The role of CSDs as financial market infrastructures
What is a CSD?
CSD stands for “Central Securities Depository”. A CSD is an entity which provides a central point for depositing financial instruments (“securities”), for example bonds and shares. CSDs’ clients are typically financial institutions themselves (such as custodian banks and brokers) rather than individual investors. Although CSDs across the world might have very different activities, the definition introduced by the EU Regulation of 2014 describes the core functions performed by a CSD:
The CSD Regulation defines a CSD as an entity which:
1. operates a securities settlement system (“settlement service”);
2. records newly issued securities in a book-entry system (“notary service”);
3. provides and maintains securities accounts at the top tier level (“central maintenance service”).
Although the Regulation only requires the performance of the settlement service, and the notary OR central maintenance service to be authorised a as CSD, in practice the vast majority of CSDs perform all three services.
In lay terms, point 1 means that CSDs operate IT platforms allowing for the settlement of securities transactions. A transaction is “settled” once the CSD has credited the account of the buyer with the purchased securities (and debited the corresponding cash amount), while debiting the account of the seller with the securities (and crediting its account with the corresponding cash amount). Such credit and debit movements typically take place simultaneous, in a process called “delivery versus payment” or DvP.
Point 2 refers to the role played by CSDs in relation to the securities issuance process. Indeed, CSDs can be described as the “first entry point” for newly created securities. Such securities, issued for example by private companies or public institutions (called “issuers”) are usually deposited into a single CSD, called the “issuer CSD”. The CSD is then often responsible for ensuring that the number of securities initially created equals the total number of securities in circulation (booked in investors’ accounts) at any time. This is what is meant by “ensuring the integrity of the issue”.
Point 3 finally refers to the fact that, once a transaction is settled, the rights and obligations linked to the securities holdings must be managed. CSDs therefore also provide for the safekeeping (or “central maintenance”) of securities, including for example the processing of corporate actions such as dividend and interest payments, or voting rights in the case of shares. The notion of “top tier level” means that CSDs find themselves at the top of the securities chain, i.e. all holdings in a given financial instrument, whether by an individual or a financial institution, are ultimately kept in a securities account at the CSD.
What is the difference between a CSD and an ICSD?
Whereas CSDs were primarily created to serve their domestic market, ICSDs or “international CSDs” were created in the 1970s to settle eurobonds, i.e. international bonds denominated in a different currency from that of the country in which they are issued. Over the years, ICSDs have extended the scope of their services to cover all types of internationally-traded financial instruments, including equities and investment funds. There are two ICSDs in the European Union, which are both members of ECSDA: Clearstream Banking Luxembourg and Euroclear Bank in Belgium. Both hold a banking license and provide settlement in different currencies.
Who owns and operates a CSD?
In many countries, CSDs were historically set up by, or under the auspices of, national financial authorities such as the central bank or the Ministry of Finance. This public involvement was justified by the fact that CSDs were perceived as “utilities” operating in a network environment characterised by large economies of scale and of scope. However, following the deregulation of financial markets in the 1980s-1990s, most European CSDs have become privately owned entities. Only a few central banks still operate settlement systems directly (and typically only for government-issued securities), but in some countries they have maintained an ownership stake in the domestic CSD.
Among privately owned CSDs, there are different ownership and governance models. For example, some CSDs belong to publicly listed companies while others are user-owned (which means that their owners are drawn from the pool of their clients). Some CSDs are part of a corporate group including a Stock Exchange and/or a CCP, while others operate separately from the trading and clearing infrastructures.
For more details on the different ownership and governance models of CSDs, please refer to the CSD database.
What is the difference between a CCP and a CSD?
CCPs and CSDs are different animals, although they are both included under the term “post-trade infrastructures”. CCPs or central clearing counterparties intervene between the trading layer (on the stock exchange, another trading platform or OTC) and the settlement layer. Because they act as a buyer to every seller and as a seller to every buyer, they play a key role in managing counterparty credit risk. CSDs, on the other hand, intervene at the final layer when ownership of the securities is transferred. CSDs are primarily concerned with operational risk.
For more information on European CCPs, please check the website of EACH (European Association of CCP Clearing Houses).
What is the difference between a CSD and a bank?
Banks, also sometimes referred to more generally as “financial intermediaries”, perform a wide variety of functions in the retail and wholesale markets such as taking deposits from the public, granting credit to individuals and companies, offering investor advice etc.
CSDs, on the other hand, are financial market infrastructures performing key functions for the whole market and primarily have intermediaries as their clients. Banks holding securities on behalf of their clients typically have these securities deposited with a CSD (or within another intermediary having an account at a CSD).
What types of financial instruments are accepted by CSDs?
CSDs offer settlement and safekeeping services for different types of financial instruments. These can (but do not always) include money market instruments (treasury bills, commercial paper…), bonds (corporate and government and supranational debt, in different forms, including structured securities), equities (shares in listed companies), investment funds (UCITS, pension funds, hedge funds…) and many other instruments depending on the markets under consideration (e.g. commodities, carbon emission rights etc.). These instruments can be traded on an organised trading venue (securities exchange, multilateral trading facility…) or over the counter (OTC).
Why do we need CSDs? What do they have to do with end investors?
Even if some CSDs maintain end investor accounts, in most cases, CSDs only accept wholesale counterparties (intermediaries such as custodian banks or brokers) as clients, provided they meet a set of predefined requirements (e.g. high creditworthiness, technical capability etc.). The use of CSDs however entails benefits for the entire market, including institutional and retail investors. This is because CSDs act as a central point of reference for the market. Once a buy or sell order has been executed at the trading venue or cleared by a CCP, CSDs take care of settling the transaction. They offer Delivery versus Payment (DvP) settlement, thereby reducing risks for both buyers and sellers, and they administer the securities once the final transfer of ownership has occurred. In addition, they make sure that the number of securities in circulation is at any time the same as the number of securities issued.
How many CSDs are there in Europe?
The answer to this question depends on two things: (1) how you define CSDs, and (2) how you define Europe.
As of October 2014, ECSDA had 41 member (I)CSDs in 37 countries covering the whole geographical area of Europe. The list of ECSDA members is available here.
In the 28 countries of the European Union, there are 31 CSDs, including VP Lux, which is not a direct ECSDA member. To this number are sometimes added the 6 securities settlement systems operated by national central banks (in Belgium, Bulgaria, the Czech Republic, Greece, Poland and Romania), which primarily settle government securities.
What about CSDs outside Europe?
CSDs exist on all continents, although the type of services they offer varies depending on the local market structure. ECSDA has regular exchanges with sister regional CSD associations in America, Asia, Eurasia, Africa and the Middle East.
Every two years, an international conference gathers CSD professionals across the globe to discuss issues of common interest and share experiences. The next conference, WFC2015, will take place in Cancun, Mexico, in May 2015. To find out more, check the “international cooperation” page.
What role do CSDs play in financial crises?
CSDs have proven highly resilient during periods of market stress, including the 2008 financial crisis which followed the collapse of Lehman Brothers. Their role is to mitigate risks for market participants, thereby supporting financial stability. In times of crisis, CSDs ensure that higher transaction volumes can be processed seamlessly while handling the failure of major market participants so as to minimise the effects on other market players and on the system as a whole.
The 2008 financial crisis highlighted concerns over counterparty credit risk, and in particular credit derivative products traded OTC. CSDs, on the other hand, primarily service the cash markets and mostly deal with operational rather than credit risks. This is an important difference with CCPs. It explains why the G20 post-crisis reform agenda focuses on the central clearing of derivatives without mentioning CSDs.
The CSD business: issuance, settlement and custody
Why do issuers record their securities in a CSD?
Issuers are private companies or public sector institutions (or any other type of eligible entities) which issue securities (for example shares or bonds) to investors. These securities, once created, are usually recorded and deposited in a single CSD, called the “issuer CSD”. The CSD is then often responsible for ensuring that the number of securities initially created equals the total number of securities in circulation (booked in investors’ accounts) at any time. This function is sometimes referred to as “ensuring the integrity of securities issues”.
What is a so-called “direct holding” or “transparent” CSD?
Securities holdings typically involve a number of intermediaries (e.g. custodian banks) between the final investor of the securities (e.g. an individual, a pension fund…) and the CSD, where the securities are ultimately deposited.
In some European markets (such as the Nordic countries and Greece, among others), the final investor is known to the CSD, sometimes as the result of national legal requirements. These markets are called “direct holding” or “transparent” markets because end investors (also called beneficial owners) are not only identified at the level of their bank, but also have individual accounts in the level of the CSD.
What does “DvP” mean?
DVP or DvP stands for delivery versus payment. It basically means that securities are delivered to a buyer when (and only when) the buyer sends a payment to the seller. In practice, CSDs offer DvP facilities to their clients so that the transfer of securities from the seller to the buyer only occurs if the payment has been made from the buyer to the seller (and vice versa).
Other types of instructions are possible, such as free of payment transfers (FoP), where a delivery of securities is not linked to a corresponding cash payment (for example, moving securities from one account to another to correct a mistake).
What is the difference between settlement in central bank money and commercial bank money?
An important part of settlement activity in the books of CSDs typically occurs in central bank money (CeBM), which means that the cash leg of a securities transactions is paid from/received on an account held by the CSD client at a central bank. Other transactions, however, involve commercial bank money (CoBM), meaning that the cash debits/credits occur on the books of a commercial bank rather than a central bank. This is typically the case when CSD clients settle in foreign currencies or when they receive proceeds from corporate actions or redemptions. Both CeBM and CoBM have their place in a safe and efficient EU securities services landscape.
What is a CSD link?
What is typically meant by “a CSD link” is an arrangement between two CSDs to allow for the transfer of securities from one CSD to the other (cross-system settlement). Concretely, a CSD A opens an account with another CSD B in order to provide its clients with access to foreign securities held by CSD A.
The two ICSDs have gone further than just giving each other access to an account and have built a so-called “interoperable” link (a more complex arrangement for exchanging information between them). It is the famous “bridge” between Euroclear Bank and Clearstream Banking Luxembourg.
What is an “issuer CSD”? an “investor CSD”?
A CSD is the “issuer CSD” of a given security if the initial issuance of this security was deposited with this CSD. An “investor CSD” allows its clients to hold securities in its books which were issued by another CSD (issuer CSD). This is made possible by the fact that CSDs can (and do) open accounts with other, “issuer” CSDs.
The European regulatory framework for CSDs
How are CSDs regulated?
As securities infrastructures, CSDs operate in a highly regulated environment. They are subject to national laws on securities issuance, settlement and safekeeping, while being supervised by the relevant authorities, typically the securities or banking regulator, and subject to the oversight of the relevant central bank(s).
Since 2014, CSDs in the European Union have to comply with the CSD Regulation, which stipulates prudential standards and various other requirements as a basis for a common authorisation process.
CSDs are also subject to International Principles for financial market infrastructures issued by the CPMI, IOSCO and the FSB.
What is T2S and how does it impact CSDs?
TARGET2-Securities, or “T2S” is a project of the Eurosystem aimed at building a common IT platform delivering harmonised DvP settlement in central bank money for most European securities as of June 2015.
T2S is not a CSD. Rather, it serves as a technical platform for providing settlement services to those CSDs which are part of the project. CSDs remain responsible for opening and managing the accounts of their clients, as well as for providing various services related to settlement. The ECB website provides regular more information on the T2S project.
What is the Code of Conduct for market infrastructures?
The Code of Conduct for market infrastructures is a voluntary industry code of good practice which was signed in November 2006 by the three European associations representing financial markets infrastructures (FESE, EACH, and ECSDA, representing exchanges, CCPs and CSDs respectively) under the auspices of the European Commission.
The Code represented an important step towards promoting transparency and competition into post-trade. Its three main components include:
- price transparency, including the requirement for infrastructures to publish price lists on their website, including rebate schemes and price examples;
- an access and interoperability guideline specifying the conditions for infrastructures to establish links with one another;
- provisions on account separation and service unbundling.
What are the Giovannini barriers?
The so-called “Giovannini barriers” were identified in two reports, in 2001 and 2003. They describe the main obstacles to efficient cross-border clearing and settlement in Europe, whether legal, fiscal, or linked to market practice.
The CESAME group, in which ECSDA actively participated, produced its final report in 2008. This report provides a good overview of these barriers and the measures adopted or underway to overcome them.