Developments in the CSD market could see new entrants, changed business models and more competition. Nicholas Pratt looks for potential benefits for investment managers.

The Central Securities Depositary (CSD) market has not changed much in the past 30 years – but in much the same way as overdue buses finally arrive simultaneously, there are now a number of important developments all occurring at once. The implications are that CSDs, which hold securities and facilitate clearing and settlement, will face new competition among themselves and from new entrants, such as global custodians. The issue is whether this competition will be meaningful enough to create true benefits for market participants.

For the optimistic, competition means reduced fees and expanded services. For the sceptical, change will result in an initial flurry of new entrants and lead to fragmentation and confusion in the short-term, followed by a return to the status quo in the long-term, once all newcomers have been acquired by old-stagers.

The major development in the CSD market is Target2Securities (T2S), the European Central Bank (ECB) initiative to introduce a harmonised pan-European settlement platform for cross-border securities settlement in central bank money, which comes into effect in 2014. This means CSDs will lose some of their core business of providing settlement services in their domestic markets, which will go to the ECB’s centralised platform.

However, they will be able to expand their range of services under T2S – for example, asset servicing – as well as look to operate in other European markets.  

As T2S allows custodians to adopt CSD status, it brings the two institutions into competition. For global custodians there are multiple reasons to move into the CSD market. The most obvious reason relates to changes in collateral management practices from regulations like the European Market Infrastructure Regulation (Emir) that have made it easier and more attractive for market participants to have an account within a CSD in order to manage the collateral demands of institutional counterparties, such as central banks and central counterparties (CCPs).

It is, therefore, no surprise that the two global custodians with the biggest collateral management services have been the first to enter the CSD market.

In December 2012, BNY Mellon launched its own CSD. Meanwhile, JP Morgan has contracted the London Stock Exchange’s newly established CSD in Luxembourg to offer collateral management services.

A second reason is the threat to their issuance business given that global custodians could be supplanted by CSDs in their role as common depositaries for the issuance of Eurobonds.

And then there are the aforementioned benefits of adopting CSD status for T2S: fewer connections to manage thus reducing its bill for system changes; and a greater say in the ongoing governance of the T2S project.

At BNY Mellon, the idea to launch a CSD was first conceived back in 2010 as part of the bank’s European strategy for investor services at a time when the bank was concerned about the potential impact that new regulations, like Emir and Basel III.

In addition to BNY Mellon’s custody and administration business, there is also an issuance business and a corporate trust and clearing business. “It was both a defensive move to protect our collateral management and corporate trust business and an offensive move to ensure we were advancing services for our clients during this period of regulatory change,” says Nadine Chakar, head of product development and strategy for BNY Mellon’s global collateral services business.

As to whether the move will herald a new era of competition between CSDs and custodians, Chakar says that the bank’s main priority is to protect and serve its existing clients rather than seek new ones.

“In the new regulatory framework, I think the lines between competitors and partners will blur. Furthermore, our services and our client base do not really compare with the CSDs. The CSDs specialise more in fixed income and are European while we are global, more equity-focused and more closely connected to the buy-side. While there are some areas where we will compete with the CSDs, there are more areas where we can collaborate.”

Chakar also hopes that investment managers will be focused more on the potential benefits from developments in the CSD market. “From an investment services perspective, we are the only custodian to be a direct participant in T2S. That will bring more harmonised settlement, quicker settlement cycles, cash and collateral auto-authorisation, helping them to increase the velocity of their collateral management, and reduce processing cycles.

“This will also help fund managers reduce their settlement risk and give them better tools for risk management, collateral management and regulatory compliance.”

The awareness of these benefits is not evident among fund managers. Chakar says: “Most fund managers do not access CSDs directly, but do so through their brokers. Now that everybody has raced to achieve initial compliance, they will be thinking about more long-term and sustainable strategies in terms of market infrastructure.”

Not all custodians have ambitions to launch a CSD. “We do not have the same concerns as the main players in the collateral management market,” says Eric de Nexon, head of strategy for market infrastructures at Societe Generale Securities Services (SGSS).

“Moreover, we are at the beginning of a developing market where the full impact of T2S and CSD regulations are yet to be seen.”

For example, a reduction in CSD fees may not materialise immediately and de Nexon also voices some concern about the use of investor CSDs under the Alternative Investment Fund Managers Directive, whereby a depositary is exempt from liability of lost assets if those assets are entrusted to a CSD.

This exemption only applies where it is an issuer CSD and not an investor CSD, says de Nexon. But, should the regulators allow such an exemption, then asset managers should consider whether the cheaper option of an investor CSD will also be a more secure one.

Just as custodians and other service providers can enter the CSD market, so can CSDs extend their range of services. VP Securities is an established CSD in Denmark but was one of the earliest to create one in another European market when it became the first issuer CSD in Luxembourg to offer a service for fund managers and distributors.

“Slowly but surely we have realised that just being a CSD doesn’t work,” says Jan Vandendriessche, head of funds platforms, VP Luxembourg.

There is likely to be competition from transfer agents (TAs) that dominate distribution and issuance in Luxembourg, although Vandendriessche hopes that the TAs will be less focused on feverishly guarding their issuance business and more willing to “embrace the CSD business” especially where they are increasingly working on lower margins.

Vandendriessche also hopes that investment managers will note the potential benefits that could result from these developments. “Competition leads to creativity, new business models and more niches. Investment managers should keep a close look on the CSD market because maybe they can profit from some of the services provided by the first movers.”

The international CSDs will also be looking to benefit from the changes in the CSD market.

For example, Marc Robert-Nicoud, senior project manager at Clearstream Banking, suggests that investment managers and their intermediaries would be well advised to centralise their clearing and settlement and consolidate their activity with a single CSD of choice that operates across Europe.

“This would reduce their settlement costs via T2S, reduce their cost of capital and reduce their cost of covering their exposure by giving them access to a wider pool of collateral. In today’s markets, many firms will use domestic assets to cover domestic exposures but there will be times when additional collateral is needed which comes at a major cost. So access to a wider pool of collateral will be a major saving.”

For any investment managers or intermediaries not yet engaged by the developments in the CSD market, Robert-Nicoud stresses the rarity of the changes about to occur.

“There is a unique opportunity for market participants to reconsider the way they are accessing the market and these opportunities are very rare.

And in 2014, people will have to budget for the changes they will make as a result of T2S and select the CSD they will want to move to or whether they want to stay with their current CSD. It is definitely the right time to consider your options.”

©2014 funds europe



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