Celent’s Ran Pieris explores EMIR and CSDR impacts both CCPs and CSDs in the long-term and how these market utilities must adapt their operational and technology to ensure compliance with the new regulation. Comments from a recent DerivSource podcast where Ran offers additional insight from his recent report – “EMIR and CSDR: Understanding the Impact on CCPs and CSDs” .
About EMIR & CSDR
To assess the impact of new financial regulation we need to understand a few things about the new regulations themselves. The European Market Infrastructure (EMIR) has been in motion since 2012 and we are now seeing the last few provisions. The first concerns the mandatory clearing of OTC asset classes such as interest rate swaps (IRS) and credit default swaps (CDS), FX and commodities via a central counterparty (CCP). Linked to this is a requirement for frontloading where existing OTC derivatives contracts would need to be centrally cleared. This is only going to apply to Category I firms which are those that are directly linked to CCPs, and Category II firms which are clients of Category I firms.
The second provision is the bilateral margining of non-centrally cleared OTC derivatives. In this case it becomes necessary for any OTC instrument that can’t be standardised or has to be cleared via a CCP to be margined by a third party. At first this may be based on variation margins, followed by the introduction of initial margin at later stages. CCPs who have already been authorised and can clear IRS and CDS instruments won’t have to update many of their systems but those that do not have approval for these specific products, and there are quite a few out there, would need to invest in systems and processes. The bilateral margining of non-centrally cleared trades is now outside the scope of CCPs, so effectively it isn’t something they are going to cover. However, one of the requirements of this provision is to have a third party holding on to the collateral, which might include custodians and central securities depositories (CSDs).
The Central Securities Depositories Regulation (CSDR) is a much newer piece of legislation. It came into force in September 2014, with the consultation ending in February 2015, and the draft technical standard is expected to be delivered by the European Securities and Markets Authority (ESMA) in June 2015. It includes two provisions on post-trade services – standards on settlement discipline and the penalty for settlement fails. They have already had an impact because of the move to the T+2 settlement cycles across most of Europe.
ESMA effectively is trying to harmonise the standards for settlement in Europe via the Target2Securities (T2S) platform over the next three years. The standardisation of CSD services means the offering could look the same which begs the question, ‘who will be the best partner to help you achieve your particular goals?’ The other requirement – the use of Legal Entity Identifiers (LEIs) – tries to record mandatory book entry across transferable securities and this will require system changes although will not alter the services that CSDs provide.
Necessary operational and technology changes for market utilities
On an operational front, there is more work to be done for CSDR because EMIR is almost three years old and there are only a few provisions left to be implemented. CCPs who already provide clearing services for any asset classes undergoing the clearing obligation won’t have to do much, but those who want to increase their asset coverage will have to introduce systems and processes to expand their services. On the whole though, most of the changes have been made and it is only a matter of rationalising the services that they are offering to their clients, such as account structures and increasing product ranges.
As for the CSDR, there are six things that need to be covered by the CSDs.
The first is that CSDs will need to use LEIs for regulatory reporting and for their own record-keeping.
Secondly, they will have to keep a record of the direct participants as well as their participant clients. Most CSDs keep records of direct participants, but they will have to update their existing operational processes and systems to include the new category.
Third is dealing with late penalties, which are based on a prescriptive set of rules. CSDs will need to maintain a database of instruments to know how to apply the late settlement charges.
Fourth – they will have to get more involved in the buying process by collecting data on buy-ins, adopting a buy-in agent, and preventing multiple buy-ins. Buy-ins have normally been carried out by CCPs and exchanges, but now CSDs will have to introduce new procedures and systems to cope with this requirement.
Fifth – CSDR is going to slowly introduce a book entry of all transferable securities although not until 2025 when all securities will have to be de-materialised. From what I can see national governments will be responsible for making this happen.
Finally and the sixth item is that CSDR will introduce a non-discriminatory access to CCPs and trading venues. CSDs will have to determine the cost and benefits of this, but I suspect that the most successful ones will not shirk away from expanding their networks.
* To hear more from Celent’s Ran Pieris on this topic please listen to our podcast or read the transcript.
