CSDs need solid and proportionate capital requirements

CSDs need solid and proportionate capital requirements

27 Apr 2015 – Minimum capital requirements should reflect CSDs’ specific activities and their low risk profile compared to banks and CCPs. In its response to the European Banking Authority consultation, ECSDA makes several recommendations on how to achieve solid and truly proportionate capital requirements for central securities depositories.

    ECSDA is convinced that the regulatory technical standards (RTS) currently being preparedby the EBA can bring important improvements to the current situation by ensuring that:

  • all EU-authorised CSDs with an identical risk profile are subject to similar capital requirements;
  • the level of CSD capital is proportional to the risks arising from the activities of a CSD, as opposed to a fixed and arbitrary amount of capital.

European CSDs are not advocating the status quo or ‘harmonisation by the bottom’. They recognise that some of them will need to increase their capital level as a result of the new standards. However, ECSDA regrets that the draft standards are not sufficiently tailored to CSDs’ specificities and fears that they will not be practically implementable unless they include some important adaptations.

In order to achieve solid and truly proportionate capital requirements, ECSDA recommends that:

  1. Provisions coming from the framework in place for banks and/or CCPs and which are largely if not totally irrelevant in a CSD context should be removed from the draft RTS. The vast majority of EU CSDs do not provide cash credit and are thus not exposed to counterparty credit risk in relation to their participants. This is an important difference with banks and CCPs. This needs to be reflected in prudential requirements for CSDs. To give just one example, the notion of “client short and long balances” in Annex II of the draft RTS is simply not applicable in a CSD context, at least for CSDs without a banking licence.
  2. Custody risk in the Level 1 CSDR refers to the risk faced by the CSD itself, not its participants. Any potential risks that a CSD faces as a result of its participants’ custody risk (whether in relation to securities held directly in the CSD or via a CSD link) are already covered under operational and legal risks. Duplicate requirements should be avoided.
  3. CSDs should only have to set aside capital for winding-down or restructuring their activities to the extent that this does not overlap with capital requirements for business risk. International Principles allow CSDs to use the same capital for ensuring that the infrastructure operates as a going concern and for ensuring an orderly recovery or wind-down of critical operations. Given the lower risk profile of CSDs compared to CCPs, ECSDA does not think that it was the intention of the EU legislator in the Level 1 CSDR to impose strict cumulative requirements exceeding international standards.
  4. Some requirements should be recalibrated to reflect CSDs’ low risk profile and specific arrangements. For example, for assessing operational and legal risks, ECSDA recommends a ratio of 10% instead of 15% as well as the possibility to take into account specific insurance arrangements covering operational and legal risks. For business risk, the proposed ratio of 25% is largely excessive in view of CSDs’ low risk activities. Business risk should be primarily covered by net income and equity coverage should only be required in case of net losses.
  5. The predefined business risk and winding-down scenarios suggested by the EBA for determining capital requirements should be replaced by a more flexible approach allowing CSDs to define reasonably foreseeable adverse scenarios relevant to their business model, subject to the approval of the competent authority.
  6. When assessing the quantitative impact of the new standards on existing CSD capital levels, the EBA should also look at the impact on the structure of CSDs’ capital. Although ECSDA was not able to carry out a comprehensive assessment, we anticipate that the draft RTS could result in an increase of minimum capital requirements for almost all CSDs, raising the bar far beyond current domestic and international requirements.

Read the full ECSDA response to the EBA on CSD prudential requirements

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