that it stopped providing services with respect to foreign securities in order to avoid it 138 ) and some of its requirements are unclear and could result in divergent interpretations by national authorities, thus reducing CSDs’ cross-border activity and leading to disproportionate compliance costs (see sections 2.2.1 and 2.2.2). As underlined by one stakeholder: “the rules in CSDR Article 23 – together with divergent application by National Competent Authorities (NCAs) of Article 23 and the closely related Article 49.1 list – have reduced the possibility for CSDs to offer services as Issuer CSDs for instruments issued under the law of another Member State.” 139  

The costs per passport are estimated to amount on average to ca. EUR 30 000. 140 This means that, at least theoretically, for a CSD to be able to provide services for financial instruments constituted under the law of 26 other Member States it may be required to pay on average about EUR 780 000. 141 Similarly, internal resources in terms of the time required to prepare an application for a passport are estimated at 1-3 months (1 FTE).  142  At least theoretically, for a CSD to be able to provide its services throughout 26 other Member States it needs to dedicate one FTE that would have to spend between 26 and 78 months (i.e. 6.5 years). 143  Once a passport is granted, the applicant CSD also has to continue to monitor it to ensure ongoing compliance, which also entails costs. These costs are estimated at on average ca. EUR 2 000 per passport per year. 144 This means that, at least theoretically, when the CSD has obtained a passport in 26 other Member States it may be required to pay on average about EUR 52 000 per year.

Given, amongst others, the high cost of the passport, CSDs require a minimum amount of activity in order to provide services cross-border. This means that cross-border services are generally provided to larger issuances in order to make them more economically viable, potentially limiting the access of smaller- and medium-sized companies to the benefits of the single market. 145  

The costs of passporting are less significant for authorities; ranging from ca. EUR 1 000 per passport for the home national authority 146 to EUR 3 000 for the host national authority. This means that, at least theoretically, a CSD that would decide to passport in 26 Member States would generate estimated costs of ca. EUR 79 000. 147  

Annex 6 provides further examples of burdensome and unclear passporting requirements.

Finally, the effects of the burdensome and unclear passporting requirements are illustrated by the figures showing the slow progression of provision of cross-border services (see section 1.3). According to ESMA “there has been a limited progression of the provision of CSD services on a cross-border basis within the EU since of the entry into force since 2017 and in the context of the progressive entry into force of CSDR”. 148  

2.3.2.Insufficient coordination and cooperation between authorities 

CSDR requires the cooperation of authorities that have an interest in the operations of CSDs that operate domestically and cross-border. Nonetheless, the supervisory arrangements remain fragmented and can lead to differences in the allocation and nature of supervisory powers depending on the EU CSD concerned. This in turn creates barriers to the cross-border provision of CSD services, perpetuates the remaining inefficiencies in the EU settlement market and has negative impacts on the stability of EU financial markets.

Notwithstanding ESMA's competence to promote supervisory convergence, the powers of national supervisors and the requirements for CSDs are interpreted differently across the EU resulting in a significant heterogeneity in supervisory practices, in particular as regards CSDs that operate cross-border.

First, insufficient cooperation between home and host supervisors prevents the creation of a single market for CSD services, as acknowledged amongst others by ESMA and the CMU High Level Forum. CSDR does not ensure the effective cooperation between home and host national supervisors for several reasons:

·formal cooperation of home and host authorities on a continuous basis (through the establishment of the so-called ‘cooperation arrangements’) is required only for CSDs that establish a branch in a host Member State or when the activities of a CSD are of substantial importance for the functioning of the securities markets and the protection of the investors in that host Member State. This means that only for certain CSDs with activities in host Member States structural and ongoing cooperation between home and host authorities is required. For other situations, home and host authorities may cooperate on an ad hoc basis on request. CSDs of substantial importance to different host Member States are subject to national supervisors’ divergent interpretations as to the content of CSDs’ reporting obligations, which can be burdensome especially for small CSDs. 149  Furthermore, due to the absence of structured cooperation between the home and host authorities before the granting of the passport, CSDs face widely divergent interpretations of the same requirements, as illustrated by the differences in the time and cost that each passport requires (see Section 2.3.1).

·It is not specified what these cooperation arrangements should entail in practice. This means that it is up to each home supervisor to decide when setting them up. 

·CSDR states that when a CSD is of substantial importance for the functioning of the securities markets and the protection of the investors in more than one host Member State, it is up to the home Member State to decide that such cooperation arrangements are to take the form of a college. To date only one college has been set up (with six authorities from four Member States, without ESMA’s participation). The experience of that home supervisor has been positive, as it serves as good forum for discussion, information exchange and enables an exchange of expertise, potentially even dividing tasks.

Second, CSDR does not sufficiently consider the fact that several CSDs are part of larger groups comprising several CSDs or financial market infrastructures. CSDs in a group may outsource key IT infrastructure components, activities and processes (e.g. risk management, cyber security) to other group entities and major strategic, business, risk management decisions and governance may be established (directly or indirectly) at group level. While during the authorisation process CSDR provides for the consultation of competent authorities from other Member States where the CSD is part of a group of CSDs, the current supervisory and cooperation approach focuses on individual CSDs, and not on the group or the entity which has been outsourced to. Nonetheless, decisions made by the authority of one CSD in the group can impact the other financial market infrastructures in the group. 150

As an example to illustrate the above, Figure III in Annex 8 151  includes the governance structure of one of the biggest groups of CSDs in the EU, Euroclear. Euroclear SA is the parent company for six domestic CSDs and an ICSD, Euroclear Bank. Three of those domestic CSDs (Euroclear France, Belgium and the Netherlands) use a common settlement platform (ESES) and, amongst others, use a common admission process. While the Belgian national supervisor cooperates with the French and Dutch overseers and market supervisors, 152  this cooperation does not take place under the CSDR framework and ESMA is not involved.

Finally, regarding domestic CSDs, there is insufficient cooperation and supervisory convergence amongst authorities interested in CSDs’ activities. This means that their concerns may not be sufficiently taken into account by the national authority when making decisions. One stakeholder noted that it was not easy to get a good understanding of the overall functioning of the CSD, the supervisory approach, the interpretation and application of the regulatory provisions, the aspects of concern for the competent authority, the views/opinions of the other authorities if others were involved, etc. Furthermore, some authorisation and review and evaluation processes revealed a different understanding and application of various requirements as well as different readings of background documents, which may impact the consistent application of CSDR and distort the level playing field.

Additionally, while CSDR requires national supervisors to involve other relevant authorities, i.e. central banks, in the authorisation of CSDs, the former are not required to inform the latter if and how their views have been considered in the outcome of the authorisation process and if additional issues have been identified. This means that relevant central banks may not be able to express their views on newly identified issues or they may not know that their concerns have not been taken on board, in which they could adopt a more rigorous oversight approach, especially in areas of concern.

2.3.3.Restrictive requirements for provision of banking services related to settlement in foreign currencies

An important element of the functioning of CSDR is the banking services that CSDs can offer to clients 153  in addition to the core CSD services and other non-banking settlement services. 154  As noted, the provision of banking services is a prerequisite to settle in foreign currencies, if no access to the relevant central bank is practical or available. 155  Nonetheless, the requirements for the provision of banking-type services related to settlement are restrictive, leading to both a reduction of CSDs’ cross-border activity and to disproportionate compliance costs (see sections 2.2.1 and 2.2.2).

First, under CSDR, apart from being authorised themselves to provide banking services, CSDs may also use a designated credit institution for such services. Nonetheless, the conditions set out in CSDR for such institutions are very strict 156 to mitigate risks to financial stability: in addition to having to be authorised as a credit institution under the applicable EU banking legislation (Capital Requirements Regulation, Capital Requirements Directive 157 ) and to comply with additional prudential and liquidity requirements under CSDR, 158  designated credit institutions can only offer services in relation to settlement. This means that there is a very limited business case for such entities, as also evidenced by the fact that no such institutions exist to date. Furthermore, CSDR requires that designated credit institutions do not carry out themselves any of the core CSDR services (i.e. notary, central maintenance, settlement). This means that CSDs that have been authorised to provide banking-type services themselves cannot function as designated credit institutions to other CSDs (even if they are part of the same corporate group), which greatly limits synergies and restricts access to commercial bank money.

Second, the threshold under which a commercial bank may provide banking services (i.e. the total value of cash settlement is less than 1% of the total value of all securities transactions against cash settled in the books of the CSD and does not exceed a maximum of EUR 2.5 billion per year) 159 is considered by the majority of stakeholders, including CSDs and their association as well as a public authority, as too low for the majority of EU CSDs to be able to compete in the settlement in foreign currencies. CSDs without a banking license could increase their settlement activity in foreign currencies over a 5 year horizon to ca. 5% of their total yearly settlement activity. 160  As an example, for smaller CSDs with lower turnover ratio, 161 e.g. 11, the current threshold of EUR 2.5 billion settlement per year would be reached with issuance corresponding to EUR 229 million 162  – less than half the size of a regular bond issue, leaving no possibility to offer issuance to others in the same or other currencies in commercial bank money or even allow the same entity to do other issuances.

2.3.4.Unclear and complicated requirements for settlement discipline

CSDR introduced rules on settlement discipline to prevent and address failures in the settlement of securities transactions and therefore ensure the safety of settlement (see section 2.2.2). Despite the absence of experience in applying the rules, the development and specification of the framework in the relevant RTS has allowed all interested parties to better understand the regime and the challenges its application could give rise to, especially at times of crisis, e.g. the COVID-19 crisis in spring 2020.

A large majority of respondents to the Commission targeted consultation (public authorities, CSDs, CCPs, banks, asset management companies, market makers, and their respective associations), considered that the settlement discipline framework should be reviewed. 163  Member States took a similar position in the Member States' Experts Group meeting in July 2021. They almost unanimously expressed concerns about the current design of mandatory buy-ins and their influence, in particularly on trading activity, liquidity or the competitiveness of EU capital markets. ESMA also supported a delay in the application of the buy-in regime noting that “ESMA is aware of market participants’ serious difficulties regarding the implementation of the buy-in regime.”

Two main issues have been identified: the lack of clarity and the complexity/burden of the settlement discipline requirements. These drivers lead to disproportionate compliance costs, in so far as the costs of complying with the framework potentially seem to outweigh the achievable benefits (see section 5.1.4).

First, the requirements of the settlement discipline regime are often unclear, creating legal uncertainty, thus increasing compliance costs. This lack of clarity is also shown by the number of Q&As received by ESMA and the Commission. Since 2017, ESMA has frequently updated its CSDR Q&As, with currently 164  seven Q&A’s related to settlement discipline. More than 25 Q&As on settlement discipline are also currently being assessed. The need to clarify questions related to the settlement discipline regime puts an additional burden on market participants, but also the relevant authorities. This uncertainty means that companies have to obtain additional legal opinions on how the rules should be applied, to enable them to adapt existing trading and reporting procedures. Should those rules subsequently be interpreted differently, additional costs will be incurred to re-adapt.

The unclear requirements are primarily linked to the scope of cash penalties and buy-in rules. One business association stated “…the different provisions of CSDR setting out the scope of the requirements such as settlement fails reporting, cash penalties or buy-ins are not always clear. This lack of legal certainty could potentially lead to reducing the efficiency in securities settlement.” 165

·Unclear scope of rules on cash penalties: 166  A cash penalty applies for each day that a transaction fails to be settled after its intended settlement date. Examples of lack of clarity relate to the types of securities transactions covered and the scope of entities concerned by cash penalties. 167  As an example, the scope of “transactions” is not defined in CSDR; however certain transactions are outside CSD participants’ control. It is therefore unclear whether such transactions should be within the scope of the cash penalty regime. This uncertainty generates costs when CSDs implement the IT systems to monitor cash penalties, requires additional legal advice and increases potential legal risks. The questions about the interpretation of CSDR stem not only from the text of the Regulation itself but also from the delegated acts; e.g. Commission Delegated Regulation (EU) 2017/389 states that, in certain circumstances, the calculation of penalties rates should use the official interest rate for overnight credit charged by the central bank issuing the settlement currency. However, in at least two Member States, it has been reported recently that central banks do not have this official rate and therefore the calculation of the penalties cannot fulfil this requirement.

·Unclear scope of rules on buy-ins: there is lack of clarity on a wide range of issues, i.e. types of securities covered, scope of entities concerned, and in-scope transactions. 168  For example, while CSDR refers only to participants (i.e. failing participant and receiving participant), multiple terms are used in Level 2 (e.g. failing trading party, failing trading venue member, failing clearing member) which could create difficulties of interpretation and lead to legal challenges. 169

Second, the requirements of the settlement discipline regime are often complicated and increase compliance costs. In addition to one-off costs incurred to adapt IT systems, 170 the two examples below on contractual repapering (i.e. update of existing contracts) and the use of buy-in agents show how the actual application of the requirements could increase costs for market participants.

Trading parties that settle transactions in-scope of mandatory buy-ins would need a global repapering exercise. 171  This would ensure that appropriate contractual arrangements are in place between the relevant counterparties to guarantee effective application and enforceability of the buy-in requirements, even where some parties are located outside the EU. 172  EU securities valued EUR 33.5 trillion and bonds valued at EUR 13.2 trillion could be subject to this exercise 173  showing the one-off compliance costs it could generate. Data suggests that, on average, each firm would need to repaper 27 120 agreements, taking on average 10 months to complete. 174 The scope of the repapering is however related to and reliant on the interpretation of the scope of the rules.

Increased compliance costs result also from the requirement to use buy-in agents. 175  The concerns relate mainly to the limited number of third-party buy-in agents (currently only one stakeholder has made substantial investments to comply with these rules and establish themselves as buy-in agent). This adds one-off investment and ongoing costs to trading for asset managers in terms of onboarding, connectivity, fees and collateral requirements as well as impacting best execution and adding concentration risk 176 . In addition, some stakeholders claim that the current buy-in offering may not be compatible with the diverse needs of market participants. 177 Therefore, certain market participants (e.g., asset managers) may have to provide the buy-in agent with sufficient liquidity even if they will use the service rarely. 178  Due to the costs and risks linked to the role of buy-in agents, some market-makers traditionally acting as buy-in agents for specific instruments have stopped providing that service. Other concerns related to high costs, 179 the potential risk associated with abuse of a dominant position by the agents or the difficulty to execute a buy-in for instruments with limited supply (the use of substitute instruments has been advocated in such a case). These further drive up firms’ compliance costs.

2.3.5.Insufficient reporting for third-country CSDs 

Under CSDR, certain third-country CSDs providing services for financial instruments constituted under the law of a Member State could benefit from a lighter regulatory regime. The insufficient reporting by third-country CSDs leads to insufficient insight into their activities (see section 2.2.3), mainly due to two factors.

First, third-country CSDs 180  that provide services in relation to financial instruments constituted under the law of a Member State under the national laws applicable before the adoption of CSDR can continue to do so until they have been recognised by ESMA (the “grandfathering clause”). 181  The objective of that clause was to defer application of CSDR to provide CSDs with sufficient time to apply for recognition. However, even though CSDR was adopted in July 2014, 182  the grandfathering clause still applies and does not have an end-date. 183 This means that third-country CSDs have no incentive to apply for recognition to ESMA. To date, no third-country CSD, other than the UK CSD, has applied for recognition.

Under the current regime, third-country CSDs benefiting from the grandfathering clause can indefinitely provide services in relation to financial instruments constituted under the law of a Member State even though: (a) they do not have to comply with CSDR or rules that have been considered as equivalent by the Commission and, (b) they have not been recognised by ESMA - while authorised EU CSDs with which they compete have to comply with CSDR. Third-country CSDs benefiting from the grandfathering clause are also not under any notification requirements regarding their activities in the EU. Hence, they are not required to provide any information to EU authorities.

Second, settlement services are outside the scope of the CSDR third-country regime. Under CSDR, 184 third-country CSDs that do not benefit from the grandfathering clause, may provide services in relation to financial instruments issued under the law of a Member State, including through setting up a branch, only if they comply with the CSDR third-country framework. Requirements applying to third-country CSDs differ however depending on the type of service (notary, central maintenance, settlement) they intend to provide. A recognition by ESMA is required for notary or central maintenance services; a condition of this recognition is that the Commission has adopted an equivalence decision, determining that the legal and supervisory arrangements of the third country ensure that CSDs authorised therein comply with legally binding requirements which are in effect equivalent to the requirements of CSDR. Settlement services provided by third-country CSDs do not require recognition by ESMA.

Despite the fact that settlement is one of the three core services provided by CSDs, third-country CSDs may provide settlement services for securities issued under the law of a Member State without applying for recognition by ESMA. In that case, third-country CSDs do not have to comply with CSDR or at least equivalent rules nor are they required to provide any information or notification regarding their activity. They are also not subject to any type of supervisory activity by an EU supervisor.

To conclude, third-country CSDs operating in the EU under the grandfathering clause or providing settlement services might not comply with CSDR or equivalent rules. National and EU authorities have very little information on the activities of these third-country CSDs, as confirmed also by ESMA. 185

2.4.How will the problem evolve?

2.4.1.Ongoing inefficiencies in the EU settlement market

The ongoing inefficiencies in the EU settlement market stem from two main problems: barriers to cross border settlement (see section 2.2.1) and disproportionate compliance costs (see section 2.2.2).

Under a baseline scenario, CSDR is unchanged, barriers to cross-border settlement through: burdensome passporting requirements; insufficient coordination among authorities; burdensome, even restrictive, requirements for the provision of banking services; and a disproportionate settlement discipline regime would remain.

Competition among CSDs within the EU would not improve. For example, challenges accessing banking services and in particular settling in foreign currencies would reduce the possibility of CSDs offering multi-currency services therefore reducing their attractiveness. Consequently, cross-border investment will remain at a lower level than could otherwise be achieved, leading to a sub-optimal pan-EU settlement market.

The entry into application of mandatory buy-ins could further increase the costs for CSDs, investors and market makers (see section 2.3.4). This could lead to a reduced willingness by liquidity providers to create markets and offer prices for a security when they do not have access to inventory or for securities which cannot be readily sourced. Market makers will find price-setting complicated for these instruments as it is unclear whether the trade will be subject to a mandatory buy-in. This could also lead to increased higher bid-offer spreads for investors as market makers hedge risks related to such difficulty to set prices of less liquid instruments. This, in particular, could affect negatively less liquid instruments and even lead to a substantial drop of liquidity, as market makers withdraw from making markets for these instruments.

The EU post-trade landscape will remain fragmented along national lines, impairing cross-border investment due to additional costs caused by added complexity relative to other jurisdictions, e.g. the US and the UK. Transaction costs in the EU could increase with full entry into force of the settlement discipline regime (see section 2.2.1).

If nothing is done, it will continue to be easier to do business outside the EU than within the EU. Participants will increasingly be attracted to issuing their securities and settling in non-EU 27 countries as EU CSDs’ ability to offer a wide range of services including in different currencies is limited by burdensome passporting processes and restrictive requirements for the settlement in commercial bank money. In addition, lending market participants may increase the amount of stock they hold back as buffer by up to 10% to reduce the risk of buy-ins. 186 This would represent a fall of EUR 398 billion in securities available to facilitate market liquidity and banking financing activities. 187  

Together these impacts negatively impact the safety and efficiency of EU financial markets, limiting the potential benefits of a larger-scale integrated EU market. They would be to the detriment of the EU financial system as a crucial building block of CMU would perform sub-optimally, to the detriment of EU investors and businesses.

2.4.2.Negative impacts on stability of EU financial markets

The negative impacts of CSDR on the stability of EU financial markets stem from three main problems: barriers to cross border settlement (see section 2.2.1), insufficient insight on third-country CSDs activities (see section 2.2.3) and disproportionate compliance costs (see section 2.2.2).

First, cross-border settlement remains difficult, limiting competition in the EU, hampering the development of CMU. Inability to ensure swift cross-border settlement may restrict activity to national capital markets, which would make them more vulnerable to country-specific asymmetric shocks that may over time endanger the stability of the EU capital market. If nothing is done, CSDs will continue to find providing cross-border services difficult. The level of cross-border activity will remain reduced, limiting competition and entrenching fragmentation of EU capital markets along national borders, potentially exposing EU capital markets to asymmetric shocks, in particular for some shallow national markets that cannot rely on abundant liquidity.

Second, the insufficient insight into third-country CSDs’ activities could potentially lead to financial stability risks. EU and national authorities alike currently do not have information on most third-country CSDs activities in the EU; this means that they cannot evaluate whether any of these CSDs are important for the EU financial stability, which in itself creates a potential risk to financial stability. If nothing is done, this risk will persist. Furthermore, market participants may choose to use the services of third-country CSDs outside the transparency arrangements set by CSDR, potentially allowing for a build-up of risk that may threaten the stability of the EU capital market.

Third, if no specialised credit institution can provide access to commercial bank money to CSDs under the CSDR due to disproportionate compliance costs, the risk is that non-bank CSDs may not be able to provide DvP settlement in foreign currencies to their participants. This could lead to transactions being processed free of payment instead of versus payment, leading to less safe markets and undermining the CSDR’s objective of promoting DvP settlement. The decrease in foreign currency settlement at non-bank CSDs would constitute a step backwards if it results in the settlement of these transactions outside CSDs. 188

3.Why should the EU act?

3.1.Legal basis

CSDR has a comprehensive regulatory framework for the settlement of financial instruments in the EU as well as common rules on the organisation and conduct of CSDs to promote safe, efficient and smooth settlement. The legal basis for CSDR was Article 114 of the Treaty on the Functioning of the European Union (TFEU) as it aimed to create an integrated market for securities settlement with no distinction between national and cross-border securities transactions. Considering that this initiative proposes policy actions to allow the achievement of these objectives more effectively and efficiently, amendments to CSDR would be adopted under the same legal basis.

3.2.Subsidiarity: Necessity of EU action 

The review could amend certain provisions of CSDR, in particular to clarify and simplify burdensome and unclear requirements, reduce administrative burden and costs, and ensure that authorities have enough information to monitor risks. EU action should therefore ensure that CSDR’s regulatory requirements are more effective, efficient and proportionate, are applied uniformly, and guarantee a sound and consistent regulatory framework for securities settlement in the EU and the operations of CSDs, both of which are essential foundation stones for the development of CMU as well as to ensure a safe and efficient single market for financial services.

3.3.Subsidiarity: Added value of EU action

The 2020 CMU Action Plan 189 explicitly acknowledged that amending CSDR could help develop a more integrated post-trading landscape in the EU and thus contribute to the development of CMU. The objectives of CSDR, namely to lay down uniform requirements for the settlement of financial instruments in the EU and rules on the organisation and conduct of CSDs, to promote safe, efficient and smooth settlement cannot be sufficiently achieved by the Member States alone, as the co-legislators already acknowledged in 2014 when adopting CSDR. Similarly, today Member States and national supervisors cannot solve on their own the challenges arising from the burdensome and unclear CSDR requirements or the risks resulting from diverging national supervisory practices, in particular where those stem from primary or secondary legislation. In addition, Member States and national authorities cannot address on their own the risk to the EU financial stability that the lack of information on the activities of third-country CSDs may pose, as the conditions for the regime are contained in CSDR. 

As such, the objectives of CSDR cannot be sufficiently achieved by the Member States and can therefore, by reason of the scale of actions, be better achieved at EU level in accordance with the principle of subsidiarity as set out in Article 5 of the TEU.

4.Objectives: What is to be achieved?

4.1.General objectives

The general objective of CSDR remains to create a safe and efficient market for the settlement of securities transactions in the EU. This could be achieved by enhancing cross-border competition between CSDs, improved risk monitoring for EU and non-EU CSDs, more efficient supervisory cooperation and reduced compliance costs, where appropriate, for post-trade service providers, market participants and competent authorities. The benefits should however not come at the expense of the resilience and stability of the EU financial system. In this respect, the present initiative aims to render the application of CSDR more proportionate, effective and efficient and, by fine-tuning certain requirements, to reduce the regulatory and compliance burden for market participants where compliance costs outweigh benefits, but without endangering financial stability. The initiative thus contributes to the Commission's Better Regulation Agenda and the Regulatory Fitness and Performance (REFIT) programme.

The overarching policy objective will be achieved via the pursuit of the following specific objectives:

·Minimise barriers to cross border settlement;

·Ensure adequate powers and information to monitor risks;

·Reduce administrative burden and compliance costs, without endangering financial stability;

This initiative is also in line with the objectives of the CMU. Efficient and resilient post-trading systems are essential elements for the well-functioning of the CMU. Better means of cooperation between competent authorities, streamlined procedures, better access to liquidity for CSDs and credit institutions will contribute to integrating the EU capital market, that is currently fragmented along national lines, will strengthen cross-border investment and will lower investment costs for market participants while ensuring that the associated risks are contained and managed. Effective and efficient CSDR rules thus contribute to achieving the objectives of the CMU and help making post-trade markets an important building block of an economy that works for people, in line with the strategic priorities of the Commission.

Figure VII: Objective tree

4.2.Specific objectives

There are three specific objectives, relating to the five problem drivers (see section 2.3).

4.2.1.Reduce administrative burden and compliance costs, without endangering financial stability

The effectiveness and efficiency of applying CSDR should be improved by simplifying and clarifying the passporting process. This should, in turn, enable more competition for CSD services across borders. Furthermore, to facilitate settlement in foreign currencies, and promote more cross-border activity, the requirements faced by CSDs and credit institutions when providing banking-type ancillary services should be more proportionate. Lastly, the efficiency and safety of settlement should be ensured through more proportionate requirements for settlement discipline, which balance the reliability of settlement with potential negative impacts on trading behaviour and markets, including financial stability.

4.2.2.Minimise barriers to cross-border settlement

Provision of cross-border services should be enhanced by: (a) clarifying and streamlining the passporting process for CSDs offering such services or setting up a branch in another Member State; (b) increasing the cooperation between authorities involved in the supervision of the relevant CSDs; and (c) improving access to banking services related to settlement.

4.2.3.Ensure adequate powers and information to monitor risks

The insufficient insight of EU authorities into the activities of third-country CSDs should be addressed by increasing the reporting obligations for such CSDs. This should ensure that adequate information is available to monitor risks. Furthermore, while better coordination and cooperation between authorities involved in the supervision of EU CSDs aims primarily at minimising barriers to the cross-border provision of services, it will also provide authorities with increased powers and information to monitor any risks that may be arising from the operation of these CSDs.

5.What are the available policy options?

5.1.What is the baseline from which options are assessed?

This section describes, for each policy option, the most likely scenario is going to be without any further intervention. 

5.1.1.Burdensome and unclear passporting requirements 

All issues identified in Section 2.3.1 remain. The passporting requirements are unclear and burdensome for CSDs and national authorities, generating costs and lengthy processes. Consequently, cross-border activities of CSDs may stagnate or fall and the administrative burden for CSDs and national authorities remains high. Indirectly, issuers could be negatively impacted as less cross-border CSD activities would mean less competition and reduced choice, preventing them from benefitting from an integrated capital market for financial services. National authorities would continue to face unclear requirements when assessing CSDs’ applications to obtain a passport.

5.1.2.Insufficient coordination and cooperation between authorities

All issues identified in Section 2.3.2 remain. Cooperation between authorities in home and host Member States is insufficient, creating obstacles in the cross-border operations of CSDs and hindering the creation of a true single market for CSD services. In particular, communication between authorities in different Member States is not standardised and the same CSD may be subject to different supervisory arrangements and requirements in the different Member States in which it may be operating. Inefficiencies in the cooperation of authorities interested in the activities of CSDs operating domestically also remain.

5.1.3.Restrictive requirements for provision of banking services related to settlement in foreign currencies

All issues identified in section 2.3.3 will remain regarding CSDs’ access to commercial bank money. In particular, settlement in foreign currencies by CSDs will continue to be limited as no designated credit institution is likely to be established and commercial banks will remain limited in their service offering (mostly intraday- credit and liquidity to the participants of the CSD). This situation will hamper cross-border securities transactions, e.g. bond issuances in foreign currencies, due to the disproportionate compliance costs of obtaining these services. CSDs will be limited in their choice of providers to settle in foreign currencies, be it designated credit institutions (which do not exist currently) or commercial banks that are only allowed to provide these services within the limits set by CSDR. This runs counter to the EU’s objective to ensure a true single market for CSD services.

Although the requirements to provide banking services have a positive effect on the stability of the financial system as liquidity and credit risks attached to these services remain limited, they also affect competition on the EU settlements markets. Due to the restrictiveness in the provision of these services and the compliance costs, new players, whether in the form of a designated credit institutions or commercial banks offering these services, will not enter the market. This runs counter to the core of the CMU Action Plan to enhance the Union’s capital markets.

5.1.4.Unclear and complicated requirements for settlement discipline 

The settlement discipline regime, as described in Art. 6 and Art.7 of CSDR and Regulation (EU) 2018/1229, would enter into force on 1 February 2022. Retail investors should benefit from improved settlement efficiency due to the fact that market makers often provide prices for many financial instruments without having immediate access to these securities. In case of smaller equity trades which are often carried out by retail investors, the coverage of these sales may be considered as too expensive and cumbersome, leading to no delivery taking place. Settlement discipline measures aim at incentivising market makers to avoid this kind of situation. The settlement discipline regime would also potentially allow investors to consolidate trading positions and rely on cross-border settlement to settle trades, as they would have more confidence that they would be settled. Finally, mandatory buy-ins can be applied by the market. Regulation (EU) No 236/2012 (Short Selling Regulation (SSR)) introduced them for centrally cleared equity transactions. According to some stakeholders, settlement efficiency on intended settlement date is now almost 100% for centrally cleared equity transactions 190 . However, it should be noted that equity trading generally features high levels of liquidity. Implementation and the resulting effect cannot therefore be directly compared to other, less liquid markets.

However, the impact of a miscalibrated settlement discipline regime on overall market conditions could outweigh these benefits for investors. The majority of the potential negative impacts of the settlement discipline regime are likely to be related to mandatory buy-ins. In particular, mandatory buy-ins as currently designed could theoretically widen bid-offer spreads and negatively impact market liquidity, favouring settlement in non-EU CSDs particularly for less liquid securities, 191 remove incentives for securities lending in the securities lending and repo markets and ultimately lead to increased costs for end investors without providing additional benefits to markets or investors. 192  This could affect a broad range of asset classes including corporate bonds, sovereign bonds, securities lending / repo transactions and other exchange traded products. 193  These increased costs would negatively impact investors’ returns and their ability to save, and companies’ access to capital market funding, especially in times of market stress. 194  Estimates 195 provided suggest that in normal market conditions a mandatory buy-in regime would theoretically increase the mid-offer price by 21 cents or 59% when the regime applies. In times of stress the regime could theoretically increase the mid-offer price by 146 cents or 291% in the event that the current settlement discipline regime applies unchanged. It is thus estimated that up to 4%-5% of trade volume could cease to occur (estimated at up to EUR 7 trillion in 2020, combining debt and equity instruments) in the future. Therefore, applying a mandatory buy-in regime in its current form could potentially impact negatively the efficiency of EU capital markets, leading to wider bid-offer spreads, reduced market efficiency and less incentives to lend securities in the securities lending and repo markets. Such developments may ultimately favour the settlement of less liquid securities in non-EU CSDs.

In particular both equity and debt instruments with a lower floatation, such as less liquid bonds or shares of SMEs, could be negatively affected as investors withdraw from making markets/ trading in those instruments. Traders would either have to keep securities on their books to cover any buy-ins, freezing capital, or trade only in instruments where the supply is easily available. This could lead to an even greater concentration of trading on a limited number of instruments, both threatening investors’ risk diversification strategies and creating systemic risk. Asset managers may not be able to obtain the securities they want on behalf of investors, and thus may have to make sub-optimal investment decisions or may have to pay a liquidity premium. Furthermore, national authorities, ESMA and the Commission would need to issue numerous Q&As and guidelines to address the lack of clarity in the relevant provisions.

Introducing a mandatory buy-in regime as of 1 February 2022 could also lead to a duplicative re-papering exercise of existing contracts between market players in order to take account of the upcoming rules change potentially introduced under the ongoing review of CSDR; one estimate puts the number of clients’ contracts to be repapered at a financial institution at between 30 - 40 000 196 over a period of 10 months. Repapering of client-facing documentation would have to go beyond updates to generic terms and conditions adding complexity to interdependent sets of client documents. A law firm concluded that clauses reflecting clients’ mandatory buy-in obligations, including the necessity to appoint a buy-in agent, would be difficult and impracticable to understand in particular for retail investors. 197

Another related cost will be the obligation to connect to a buy-in agent. Market participants will have to appoint a buy-in agent to carry out the mandatory buy-in in case of delayed settlement. The costs for appointing and connecting to a buy-in agent are high. One estimate provided in the targeted consultation shows that the estimated annual cost of appointing buy-in agents to handle government bond fails in one CSD could amount to between EUR 598 900 294 to EUR 1 197 800 588. 198  One investment fund 199 indicated that connecting all their funds to a buy-in agent would require a one-off cost of EUR 1 million. Operational costs of running a buy-in framework are also potentially high, leading some market participants to consider changing their business model to avoid the requirement to connect to a buy-in agent. 200  This would outweigh the potential postponed cost related to the setting up of a buy-in agent offering by one entity (only one buy-in agent service provider that has emerged so far). 201

A mandatory buy-in regime could also indirectly negatively affect issuers. Issuance ability and pricing is related to the expected liquidity of the instrument. A decrease in liquidity, from the knock-on effects of the mandatory buy-in regime, could increase borrowing costs for issuers, with the greatest impact likely to fall on smaller and lower credit rated companies, especially in times of stress where access to a wide range of financing channels is needed. Higher issuance costs and limited liquidity could increase the cost of capital for EU issuers, including innovative start-ups and SMEs, who may continue to rely on bank loans or private placements 202  for financing, inhibiting the development of the EU capital market.

Furthermore, there is some evidence that these costs could be born to potentially address a less significant problem, as the majority of fails seem to be resolved between one and five days after the intended settlement date, meaning they would not enter buy-in. 203  It should also be noted that, in general, fails are most likely to appear in less liquid instruments, increasing the probability that even the eventual buy-in may not be successful due to the inability to source the necessary securities. 204 This holds true both for bonds and equity instruments.

Since market participants will not know which transactions will enter a buy-in, stakeholders argue that they will have to disperse the costs of a potential buy-in across a wide spectrum of transactions. At the end of the day, if this were to happen, end-investors would have to pay a higher price for the same security (because of its lower liquidity) and will ask for a higher return. The consequence at the end of the chain would be a higher funding cost for issuers. Hence, some stakeholders argue that in order to incrementally improve a relatively low level of settlement fails, a mandatory buy-in would impact the costs of trading more widely. 205

While mandatory buy-ins are expected to negatively impact all asset classes, the impact will be most detrimental for less actively traded/illiquid securities, e.g. instruments issued by SMEs, high yield and emerging markets securities. The mandatory buy-in regime in its current form could therefore be perceived to be contrary to the wider CMU objectives, especially when aiming to provide efficient financing to smaller corporate clients and SMEs, whose securities will have lower inherent liquidity and would be disproportionately affected by this regime.

Lastly, there is some limited evidence that the mandatory buy-in regime may also indirectly undermine the CSDR objectives of safe and efficient settlement as companies may migrate to internalised settlement to avoid the burden of the discipline regime. ESMA observed increasing levels of internalised settlement in several jurisdictions accompanied by a high degree of concentration. As such, they called for continuing monitoring, including of this activity and the associated risks. 206

5.1.5.Insufficient reporting for third-country CSDs 

All issues identified in Section 2.3.5 remain. In particular, there would be little information on third-country CSDs’ activities. This would directly negatively impact the EU’s financial stability as ESMA and national authorities will continue to have no information on these CSDs’ activities and therefore will not be able to monitor risks. It would also directly negatively impact EU CSDs which have to comply with CSDR as well as issuers considering that for third-country CSDs operating under the grandfathering clause, their national supervisory and regulatory framework has not been deemed as equivalent by the Commission.

5.2.Description of the policy options

5.2.1.Burdensome and unclear passporting requirements 

The objective is to minimise barriers to cross-border settlement to enhance the cross-border provision of services. Options 3 and 4 may be complementary.

5.2.2.Insufficient coordination and cooperation between authorities

The objective is to minimise barriers to cross-border settlement by enhancing coordination and cooperation between authorities involved in the supervision of CSDs. All of the options presented are alternatives.

5.2.3.Restrictive requirements for provision of banking services related to settlement in foreign currencies

The objective is to enhance the cross-border provision of CSD services, through improved access to banking-type services while ensuring financial stability. Options 2 and 3 may be complementary.

5.2.4.Unclear and complicated requirements for settlement discipline

The objective is to minimise the burden and compliance costs of the settlement discipline regime, avoid negative impacts on EU capital markets, while ensuring a high degree of settlement efficiency.

The objective is to minimise the burden and compliance costs of the settlement discipline regime, avoid negative impacts on EU capital markets, while ensuring a high degree of settlement efficiency. Options 2, 3, and 4 are complementary, Option 3 and 4 alternative.

5.2.5.Insufficient reporting for third-country CSDs 

The objective is to increase information available on third-country CSDs’ activities in relation to financial instruments constituted under the law of a Member State to allow authorities in the EU to assess potential risks (see section 2.3.5). Options 2 and 3 may also be complementary whereas Option 4 is an alternative.

5.3.Options discarded at an early stage

Certain options have been discarded at an early stage as inconsistent with the EU legal framework or the objectives of this initiative to ensure a resilient and efficient market for settlement in the EU. These relate in particular to the restrictive requirements for the provision of banking-type ancillary services and the unclear and complicated requirements for settlement discipline.

Regarding the former, the option to introduce in CSDR a requirement for central banks to facilitate CSDs’ access to central bank money was discarded. CSDR should be without prejudice to the independence of central banks, which is enshrined in the TFEU, as concerns their policies on access of domestic or foreign financial market institutions to central banks’ accounts and central banks’ facilities. Therefore, CSDR is not an appropriate place to impose obligations on the EU central banks. 211

With regards to the unclear and complicated requirements for settlement discipline the option to suspend the framework in its entirety was discarded. Settlement fails in the EU remain consistently higher than in other major financial markets which affects negatively the standing of EU financial markets as a target of investment and source of financing among EU market participants, while also undermining the international competitiveness of EU financial markets.

Similarly the option to differentiate the settlement discipline regime based on instrument type, market or the existence of a clearing obligation was disregarded for several reasons. First, this would create a two-tier market structure leading to arbitrage risks and investors fleeing to the lighter regulated market. This runs clearly against the objectives of CMU. Second, tougher settlement discipline measures only on the less performing markets will likely drive away any liquidity and trading from these venues undermining financial markets in these Member States while leading to concentration of market activity on a few Union markets. Finally, it could encourage failing market participants to migrate to venues that are not subject to the tougher settlement discipline measures. These effects combined could lead to a two-tier capital market in the EU, with a small number of liquid and efficient markets and a large number of smaller, less liquid and risky national capital markets, undermining the role of financial markets as drivers of growth and economic stability.

6.What are the impacts of the policy options?

This section describes the impact of each policy option against the drivers. In addition, each policy option considered (other than Option 1 (baseline)) will be assessed against the specific objectives presented in Section 4. In essence, under Option 1 (see section 5.1), all problems identified will remain, meaning that inefficiencies and disproportionate costs will remain, to the detriment of the competitiveness of EU financial markets.

For readability and flow of the text, the sections below focus on the effectiveness of each option in meeting the specific objectives, its coherence with the EU framework as well as the rationale for selecting each preferred policy option. A detailed description of the costs and benefits (efficiency) of each option can be found in Annex 7.

6.1.Impact of the policy options regarding passporting requirements 

6.1.1.Option 2 - Reduce the scope of the passporting requirements

Effectiveness in meeting the specific objectives

Passporting requirements would not apply for non-equity securities. There would be no need for CSDs to apply for a passport when providing services for these instruments cross-border. This would provide legal clarity (no requirements) for CSDs and national authorities, reducing the administrative burden and compliance costs for both.

The two specific objectives would however only be partially met, as the problems identified would remain for equities. As such, cross-border settlement activities of CSDs for equities may stagnate or reduce, and the administrative burden for CSDs and national authorities would remain. In addition, as passporting requirements would not apply to non-equity securities, national authorities would not have a clear overview of the services provided for non-equity instruments by CSDs established outside their jurisdiction and the risks that they may or may not entail. This could impact the specific objective to ensure adequate powers and information to monitor risks. Finally, there is no strong justification why two categories of securities should be treated differently.

Coherence

This option ensures that CSDs benefit from a less burdensome passporting process, but only for non-equity securities (and not for equity securities). This is only partly coherent with the objective of CSDR to provide CSDs with the freedom to provide services across the EU. In addition, it is only partially coherent with the CMU Action Plan 212 which favours amendments to the functioning of the CSD cross-border passport in general, and not only for non-equity securities, to contribute to the development of a more integrated post-trading landscape in the EU.

6.1.2.Option 3 - Clarify the role and powers of competent authorities and requirements related to national laws 

Effectiveness in meeting the specific objectives

Clarifying the passporting requirements would help CSDs and national authorities to reduce the costs of trying to understand them (e.g. legal opinion, discussions with legal counsel). The requirements will however remain burdensome, in particular those related to national laws. As such, while the specific objective of reducing administrative burden and costs could be partially met through more clarity and thus legal certainty, the specific objective to minimise barriers to cross-border settlement will not.

Coherence

This option would ensure that CSDs benefit from clearer passporting requirements. This would however only in part be coherent with the CMU Action Plan 213 as the content of requirements, in particular those related to national laws, will remain burdensome and, in turn, not fully enhance the functioning of the CSD passport. The CMU Action Plan 214  favours amendments to the functioning of the CSD cross-border passport to contribute to the development of a more integrated post-trading landscape in the EU.

6.1.3.Option 4 - Replace the passporting procedure at the host Member State level with a notification.

Effectiveness in meeting the specific objectives

Replacing the passporting procedure at the host Member State level with a notification procedure would remove that unclear and burdensome passporting requirement. As such, it would meet the specific objectives of reducing administrative burden and costs as well as minimising barriers to cross-border settlement. Option 4 does not waive the obligations stemming from national corporate legislation since harmonisation of the corporate laws is not the objective of CSDR and such national corporate legislation applies to participants directly 215 . Furthermore, as a notification procedure will still remain in place, it would ensure that authorities have adequate information to monitor risks. Not only would the host national supervisor be notified of the passport by the home national supervisor (and would have the possibility to discuss it with the home national supervisor during and after the passporting procedure), but the former would also potentially be able, through the establishment of colleges (see Section 6.2.2) to have a better overview of the supervision of the CSD on an ongoing basis, better cooperate and raise its concerns with the home national supervisor. 

216 Finally, Option 4 is aligned with the status of one of the main core services, settlement, for which no passport process is currently required. 

Coherence

This option is fully coherent with the CMU Action Plan 217 which favour amendments to the functioning of the CSD cross-border passport that could contribute to the development of a more integrated post-trading landscape in the EU. It is also consistent with the aim of EU regulation, i.e. harmonising laws for Member States, and removing barriers stemming from national laws. 

6.1.4.Option 5 – combination of Option 3 and Option 4

Effectiveness in meeting the specific objectives

Combining Option 3 and Option 4 would allow to meet both of the following specific objectives: (i) reducing administrative burden and costs through more clarity and thus legal certainty and (ii) minimising barriers to cross-border settlement.

Coherence

This option would ensure that CSDs benefit from clearer passporting requirements and is fully coherent with the CMU Action Plan 218 which favours amendments to the functioning of the CSD cross-border passport to contribute to the development of a more integrated post-trading landscape in the EU. Finally, it is consistent with the aim of EU regulation, i.e. harmonising laws for Member States, and removing barriers stemming from national laws.

6.1.5.Choice of preferred policy option

The tables below provide a high-level summary of how the described options compare (for the sake of readability, the labels of the options have been shortened). For a detailed overview of the costs and benefits (efficiency) of each option and impacts on different stakeholders see Annex 7.

Option 2 would only partially satisfy the objectives of minimising barriers to cross-border settlement and of reducing administrative burden and costs, as the alleviations would apply only to non-equity securities and not to equity securities. Option 3 is also only partially meeting the objectives as it only addresses the lack of clarity and not the burdensome nature of the requirements. Option 4 would meet these specific objectives.This option would be consistent as it would focus on a core aim of EU regulation, i.e. mutual recognition. Option 5, which is the preferred policy option, would combine the benefits from Option 3 and Option 4.

6.2.Impact of the policy options regarding cooperation between authorities 

6.2.1.Option 2: Enhance the existing CSDR rules for cooperation arrangements

Effectiveness in meeting the specific objectives

Clarifications to the existing framework for cooperation arrangements would be introduced in certain cases, i.e. when a CSD is operating cross-border. These would partly meet the objective of minimising barriers to cross-border settlement and ensuring adequate powers for authorities to monitor risks for several reasons:

·cooperation arrangements are established bilaterally, i.e. if a CSD is of substantial importance to more than one host Member State, then the home authority needs multiple cooperation arrangements. This leads to duplication and an increased administrative burden for the home national authority, who would have to negotiate and manage multiple parallel cooperation arrangements;

·cooperation arrangements are established for a limited number of CSDs. The problems identified in Section 2.2.1 for all other cases for CSDs and national authorities would therefore remain;

·ESMA does not participate in CSDR cooperation arrangements, which means that it cannot be ensured that a similar approach will be adopted by all such arrangements. Even if the framework was amended to provide that ESMA does participate, it would not have the guarantees provided by the ESMA Regulation.

Coherence

This option is coherent with the current CSDR framework, as it builds on the already foreseen arrangements. However, it is partly coherent with the CMU Action Plan, 219 which highlights the need to develop a more integrated post-trading landscape in the EU and states that if there are indications that the supervisory set-up is inadequate, stronger supervisory coordination or direct supervision by the ESAs should be considered. Furthermore, this option is not coherent with the ESMA Regulation, which already foresees a specific framework for the cooperation of supervisors in Article 21.

6.2.2.Option 3: Introduce mandatory supervisory colleges

Effectiveness in meeting the specific objectives

Under Option 3, supervisory colleges would be established for some or all EU CSDs, depending on the design of the framework. In general, the experiences with colleges in other EU financial frameworks are positive and colleges are genuinely seen as a forum where authorities with direct interest in the activities of a financial market infrastructure gather and exchange views. As such, colleges are already enshrined in the ESMA Regulation and for example put to practice in the context of EMIR for CCPs.

To meet the specific objectives of minimising barriers to cross-border settlement and ensuring adequate powers to monitor risks, colleges could in particular be established for CSDs offering services in relation to financial instruments constituted under the law of another Member State as well as CSDs that are part of corporate groups that include at least another CSD. Participation to these colleges could be reserved for authorities that have an interest in those CSDs’ operations, e.g. the CSDs’ home and relevant authorities, the host competent and relevant authorities in the case of CSDs that operate cross-border, other CSDs’ competent and relevant authorities in the case of CSDs that are part of a group of CSDs as well as the EBA, where a CSD has been authorised to provide banking-type ancillary services.

This option would partly, but more than Option 2, meet the aforementioned specific objectives of this initiative. The main reasons for this are twofold.

First, while colleges would be set up primarily for information-sharing purposes and the home supervisor would maintain supervisory powers, the input of other authorities participating to colleges would be taken more into account through their participation in colleges, compared to under cooperation arrangements (which are only applicable where a CSD is of substantial importance to another Member State). The involvement of other authorities through the college will strengthen the passport effect and enhance the cooperation of supervisors and relevant authorities for groups of CSDs, as barriers related to lack of trust and/or sharing of information are reduced.

Second, ESMA’s role would be strengthened, as it would participate in all colleges and have all the powers entrusted to it under the ESMA Regulation. This would ensure consistency across colleges, it would allow the centralisation of supervisory information, the earlier identification of issues linked to CSDR implementation (compared to now, where ESMA is only aware of issues when raised by national supervisors or market participants) and the building of a common supervisory culture across EU CSDs. By increasing cooperation between all authorities involved in the supervision of CSDs, this option allows for a more holistic approach which more adequately responds to the increasingly systemic nature of these infrastructures within the EU financial system. In addition, ESMA would be able to build up its supervisory competence in this field.

Colleges would ensure that while supervisory responsibilities are aligned, a more coherent application of CSDR in the EU is guaranteed and the current supervisory arrangements are more effective. Nonetheless, this option does not completely eliminate the possibility for potential divergences in the application of CSDR in the EU.

Coherence

This option is coherent with the CMU Action Plan, 220 which highlights the need to develop a more integrated post-trading landscape in the EU and states that if there are indications that the supervisory set-up is inadequate for the desired level of market integration, stronger supervisory coordination or direct supervision by the European Supervisory Authorities should be considered. In addition, it is coherent with the ESMA Regulation, which already foresees in Article 21 a specific framework for the cooperation of supervisors through the establishment of colleges of supervisors. 

6.2.3.Option 4: More supervision of CSDs at EU level

Effectiveness in meeting the specific objectives

Under this option, a single supervisor would be established for CSDs. The single supervisor could be ESMA, the ECB, or a new entity as was the case for the Single Supervisory Mechanism (SSM) in the field of banking. Depending on the exact design, the single supervisor would be given full responsibility for the supervision of all or certain CSDs in the EU, including powers to authorise CSDs and oversee compliance with conduct of business rules. In performing these tasks, it would be required to cooperate closely with other bodies, such as the ESCB, as well as the ESAs. However, none of these authorities would have binding powers over the single supervisor.

This option would eliminate barriers to the cross-border provision of services (as CSDs would be authorised and supervised at EU level) and ensure a coherent application of CSDR within the EU, addressing effectively the need for supervisory convergence.

However, it should be noted that some CSDs in the EU are already exempt from certain CSDR requirements, 221 therefore it is not clear whether they would be able to be subject to supervision by an EU body. In addition, no EU body has substantial supervisory experience over CSDs now in order to be able to be immediately operational.

It is worth noting that the main advantages and disadvantages of moving supervision of EU CSDs at EU level are broadly the same regardless of whether EU supervision is exercised over all or a subset of EU CSDs.

Coherence

This option is coherent with the CMU 2020 Action Plan, 222 which highlights the need to develop a more integrated post-trading landscape in the EU and states that if there are indications that the supervisory set-up is inadequate for the desired level of market integration, stronger supervisory coordination or direct supervision by the European Supervisory Authorities should be considered. In addition, it is coherent with the approach followed in the case of other financial institutions for which ESMA has already been granted either a role in their supervision through its participation in colleges (e.g. for CCPs) or direct supervisory powers (for credit rating agencies and trade repositories).

6.2.4.Choice of preferred policy option

The tables below provide a high-level summary of how the described options compare (for the sake of readability, the labels of the options have been shortened). For a detailed overview of the costs and benefits (efficiency) of each option and impacts on different stakeholders see Annex 7.

In view of the high political priority of the review to facilitate CSDs’ access to markets other than that of their authorisation as well as ensure financial stability by providing supervisors with more powers to monitor risks, Option 3 is deemed more appropriate and proportionate for the following reasons: first, it attains the right balance between achieving the aforementioned objectives and Member States’ responsibilities; second, it reflects the fact that ESMA does not currently have experience in the supervision of CSDs and gives it time to build up its supervisory capacity; third, it is the most cost-effective option at this point in time (see Annex 7 on the costs colleges and EU level supervision would entail for all interested stakeholders).

6.3.Impact of the policy options regarding provision of banking services related to settlement in foreign currencies

6.3.1.Option 2: Introduce targeted amendments for designated credit institutions

Effectiveness in meeting the specific objectives

Targeted amendments would be made to the regime for the provision of banking-type ancillary services. Financial stability considerations led to strict rules to limit the liquidity and credit risks incurred by CSDs. As outlined in section 2.3.3, these requirements mean that no designated credit institution exists and compliance costs limit foreign currency settlement as banking CSDs are unable to offer services to non-banking CSDs even within their group. Targeted amendments could consist of removing some restrictions for designated credit institutions, allowing more banks to provide these services (Option 2a), or allowing CSDs authorised to provide banking services to offer CSD services (e.g. within their corporate group of companies) (Option 2b).

For both options, cross-border settlement would improve as options for CSDs will increase, providing issuers and investors with more opportunities and choice. In addition, economies of scale could be more easily reached, increasing the attractiveness for new CSD entrants in this market, in particular those based on new technologies. This would also be consistent with the CMU Action Plan aiming for more integrated post-trade markets and enhanced capital markets in the EU, as well as efforts to promote new technologies.

Financial stability risks would however increase as credit and liquidity risks could rise. This would be the case for both options 2a and 2b. For Option 2b, concentration risk would increase as exposures would be concentrated in the, at present, five CSDs that have been authorised to provide banking-type ancillary services including within groups of CSDs. Nevertheless, the potential wider risks for financial stability would potentially be greater for Option 2a as the risk of contagion to the wider banking sector would be larger. In addition, credit institutions would not be subject to the additional capital surcharge that CSDs are under CSDR, further amplifying the potential risks for the banking sector. Nevertheless, for both options, it is unsure whether and if yes, to what extent, the market will make use of the additional opportunities, which in particular, is especially true for Option 2a where the market cannot benefit from existing established structures, such as they could in Option 2b.

Coherence

The option to partially or completely remove restrictions for the designated credit institution is not coherent with the current CSDR framework, as it will introduce possibly unlimited risk into the financial system, whereas 2b could introduce more risks but within the current arrangements of CSDR. At the same time, Option 2a could bring further risks as potentially a greater level of risk could spread beyond CSDs to the wider banking system, when compared to 2a. Both 2a and 2b are however, coherent with the CMU 2020 Action Plan, which highlights the need to develop a more integrated post-trading landscape in the EU and aims to improve cross border transactions within the EU. Option 2b is relatively better than 2a in this respect. Both sub-options are coherent with existing banking regulations as they will continue to apply on the CSDs in this option.

6.3.2.Option 3: Amend the thresholds under which CSDs can use a commercial bank for banking-type ancillary services.

Effectiveness in meeting the specific objectives

Under this option targeted amendments would be made to the threshold for CSDs (currently maximum of 1% of total assets and EUR 2.5 billion) to provide ancillary banking services. This would make the provision of these services less burdensome and, due to lower compliance costs, economies of scale for the provision of settlement in foreign currencies could be more easily achieved. Achieving these economies of scale would also facilitate CSDs to transition to settlement of foreign currencies in central bank money (one of CSDR’s aims) by enabling them to reach appropriate economies of scale to justify connecting to the relevant central bank. This would help make cross-border transactions more available to investors against a minimum of compliance costs for CSDs. The price for this is in terms of financial stability risks, since credit and liquidity risks of the CSD could potentially increase, could be mitigated by increased supervisory monitoring by the relevant banking authority. Changing the thresholds would also help improve the efficiency of settlement markets as competition in settlement in foreign currencies will increase and current settlement arrangements can remain in place for CSDs.

Coherence

This option is coherent with the current CSDR framework, as it builds on the already foreseen arrangements. It is also coherent with the CMU Action Plan, 223 which highlights the need to develop a more integrated post-trading landscape in the EU and aims to improve cross-border transactions in the EU while preserving financial stability. It is also coherent with banking regulations in taking financial stability as a starting point. Option 3 does not entail a big change to CSDR’s requirements which is positive. It will increase cross-border provision of settlement services as compliance costs are limited to internal operational risk processes and external compliance costs are limited. It could be relatively simple to apply as the prudential framework already covers the additional risks.

6.3.2.    Option 4: Amend the thresholds under which CSDs can use a commercial bank for banking-type ancillary services and allow banking CSDs to provide services.

Effectiveness in meeting the specific objectives

The combination of options 2(b) and 3 will help achieve the specific objectives of increasing cross-border settlement and efficiency of the provision of banking services as well as reducing administrative costs, as elaborated under options 2 and 3, in a more comprehensive manner than what could be achieved by applying only one of these options. A combination of options 2(b) and 3 would have as an additional benefit as compared to the above. While reviewing the threshold for banking services would potentially increase the notional amounts available for banking services (including foreign currency settlement) in EU settlement markets, including banking CSDs into the potential providers of these services would increase potential notional amounts available for foreign currency even further through broadening the range of providers.

Coherence

The combination of options 2(b) and 3 is coherent with EU policies, such as the objective of CMU to create a more integrated post-trading landscape in the EU contributing to the EU internal market as elaborated in the respective sections.

6.3.3.Choice of preferred policy option

The tables below provide a high-level summary of how the described options compare (for the sake of readability, the labels of the options have been shortened). For a detailed overview of the costs and benefits (efficiency) of each option and impacts on different stakeholders see Annex 7.

In view of the political priority of CMU and to create a single European market for capital, improving possibilities for CSD to offer settlement in foreign currencies adds to the aim of this review to facilitate CSDs’ access to other markets other than their home market and minimise cross-border barriers. At the same time, this should be done while preserving financial stability and keeping settlement markets safe. Hence, and since not mutually exclusive, a combination of options 2b and 3 are deemed more appropriate and proportionate (Option 4) in attaining the right balance between achieving the aforementioned objectives.

6.4.Impact of the policy options regarding settlement discipline

6.4.1.Option 2 – Introduce targeted amendments for cash penalties and mandatory buy-ins

Effectiveness in meeting the specific objectives

This option includes amendments that would simplify elements of the settlement discipline regime, e.g. with regards to the pass-on mechanism, in-scope transactions and buy-in agents. These changes would be limited, introduced only in areas where the regime would benefit from minor corrections or amendments.

First, amendments to the pass-on mechanism would allow to solve all settlement fails along the same chain by one buy-in in the original settlement fail which provoked the other fails. This would be combined with measures to address the rigidness in timing of when a buy-in is initiated and the asymmetry in price differentials. 224 This would reduce the complexity and the burden of managing a buy-in process.

Second, certain transactions may no longer be subject to the settlement discipline regime, e.g. corporate actions on stock (e.g. initial creation transactions and redemptions), certain central bank transactions (e.g. monetary policy operations which are not credit operations 225 ), and certain other transactions (e.g. auto-generated transactions by CSDs) 226 . In addition to mandatory buy-ins, certain transactions could be exempted from the cash penalties regime. These changes would permanently reduce the compliance burden on market participants by removing transactions that do not form part of market turnover or lie outside their control. Compliance costs for regulators, i.e. replying to Q&As, will also be reduced permanently. Furthermore these amendments would reduce the number of settlement fails and improve settlement efficiency.

Third, more choice could be enabled as concerns buy-in agents, i.e. appoint a broader range of actors as buy-in agents. A major concern for many stakeholders 227  is that so far only one service provider has emerged with a buy-in solution and that the offer is not consistent with the needs of all stakeholders 228 . Subject to best execution requirements and clearly defined limitations and conflicts of interest, 229 firms could be able to execute their own buy-ins. Buy-ins already exist today without a buy-in agent, e.g. at CCPs, many of which do not use a buy-in agent but go to auction, sourcing the liquidity from their network on a best execution basis. Allowing parties, within limits to execute their own buy-ins based on underlying contractual requirements, could allow flexibility to act in the best economic interest of the non-receiving party and tailor buy-ins to the characteristics of different types of financial instruments.

Such amendments would effectively and permanently reduce administrative burden and compliance costs. In particular clarifications with regards to in-scope transactions would effectively reduce complexity, administrative burden and compliance costs for all market participants. Furthermore, fewer buy-ins would improve settlement efficiency.

Coherence

This option would be coherent with the overall objectives of CMU, as well as specific objectives of CSDR. It would also be coherent with the REFIT initiative to have proportionate requirements in that it would permanently lessen to a certain extent the administrative burden and compliance costs for investors, CSDs and regulators without endangering financial stability. These benefits would be long-term.

The negative market impacts of this option would be similar to Option 1, and would be related to the introduction on the mandatory buy-in. The clarifications contained in Option 2 would not considerably diminish their negative market impacts.

6.4.2.Option 3 – Introduce a two-step approach

Effectiveness in meeting the specific objectives

Under this option cash penalties would apply immediately, while the implementation of mandatory buy-ins would be deferred and triggered only where necessary, if the other settlement discipline measures (i.e. reporting and cash penalties) prove to be insufficient to achieve an acceptable level of settlement efficiency within the Union. Any delay in the application of mandatory buy-ins should apply equally to the full market (i.e. both the cleared and uncleared space) to prevent an unlevel playing field. This is essential to avoid an unintended shift of trading volumes to a non-cleared environment, notably for less liquid securities. The monitoring and reporting obligations under CSDR and the relevant RTS will remain unchanged. 230  

Under the two-step approach it would therefore first need to be determined, following a granular analysis of the fails in the EU settlement market and at international level, where the main settlement fails occur, at which level and for which reasons. ESMA could be required to produce on a regular basis (e.g. every two years) a report on settlement fails in the market that would focus, amongst others, on the levels of fails and their evolution, the underlying drivers, the main instruments affected, an international comparison of settlement fail rates, as well as assess whether cash penalties remain a proportionate and effective tool to address these fails. The entry into application of the mandatory buy-in regime could be left to a Level 2 act to be adopted by the Commission, taking into account, where available, ESMA’s report.

This option will be effective in addressing one of the main reasons for settlement fails, i.e. insufficient capacity among market participants for post-trade functions. Practical experience from other capital markets 231 suggests that cash penalties may provide sufficient incentive for the necessary capacity improvements to address settlement fails. Furthermore, these improvements will particularly benefit the processing of smaller trades which are more prone to fail. While encouraging improved settlement, this option allows to avoid the most negative impacts of mandatory buy-ins related to liquidity, bid-ask spreads or market stability. It will also discourage strategic behaviour by counterparties. Cash penalties, like positive interest rates, will be an incentive for the selling party to source the securities, whether outright or in repo (particularly when the penalty is more punitive than the repo rate for the security). Furthermore, in the absence of mandatory buy-ins, alternatives will be available to the buyer to initiate a buy-in against a failing seller: cash compensation, bilateral cancellation or to extend the delivery time to a date when the seller can make the delivery which will ensure that the buyer receives the securities and not a cash settlement. Buy-in arrangements are usually a standardised process and are incorporated in the terms of business between counterparties, to cover specific markets. Lastly, this option will minimise the pro-cyclical effects as they are related to buy-ins rather than cash penalties. 232  The main costs of this approach is setting the conditions that would justify the introduction of mandatory buy-ins as a second step of the two-step approach.

Coherence

This option would be coherent with the objectives of CMU and CSDR as it would provide the necessary incentives to further improve EU settlement efficiency. It would also be coherent with the REFIT initiative as it would better comply with the principle of proportionality in that, to the extent that cash penalties can enhance on their own settlement efficiency, the application of additional measures (i.e. mandatory buy-ins) would go beyond what is necessary to achieve the pursued objectives. Concerns related to market stability or the ability of market participants to fulfil certain functions, such as market making, would not materialise.

6.4.3.Option 4 – Introduce voluntary buy-ins

Effectiveness in meeting the specific objectives

Under this option cash penalties would be mandatory while buy-ins would be voluntary. Even if buy-ins would be voluntary, all EU investment firms would need to put in place contractual arrangements for buy-ins with their relevant counterparties. The monitoring and reporting obligations under CSDR and the relevant RTS would remain unchanged. 233  

The decision to initiate a buy-in would be the discretionary right of the purchasing party giving it more flexibility in achieving its investment objectives. This will apply in relation to both transactions with and without the involvement of a CCP in order not to incentivise migration of trading to non-cleared markets and indirectly undermine a key EU policy objective in financial markets. In order for voluntary buy-ins to be effective a number of high-level principles 234  could be developed in CSDR. To ensure their clients’ access to voluntary buy-ins, market participants could still need to enter into a re-papering exercise, similar in scope and cost to the described under Option 3. There are also doubts about the use of and effectiveness of voluntary buy-ins to reduce settlement fails. In markets dominated by large dealers, investors may be discouraged from adopting buy-ins for fear of retaliation 235 . There is evidence that buy-ins are currently rarely used as a voluntary contractual arrangement between market participants. 236 Already today, the trading parties have the right to request buy-ins, whether through market standards (ICMA rules), legal standards (stock exchange regulations) or contractual rights. However, that is hardly practiced. Hence, voluntary buy-ins do not seem efficient in ensuring settlement efficiency.

Coherence

This option is partly coherent with the objectives of CMU and CSDR as it will provide incentives to further improve settlement efficiency in the form of cash penalties. It contains major disadvantages in the form of increased compliance costs for traders who will need to keep in place a system allowing them to carry out buy-ins if contractually agreed. It opens the possibility for abusive market practices as firms may be discouraged from applying buy-ins if it will hurt established trading relationships. This option is also not proportional. Due to their voluntary nature and evidence so far buy-ins will remain unused, although market participants would incur re-papering costs and regulators face compliance costs related to clarifications and guidance.

6.4.4.Option 5 – Combination of targeted amendments to settlement discipline regime with a two-step implementation of cash penalties and mandatory buy-ins

Effectiveness in meeting the specific objectives

The combination of Option 2 and Option 3 will help achieve the specific objective of reducing administrative burden and compliance costs without endangering financial stability, as explained in sections 6.4.2 and 6.4.3, more comprehensively than each option individually by targeting both procedural aspects of the regime (Option 2) and market impacts (Option 3).

Coherence

The combination of Option 2 and Option 3 is coherent with the objectives of CMU and CSDR as it would provide the necessary incentives to further improve EU settlement efficiency (Option 3). It would also be coherent with the REFIT initiative as it would better comply with the principle of proportionality (Option 3) and reducing administrative burden (Option 2), by introducing clarifications and simplifications to the operation of the settlement discipline regime.

6.4.5.Choice of preferred policy option

The tables below provide a high-level summary of how the described options compare (for the sake of readability, the labels of the options have been shortened). For a detailed overview of the costs and benefits (efficiency) of each option and impacts on different stakeholders see Annex 7.

In view of the importance attached by CMU to safe and efficient financial markets Option 3 offers the most effective, efficient and coherent approach. Thanks to cash penalties it will support improvements in settlement efficiency, without however endangering stability and liquidity across markets and financial instruments. It is more effective in addressing this objective than Option 4, which will have greater negative impacts on market stability, liquidity and pricing while compliance costs for market participants and regulators will be similar to Option 3. The effects of a voluntary buy-in will be similar to the ones described under Option 1, although they may be smaller as buy-ins will not be applied consistently by market participants. The targeted amendments (Option 2) will bring benefits irrespective of the chosen settlement regime in terms of effectiveness, efficiency or lower compliance costs. Hence it can be combined with either Option 3 or Option 4. The benefits will however be greatest when combined with Option 3. Settlement efficiency will improve thanks to cash penalties, which will themselves benefit from clarifications, while mandatory buy-ins will be delayed and also further refined. Hence the preferred policy option is Option 5 (combination of Options 2 and 3) and it will ensure the proportionality and efficiency of the Settlement Discipline Regime.