Modelling. xxx. a European CSD environment for the Decade Ahead: How will CSDs evolve in Changing Global Financial Markets? axxx.

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1 xxx axxx. Modelling a European CSD environment for the Decade Ahead: How will CSDs evolve in Changing Global Financial Markets? Financial Services Research August

2 Bob Currie Editorial Director, Financial Services Research Bob Currie is Editorial Director and cofounder of Financial Services Research, a journal that reports on investment performance, risk and operational efficiency in the financial services industry. Prior to his current role as financial commentator, he worked for much of the 1990s as lecturer and researcher in the UK university sector, specialising in global political economy and development strategy for emerging markets. the Monitoring Group of the Code of Conduct (MOG), and the Consultative Working Group for the Post-Trading Standing Committee. He has been a Member of the ECSDA Board and Executive Committee, Board Member and Secretary of the Board of Link-Up Markets, and Chairman of its Executive Committee. Additionally, Mr Benito belongs to the TARGET2-Securities Advisory Group and Harmonization Steering Group, the CSD Steering Group (CSG) where he serves as chairman, and the ESMA Post- Trading Consultative Working Group. After a 12 year career at Banco de España, Jesús Benito joined Iberclear in 2000, initially as Director of Strategy and Promotion before then becoming Deputy General Director. He has been CEO since in the period , including Senior Vice President and Global Head of Custody Services at Nordea ( ) and Senior Vice President and Head of Securities Services in Christiania Bank ( ). Mr Dyrdal has held various board memberships in the securities infrastructure, including the Board of VPS ( ) and the SWIFT National Member Group in Norway ( ). He has also been a board member of the market data and solutions provider Oslo Market Solutions and the clearing house Oslo Clearing, both companies in the Oslo Børs VPS Group. Chris Prior-Willeard Jesús Benito Formerly, from he worked for the Banco de España. Sveinung Dyrdal Chief Executive Officer, BNY Mellon CSD 22 Financial Services Research August 2014 Chief Executive Officer, Iberclear Jesús Benito is the Chief Executive Officer of Iberclear, the Spanish Central Securities Depository and a BME subsidiary. He has, until recently, been Managing Director of REGIS-TR, the trade repository joint venture with Clearstream. He still is a Board Member of REGIS-TR. He has worked actively with a number of pan-industry working groups such as CESAME and CESAMEII, the Expert Group Market Infrastructure (EGMI), Executive Vice President, Head of Securities Services, VPS Norway Sveinung Dyrdal is Executive Vice President and Head of Securities Services within the Norwegian Central Securities Depository (VPS), a position he has held since late Mr Dyrdal has been working in banking and securities services industry since He has held various positions in Nordea (and the predecessor Christiania Bank) Chris Prior-Willeard is Chief Executive Officer, BNY Mellon CSD SA/NAV. After leaving the Navy, Chris became Director of Futures Markets at The Baltic Futures Exchange in London, before moving to the London Stock Exchange where he was involved in launching SEAQ International, London s international equity market. He was then appointed as manager of the UK equity market following the Big Bang changes in Following this, Chris spent several years in banking with The Bank of New York, Chase Manhattan Bank and HSBC, working in both Corporate Trust and Depositary Receipts. In 1997, he joined Pricewaterhouse-

3 Coopers as a Management Consultant, first in the Risk Management and subsequently the Corporate Finance practices. He advised stock exchanges, clearing houses and banks. In the dot.com period, Chris joined the board of a client, jointly owned by ABB and Living Systems, which operated an internet-based Central Counterparty clearing both stock and commodity exchange trade flows. Chris studied at both Southampton and Nottingham Universities and at Smithfield College. He has authored books and articles on financial markets. Andrea Tranquillini His experience spans Operations, Network Management, Product Development, as well as Sales & Relationship Management and Strategy. Andrea holds an MBA in Finance from the Sacred Heart University of Fairfield, Massachusetts. Valerie Urbain Chief Executive Officer, Euroclear Belgium, Euroclear France and Euroclear Nederland Valérie Urbain is Chief Executive Officer of the three ESES central securities depositories (CSDs), namely Euroclear Belgium, Euroclear France and Euroclear Nederland. agent banks, other central securities depositories and transfer agents. Previously, Ms Urbain was head of a team of relationship managers in Euroclear s Commercial division, with responsibility for Euroclear s clients in France, southern Europe and Latin America. Before this, she headed a commercial team covering France, Ireland, the Channel Islands, the UK, the Netherlands and Scandinavia. She joined Euroclear in 1992 as an Account Officer. Before joining Euroclear, Ms Urbain worked in the Investment Banking and Bond Sales departments of Banco Hispano Americano and in the Corporate Banking division of Continental Bank (both in Brussels). Ms Urbain holds a degree in Commercial Engineering from the Solvay Business School (Belgium). Guido Wille Managing Director Business Development, Sales, Product and Network Management, globesettle SA Andrea Tranquillini is Managing Director Business Development at globesettle SA, the newly created CSD of the London Stock Exchange Group, with primary responsibilities for Sales & Marketing, Product and Network Management. He has 20 years of international experience in the European post-trade industry across Italy, United Kingdom, France, Germany, Luxembourg and Belgium working for Morgan Guaranty Trust (JP Morgan), BNP Paribas Securities Services, Clearstream Banking Luxembourg, Capco and Monte Titoli before taking his current responsibilities. Ms Urbain was previously Managing Director and head of the Human Resources division of the Euroclear group from 2005 until 2009, at which time she was promoted to her current CEO duties. Earlier in her career, Ms Urbain was head of Product Management at Euroclear UK & Ireland (formerly CRESTCo), the central securities depository for UK domestic securities and Irish equities. Ms Urbain was also a member of the Euroclear UK & Ireland Executive Committee. Before moving to Euroclear UK & Ireland in 2003, Ms Urbain was head of Network Management at Euroclear Bank s headquarters in Brussels. She and her team were responsible for managing Euroclear Bank s relationships with its worldwide network of cash and securities correspondents, including Executive Vice President, Head of Business Development, Clearstream Guido Wille is Executive Vice President and heads Business Development at Clearstream. Previously he ran Clearstream s London office with commercial responsibility for Americas, UK, Ireland & Nordic countries. Guido joined Clearstream in He has worked in the industry for 17 years in Brussels, Frankfurt, London, and Luxembourg. Financial Services Research August

4 CSDs are currently subject to an array of regulatory amendments which aim typically to promote further safety and efficiency in the global financial infrastructure and, in many cases, to open the market for CSD services. In Europe, the CSD Regulation aims to promote a common set of rules governing CSDs operations and services across the EU thereby intending that CSDs should benefit from uniform licensing requirements and an EU-wide passport for provision of services. Alongside this, CSDs are being forced to adapt to major infrastructure projects (for example, TARGET2-Securities in Europe) which will prompt a redesign of the service portfolio offered by CSDs and how risk is managed across the settlement and asset servicing arena. During the global financial crisis, many CSDs and settlement systems proved to be highly resilient. However, while many policy makers accept that CSDs typically operate safely and efficiently within national borders, some have voiced concerns that CSDs operate less safely and efficiently across borders, dictating that investors face higher risks and costs for cross-border investments. As a result, we have seen a range of financial sector reforms designed to improve efficiencies in this area. These financial rules and requirements are prompting CSDs to extend partnership or collaborative relationships with other CSDs or other entities. This may help CSDs to manage the costs and obligations associated with these financial amendments more effectively and for smaller CSDs (including those in emerging or frontier markets) to access state of the art technology, international networks (to facilitate movement of collateral and liquidity for example) and support in establishing global standard industry practice. Participants 24 Financial Services Research August 2014 Moderator: Bob Currie, Editorial Director, Financial services Research Limited Jesús Benito, Chief Executive Officer, Iberclear Sveinung Dyrdal, Head of Securities Services, VPS Norway Chris Prior-Willeard, Chief Executive Officer, BNY Mellon CSD Andrea Tranquillini, Managing Director Business Development, Sales, Product and Network Management, globesettle SA Valerie Urbain, Chief Executive Officer, Euroclear Belgium, Euroclear France and Euroclear Nederland Guido Wille, Executive Vice President, Head of Business Development, Clearstream

5 What will it mean to be a CSD over the next five years? What changes do you identify in the services and responsibilities extended to CSD participants and their customers? laying down this framework of rules, CSDR should encourage competition by eliminating barriers to access, thereby creating the foundation for an EU-wide passport for the provision of CSD services. Valerie Urbain: In predicting what CSD strategies will look like in times ahead, it is valuable to look back at the recent past and to reflect on what that experience has taught us. The financial crisis of affirmed the important role that CSDs perform in safeguarding client assets and delivering a secure and efficient post-trade infrastructure for securities processing. The direction of the European CSD sector over the next 4-5 years will be driven, at least in part, by the appetite of the market to mutualise costs and to eliminate risk. The focus of financial supervisors on mitigating post-trade risk has stepped up to a new level since the onset of the financial crisis. However, even though there has been a fresh impetus on reducing and controlling risk since the demise of Lehman Brothers, Bear Stearns and Northern Rock, risk-mitigation has been one of the top priorities of financial regulators for many years. If we consider the recent and upcoming developments in the CSD space we find, on the one hand, the CSD Regulation (CSDR), which introduces measures that promote a harmonised environment for securities settlement and asset servicing across EU member states. And, on the other hand, the launch of the ECB s T2S platform, which should deliver centralised settlement for euro-denominated and some non-euro securities. It is interesting to point out that CSDR has not been introduced to address concerns relating to how secure CSDs are. Indeed, if anything, the financial crisis has taught us that CSDs are extremely resilient and often considered as safe-havens when the financial markets are under duress. Instead, CSDR aims to promote a level playing field across European CSDs through the implementation of a common set of rules that will govern the way products and services are delivered by CSDs across the EU. In Euroclear has also been driving market harmonisation through its own initiatives, such as the single book-entry settlement platform for Belgium, France and the Netherlands (Euroclear Settlement of Euronextzone Securities, ESES) that was launched in This project was a response to the consolidation we could see evolving at stock exchange level and, in particular, across the Euronext markets. The consolidated Euronext markets, excluding Portugal, are now trading using a single-order book, so Euroclear decided to develop the ESES platform which accommodates this development while delivering greater processing efficiency and reduced costs. Effectively, we were delivering a borderless settlement platform across three EU member states. Andrea Tranquillini: We should perhaps not overestimate the level of change that we will see in the CSD sector between now and According to the proposed schedule, T2S migration waves will be completed by early 2017, with a contingency wave available to accommodate other CSDs that may wish to join. There is discussion around the market that DTCC and JASDEC may wish to link to T2S, for example, as well as the National Securities Depository, the Russian CSD. By 2018, the core elements of the CSD Regulation will also be in place, although it will be too early at this stage to evaluate their full effect. With T2S implementation, we do not anticipate a major shift in settlement liquidity from where this sits today. Looking at the access strategies of the leading global custodians, many of these are likely to retain local market access and, by 2018, it is unlikely that we will see large settlement volumes being settled outside of the domestic market. Rather, we can expect the major custodians to process settlement broadly as they do today. Probably the most significant change Financial Services Research August

6 over this timeframe will be the additional freedom that will be granted to issuers as a result of the CSD Regulation. Article 47 of CSDR introduces the right for issuers to record their securities in any CSD in the EU, along with freedom for CSDs to provide services for securities that have been issued under the law of another Member State. As issuers take advantage of these opportunities, this is likely to result in consolidation of issuance and settlement activity at a number of larger EU CSDs though in five years time we will still be at an early stage in this process. In turn, each CSD will be forced to respond to this trend setting strategies in place that enable them to retain critical mass and to defend themselves against any outmigration of volumes that this trend may trigger. changes to CSD s operating and business models. As a CSD that is on the outside of Europe Norway is not an EU member and has not adopted the euro currency VPS is monitoring these developments very closely and we are still crafting our response to these various initiatives. It is possible that VPS will connect to T2S, most likely in However, this will be dependent on the support of market participants and the decision of Norges Bank, the Norwegian central bank, regarding whether it is prepared to make the Norwegian krone available for securities settlement in T2S. With the implementation of CSDR, issuer services will be a priority. VPS has a strong network of relationships with issuers and issuer agents and we will continue to build As a CSD, one of the pressing questions confronting us is whether some of our largest clients today may emerge as some of our largest competitors tomorrow. Ultimately, this question is governed by how one can deliver value to end clients, whether these be issuers or the investors. Given that we are providing white-labelled services in both of these areas to our CSD participants, can this value best be delivered by ourselves as a utility? Or will CSD participants elect to develop their own independent solutions? 26 Financial Services Research August 2014 So issuance and liquidity are likely to be primary drivers of change in Europe s CSD sector over the coming five years. Another important consideration, particularly for some of the newly-established CSDs, is EMIR Article 47.3, which requires that initial margin during the clearing of derivatives trades be held with a licensed securities settlement system (SSS). In establishing globesettle, we are well positioned to support this requirement, enabling clearing members to reduce costs and to minimise the length of the value chain through ensuring that collateral is positioned effectively to collateralise their outstanding exposures at the CCP. Sveinung Dyrdal: I agree that this set of changes will prompt limited redirection of settlement liquidity between European CSDs in the coming five years. But CSDR and the introduction of T2S will fuel competition and they will certainly drive value on these relationships. In Nordic markets, securities market laws prohibit citizens, and some other registered legal entities, from holding assets in nominee account structures. At VPS, we maintain direct accounts for more than 1 million retail investors and this puts us in a strong position to offer value-added services to issuers and issuer agents for example, through provision of meeting services, the administration of employee share plans and through assisting distribution of investor documentation. Alongside this, VPS offers account operator services on a white-labelled basis to CSD participants in the Norwegian market including management of the Web portals that account operators make available to their beneficial owner clients, enabling these investors to manage their account holdings on a real-time basis. Additionally, VPS offers a broad range of collective

7 Chris Prior-Willeard: At the 2002 annual conference of the Federation of European Stock Exchanges (FESE) in Brussels, Alexandre Lamfalussy told the audience that the EU single market was the most important thing on the European political agenda and that, as a financial services industry, we had a central role to play in driving a harmonisation initiative that would permit free movement of goods, services and capital. At the same time, it was made clear that Europe s private sector had a specified amount of time to get things right in terms of delivering this agenda. If we failed to do so, then it was likely that policy makers would step in to accelerate the pace of reform through the introduction of new regulation. investment and fund services, including a transfer agency product that has been available in the Norwegian market since the 1990s. In planning ahead, we continue to explore avenues through which we can extend this service portfolio, both within our domestic market and on a regional basis. On balance, we believe that the notary function is likely to be key to our service capability in times ahead. Trading in the mostliquid securities on Oslo Børs accounts for a fairly large part of daily transaction volume. So it is essential for the well-being of the whole trading and post-trade infrastructure that the group retains the support of these largest issuers. This is similar to the Nokia effect that Finland has witnessed. If you lose a big issuer, you lose trading activity, you will experience a decline in investor accounts and you will not get the corporate actions activity. So, within Oslo Børs group, we have gone to great lengths over many years to ensure that we deliver high quality services to issuer clients. Projecting forwards 12 years, we are now seeing these political interventions taking effect. In drafting the CSD Regulation, the European Commission has noted that we are still some distance from a single EU market for settlement and asset servicing. Significant barriers remain to efficient post-trade operations, including inconsistencies in CSD operating rules and licensing requirements, constraints on the access that issuers have to CSDs in other jurisdictions, and limitations on CSDs ability to compete effectively for the delivery of services. The result, notes the Commission, is a very fragmented market. In the view of policy makers, the private sector has not driven movement towards a single European market as quickly as they had hoped and now we are seeing black letter legislation designed to increase the pace of this harmonisation programme. If we look historically, it is probably fair to question how far the industry has advanced in removing barriers to free movements of goods, services and capital. In the 1980s, for example, it was possible to settle securities issued in Australia, Hong Kong, South Africa and the United States via the London Stock Exchange s Talisman system, a batch processing settlement system. Subsequently, this international settlement capability has disappeared from the London Stock Exchange s service capability and this is only now gradually being re-established through the acquisition of Monte Titoli (via LSEG s purchase of Borsa Italiana) and the creation of globesettle. Financial Services Research August

8 More broadly, several trends may be significant in shaping the forthcoming five years. Geography will continue to be an important determinant of how settlement flows are processed in a T2S Europe. I agree that there is unlikely to be a dramatic relocation of settlement liquidity between EU CSDs in the next 3-5 years. This will limit the rate at which CSDs consolidate or exit the market in the near term. When T2S is live and users have adjusted to the new environment, then we are likely, over time, to see a gradual contraction in the supply of CSDs. But this consolidation phase is still several years away and is likely to gather momentum only after T2S migration has been completed. Another factor that may have important implications for CSDs and CSD participants is the impact of provisions in CSDR to harmonise settlement discipline measures across the EU. Settlement participants are clearly anxious about the potential impact of this development. 28 Financial Services Research August 2014 Jesús Benito: Yes, there is unlikely to be significant consolidation in the CSD layer over the next five years. As CSDs we have a lot on our plate. CSDs will be busy in adapting our platforms for T2S and in ensuring that we are compliant with content of the CSD Regulation. As Chris has noted, the settlement discipline provisions of CSDR are creating some uncertainties among CSD participants and Level 2 discussions are currently ongoing regarding this issue. The industry is in dialogue with ESMA to define the direction that this legislation takes. According to these proposals, the CSD sector is destined to be subject to some far-reaching changes over the next five years. Regulators and policy makers have committed to defining a future for Europe s CSDs that is based on competition. The challenges of adapting to CSDR and establishing a business case in a T2S environment are likely to prompt a restructuring of the CSD environment over time, even if this does not fully take shape until after the T2S migration waves are completed and users have adapted to the new environment. However, we must be careful to ensure that practical delivery does not fall well short of policy makers ambitions in these areas. CSDR aims to offer greater choice to issuers regarding where they issue securities and that is destined to open up greater competition in the CSD world. And even in situations where this is practical, competition between CSDs may not be the primary determinant of where an issuer chooses to issue. It may be tax advantages offered by one country over another, for example, that has greater influence on issuer decision making. Consequently, the financial authorities will need to be vigilant regarding opportunities for regulatory or fiscal arbitrage that may be extended in this new environment. With regard to our strategy at Iberclear, we are fully dedicated to adapting our systems and operating model to prepare for a T2S Europe. We have allocated substantial resources to making these changes and are well advanced on a substantial reform programme. These reforms provide confirmation that Spain is fully committed to the harmonised securities processing

9 environment that is enshrined in CSDR, a fundamental step towards creation of an EU single market for securities services. However, we are concerned that some other countries do not appear to be making a similar commitment. Harmonisation across EU Member States demands that we all move together to adopt a standardised rulebook and a common set of operating procedures. Some EU Member States do not appear to be taking appropriate steps will deliver a solution that supports multiple T2S markets. Clearstream will have direct links with all other CSDs in T2S in order to offer Investor CSD services across all markets, including asset servicing that meets the needs of international investors. Also, we expect collateral management to play a more prominent role in the service package offered by a range of CSDs. Every CSD will in some way aim to offer collateral management as part of its future service We are likely to see the development of a two-tier market in Europe s CSD segment. We will see the emergence of one group of suppliers that will deliver both core CSD functions and banking activities. Potentially there will be a second group of CSDs that do not elect to compete actively in the provision of banking services. At Iberclear, we do not intend to participate in the first of these two races. We are not currently a bank, we do not have extensive experience in the delivery of banking services and we believe that our core expertise lies elsewhere, in the delivery of core CSD and utility functions. to make this alignment and this will be bad for Europe s securities industry. As noted, the theory is one thing, the practice may be something different. If some Member States fall short of their obligations, then the harmonised environment that we have committed to build will be sadly compromised in practice. Guido Wille: There is little doubt that settlement in Europe will become more commoditised and, when T2S is live, this will largely disappear as a contributor to the revenue stream of European CSDs. A number of CSDs will be aiming to extend their asset servicing capabilities, setting in place asset servicing packages which replicate elements of the solutions offered by sub-custodians. We will also see geographical diversification as larger and more innovative CSDs attempt to market this service package in new locations, in addition to their own domestic market, as well as offering Investor CSD services for assets other than their home market securities. At this stage we feel that it is still too early to predict exactly how many CSDs will pursue this option. But potentially, we will see the emergence of a number of regional solutions where a CSD package and Clearstream works together with some of these via our Liquidity Hub GO product. For leading CSDs, this CM service will not simply involve moving collateral to where it is required to cover outstanding exposures. Rather this will involve collateral transformation and optimisation, upgrading collateral in order to enable users to manage their collateral inventory most efficiently. Within this environment, there will be greater competition between CSDs but also between CSDs and CSD participants. Some market players will establish direct access to the CSD in selected markets in which they have volume a process facilitated by the market harmonisation that will accompany CSDR and the central bank money settlement framework that the Eurosystem is creating with the launch of T2S. This will enable international banks and brokers to develop their connectivity once and then to replicate this across multiple EU markets. Although such a possibility is in theory open to any bank or broker today, in practise they would need to go through the process 24+ times, establishing bilateral connectivity with each CSD according to its Financial Services Research August

10 own proprietary configuration. The latter option is clearly not practical. Though the CSD sector is subject to significant changes that will take effect quite quickly, the effects of a number of reforms will not be fully visible within five years. Over 5-10 years we can expect to see liquidity shifts occurring: specifically, there is likely to be a movement of Eurozone fixed income securities into T2S settlement that are currently serviced by the ICSDs. T2S will provide a major concentration of liquidity in these securities; and a wider range of CSDs will provide effective collateral management options, thus extending choice in how users manage their fixed income liquidity. example, we have a long standing notary business within our corporate trust arm. We are a leading global transfer agent and provider of distribution support to collective investment funds. And we are a major provider of depositary receipt services. By creating a CSD entity, we are now able to offer greater flexibility to the customer in terms of how they access these functions, providing an integrated array of services along the securities value chain that will now be accessible through either a bank or a market infrastructure entity. Also, we offer potential opportunities to benefit from settlement internalisation for counterparties holding accounts within the BNY Mellon CSD, along with the benefits of LSEG identified new opportunities that would be created through establishing a Luxembourg-based CSD, many of these driven by regulatory changes and major infrastructure developments within Europe. Specifically, we have created a product that facilitates Eurobond settlement in central bank money, while enabling securities to be issued in a safer environment in TARGET2 and T2S. We believe the market s familiarity with the Luxembourg business and regulatory environment will provide comfort for issuers as well as investors looking to increase the use of different asset classes for collateral purposes. 30 Financial Services Research August 2014 Extending the CSD universe We have seen BNY Mellon, a large global bank, establish a CSD entity headquartered in Brussels. LSEG has also established a new CSD entity based in Luxembourg. What is the primary motivation for these CSD launches? Chris Prior-Willeard: In December 2012, BNY Mellon secured regulatory approval to establish an issuer CSD. The CSD entity is incorporated in Belgium as a non-bank subsidiary of BNY Mellon (BNY Mellon SA/ NV) and offers issuer, settlement and safekeeping services to market participants in the EU and worldwide. A number of the functions offered by the BNY Mellon CSD complement existing services offered by BNY Mellon through our commercial banking franchise. For cross-border interoperability through links with other CSDs. As an issuer CSD, this will also extend greater flexibility to securities issuers regarding their choice of issuer CSD. So in planning our future, we are positioning ourselves to benefit from new opportunities established by the CSD Regulation and EMIR as steps to creating a single pan-european market for financial services. We have taken a detailed look at the products and services that we extend to clients in a T2S Europe and globally and we have concluded that creating a BNY Mellon CSD provides an effective way of delivering best value from a number of these franchises in times ahead. Internally, we view the BNY Mellon CSD as a hybrid, able to bring the benefits of both a financial market infrastructure (FMI) and a commercial bank. We have been authorised as an international central securities depository

11 Under EMIR Article 47.3 there is also a requirement for clearing houses to hold assets with a licensed SSS and through globesettle, we have created additional options for clearing houses and clearing members to meet this obligation. With these facilities in place, LSEG is looking to capitalise on the ambitions of issuers and investors out of London and other locations to support future business expansion across the group. More broadly, LSEG is committed to supporting the development of financial services technology in emerging and frontier markets and the growth of local and international issuance out of these locations. With the technology capability that we have within the group, we are well positioned to support this expansion. and we have made it clear that we do not see ourselves as a domestic CSD. Andrea Tranquillini: London Stock Exchange Group (LSEG) identified new opportunities that would be created through establishing a Luxembourg-based CSD, many of these driven by regulatory changes and major infrastructure developments within Europe. Specifically, we have created a product that facilitates Eurobond settlement in central bank money (CeBM), while enabling securities to be issued in a safer environment in TARGET2 and T2S. We believe the market s familiarity with the Luxembourg business and regulatory environment will provide comfort for issuers as well as investors looking to increase the use of different asset classes for collateral purposes. Chris Prior-Willeard: In creating the BNY Mellon CSD, the largest challenge came not in developing and testing the technology required to support the CSD entity, but rather in obtaining the necessary regulatory and legal approvals required to operate as a CSD. Consultation around the CSD Regulation was still ongoing as we developed our CSD blueprint and it was necessary to refine the design on several occasions in order to comply with the governance requirements of this pending regulation particularly regarding the level of separation necessary between core CSD and banking functions. Indeed, under CSDR, CSDs are required to maintain legal separation between their banking functions and core CSD activities. To meet this commitment, we created a non-banking CSD entity which has a close relationship with The Bank of New York SA/ NV, which is incorporated in Belgium. When we first conceived the BNY Mellon CSD, we established an agreement with the National Bank of Belgium that CSD services would be provided through the SA/NV entity, an arrangement that is permissible under Belgian law. When provisions in the CSD Regulation appeared to specify that core CSD services could not be provided through a limited-purpose banking entity, we established a non-bank CSD that ensures we are compliant with this requirement. Financial Services Research August

12 When the BNY Mellon CSD was granted CSD authorisation in December 2012, it was a surprise to many of us that we were the only banking entity to be granted a CSD licence at this time. With this development, we are able to bring genuine advantages to our clients through being able to offer a combination of central bank money and commercial bank money settlement, and through extending a combination of functions as both a financial market infrastructure (FMI) and a commercial bank, thus providing flexibility in terms of how we deliver products and services to clients and how we can help them to manage risk. Valerie Urbain: I believe that both these entrants to the CSD space are a reflection of exactly what the financial authorities in the EU wished to see the benefits of promoting greater competition within the CSD segment. This evolution is having an additional impact as it is driving the existing CSDs to be more innovative in how they respond to the challenge. 32 Financial Services Research August 2014 We all need to manage our P&L carefully, while continuing to find new ways to differentiate ourselves from the competition and remain relevant to our clients. However, creativity and new developments require funding, so it is important for us to continually identify new revenue sources. The introduction of collateral management services, trade repository services, collective investment fund services and a host of other new product types illustrate the steps that CSDs are taking to refine their service capability and remain competitive. Within the Euroclear group, we have had a strong commercial bank money collateral management offering through the ICSD (Euroclear Bank) for many years. However, in order to ensure the Euroclear group CSDs remain competitive, we also began to offer collateral management services to our ESES clients two years ago. This development was important as it demonstrated our flexibility and allowed us to offer our clients the choice of operating in either central bank money or commercial bank money or both. Jesús Benito: Collateral management is becoming increasingly important for Iberclear. Three to four years ago we conducted an internal review of how we would deliver this service. We concluded, on the basis of this study, that there was not a strong business case for building an in-house platform and, subsequently, we took the decision to collaborate with Clearstream. At this time we were already working with Clearstream on other initiatives in the post-trade area and together we now operate REGIS-TR, our trade repository for derivatives. On balance, collateral management will be increasingly important in times ahead, not just for the ICSDs but also for the domestic or national CSDs. But you have a sizeable domestic market in Spain. Will that also be the case for CSDs that have a much smaller domestic market? Sveinung Dyrdal: It is a similar story in Norway. Collateral management will

13 become a standard product within our CSD offering. It does not make sense for VPS to develop an in-house solution from scratch, so partnership is a rational option in order to establish our place within an established global collateral management eco-system. We have chosen the same partner, becoming part of Clearstream s Global Liquidity Hub. Norges Bank, the Norwegian central bank, is also currently building its own collateral management system to support central bank lending and monetary policy operations. Links with this central bank system will be important in defining how we develop our VPS collateral management services in times ahead. other Nordic countries. But we should not assume this is a straightforward process or that there is guaranteed demand for a regionalised CSD offer. The Nordic markets have different currencies, different financial regulators and different market practice. No doubt there are some similarities when it comes to business culture, but also there are significant differences. An important component of our regionalised offer is the ability to offer flexible account structures. We have noted that, in Nordic markets, domestic retail investors are typically prevented by law from holding assets in nominee account structures and CSDR has not been introduced to address concerns relating to how secure CSDs are. Indeed, if anything, the financial crisis has taught us that CSDs are extremely resilient and often considered as safe-havens when financial markets are under duress. Instead, CSDR aims to promote a level playing field across European CSDs through the implementation of a common set of rules that will govern the way products and services are delivered by CSDs across the EU. Andrea Tranquillini: To clarify our position at globesettle because at times it has been misunderstood we do not offer an in-house collateral management service at the CSD. Rather, we offer a central interface that users may plug into, providing a link to tri-party collateral management agents or to central counterparties. In effect, our position is to remain neutral to the market in providing this interfacing role, simply offering a forum through which the key parties to a collateralised transaction can meet in one place. We have spoken about the potential for specialisation of CSD functions, but also about potential for regionalisation of CSD services. What does regionalisation mean to you as a CSD? Sveinung Dyrdal: Given the broad package of services that we have developed within the Norwegian market, it is logical to explore opportunities to market these in we maintain a retail account structure at VPS to support this requirement. However, more than 35 per cent of shares listed on Oslo Børs by value are owned by international investors. Some cross-border investors (or financial intermediaries acting on their behalf) may welcome the efficiency benefits extended through holding securities in an omnibus account. Also, growing numbers of international clients are electing to maintain a direct relationship with the CSD, holding assets in client name, in many cases supported by an account operated model through a local sub-custodian. It seems that the wind in Europe is increasingly blowing in this direction. Andrea Tranquillini: There has been a revolution over the past 5-10 years that has resulted in a progressive shift from use of omnibus account structures towards greater use of account operated models. The driver is risk management and this is prompting growing numbers of asset owners to request that their assets are held Financial Services Research August

14 in segregated accounts marked in beneficial owner name at the CSD. This momentum is not just driven by the need to identify beneficial owners to facilitate proxy voting or the management of other corporate events it has been driven by a more general drive to optimise standards of asset protection coming from regulators and asset owners. In some countries, there have been steps to include beneficial owner details as a settlement matching criteria. Jesús Benito: This trend has also been evident in the Spanish market. This is not at the level of the retail investor, as required by legislation in the Nordic markets, but a significant number of pension funds, mutual funds and large corporates are demonstrating an interest in having their assets held in segregated accounts at the CSD. Guido Wille: Inevitably the push for segregated accounts at CSD levels, and the growing appetite for global custodians and global broker-dealers to seek direct access to the CSD, has been driven in significant for example, at the height of the Fair and Clear campaign a decade or so ago. But are changing commercial dynamics and risk management priorities now driving a stronger air of co-operation? Jesús Benito: Building on our earlier discussion, I believe that we are likely to see the development of a two-tier market in Europe s CSD segment. We will see the emergence of one group of suppliers including the existing ICSDs, established CSDs that wish to offer banking services, along with new CSDs established by commercial banks that will deliver both core CSD functions and banking activities. Potentially there will be a second group of CSDs that do not elect to compete actively in the provision of banking services. At Iberclear, we do not intend to participate in the first of these two races. We are not currently a bank, we do not have extensive experience in the delivery of banking services and we believe that our core expertise lies elsewhere, in the delivery of core CSD Over 5-10 years we can expect to see liquidity shifts occurring: specifically, there is likely to be a movement of Eurozone fixed income securities into T2S settlement that are currently serviced by the ICSDs. T2S will provide a major concentration of liquidity in these securities; and a wider range of CSDs will provide effective collateral management options, thus extending choice in how users manage their fixed income liquidity. 34 Financial Services Research August 2014 part by liability provisions and delegation rules contained in AIFMD and UCITS V. Although the final word on this has not been spoken, It seems probable that a CSD may bear a lower level of liability under AIFMD and UCITS regimes than when assets are held with a bank entity. Competitive dynamics How will collaboration and competition play out between CSD groups and CSD participants in this environment? At times the relationship has been somewhat confrontational in times past and utility functions. We have consulted our CSD participants about whether, as we step into a T2S Europe, they want us to be a bank and to compete in the delivery of value-added functions. Their answer is an unreserved no. The unambiguous message is, We are a bank, we are your customer [as a CSD participant] and we do not expect Iberclear to compete with us in the delivery of banking services. For this reason, we have elected not to remodel ourselves as an ICSD. Andrea Tranquillini: The industry is evolving and certain CSDs are expanding their regional ambitions. The primary

15 group, we will remain loyal to our strategy, developing innovative solutions that will allow us to remain market neutral, while at the same time avoiding principal risk and minimising the operational risk embedded in our activities. Chris Prior-Willeard: In order to comply with CSDR, BNY Mellon CSD has created a non-banking CSD entity. However, a key differentiating factor in times ahead may not be whether an organisation holds a banking licence, but whether it is licensed to operate a securities settlement system (SSS) and this is by no means limited to existing CSDs or ICSDs. Commercial banks may secure approval to operate an SSS and we may also see some technology companies looking to offer this facility in times ahead. In their efforts to establish an efficient single market for settlement, Europe s market authorities have taken steps to increase competition in this segment and this will lead to further blurring of the roles of different service providers, be they traditional CSDs and ICSDs, banking groups or technology vendors. differentiators between these CSDs and the ICSDs will remain, first, their ability to support issuance of international debt (i.e. Eurobonds) and, second, whether they possess a banking licence. On the first point, the current Eurobond model is now 50 years old and, despite being well oiled, we believe this is becoming obsolete and has a degree of embedded risk and cost that the market cannot sustain anymore. As a group, we have created a product that facilitates the settlement of Eurobonds in central bank money and will support issuance in a much safer, dematerialised environment in T2 and T2S. For CSDs, we believe that access to a banking licence will be a real differentiator going forward. A number of CSDs and ICSDs currently have a banking licence and to some extent this provides a competitive advantage over those that do not. As a Guido Wille: Technology companies may become more active in supporting settlement activities in a T2S Europe. But it is questionable whether these are in a position fully to emulate what CSDs and ICSDs are doing. For example, to replicate Clearstream s or Euroclear s collateral engine may be within the capability of a number of technology companies, but this is not sufficient to create a sustainable business. Rather, it is the network of collateral providers and collateral takers sitting on this system that provides the foundation for a strong collateral management business and it has taken decades for the leading collateral management agents to construct these networks. This is also true for a broader range of CSD services. A CSD business is founded on an expansive network of issuers and investors and it may be difficult for a technology vendor to construct such a network from a standing start. Valerie Urbain: Another obstacle that new entrants will need to overcome is the Financial Services Research August

16 regulatory approval required to operate as a CSD, while simultaneously compiling the knowledge and skills required to run a regulated business. Chris has already outlined the exacting process that BNY Mellon had to go through to gain approval for its CSD entity. This may be a stumbling block for technology vendors that wish to enter the SSS space. Chris Prior-Willeard: I agree. At BNY Mellon CSD, we had experienced people within the team that had worked within regulated market infrastructure in the past and had a good understanding of how to approach these regulatory and compliance commitments. As a large global custodian, we were no stranger to working closely with financial regulators around the world. However, the task of establishing the BNY Mellon CSD presented a host of new challenges, not just in the area of risk management but also in legal and compliance. As a new entrant, one might have the technology and the necessary capital backing for a CSD business, but if you do not have the ability to liaise effectively with financial regulators and to convert legal specifications into an effective CSD model then it will be difficult to succeed in this sector. 36 Financial Services Research August 2014 Sveinung Dyrdal: As a CSD, one of the pressing questions confronting us is whether some of our largest clients today may emerge as some of our largest competitors tomorrow. Ultimately, this question is governed by how one can deliver value to end clients, whether these be issuers or the investors. Given that we are providing white-labelled services in both of these areas to our CSD participants, can this value best be delivered by ourselves as a utility? Or will CSD participants elect to develop their own independent solutions? Andrea Tranquillini: At globesettle, our primary business focus will be on the issuers, as they typically retain close links with their issuer CSDs. As we bring issuers into T2S, we will look to establish close relationships with the financial intermediaries that support downstream servicing of these instruments. As a global market infrastructure provider, LSEG is firmly committed to developing strong, long standing relationships with issuers, be it at the trading, clearing or settlement level. Valerie Urbain: To go back to your question on the potential for increased cooperation between CSDs, it is noteworthy that some of the same organisations that were at the heart of the Fair and Clear campaign 10 years ago are now working closely with Euroclear, especially in relation to the global Collateral Highway. As a CSD, the priority is to ensure that we remain relevant to our client base through the delivery of innovative services that bring additional value to our CSD participants. There is no room to be complacent, since the competitive situation can change quickly. I continue to stress the importance of remaining relevant from a cost, efficiency and risk management perspective as I believe that this is the best way to