Worldwide: CSDR REFIT: The Key Changes

The Central Securities Depositories Regulation (CSDR) is the European Union (EU) regulation relating to securities settlement and central securities depositaries (CSDs). It applies to CSDs that are based in the EU and their participants.

The CSDR came into force on 17 September 2014 and many of its requirements were staggered. It standardises the requirements for the settlement of financial instruments and the rules on the organisation and conduct of CSDs to promote safe, efficient and smooth settlement. The regulation introduced shorter settlement periods, settlement discipline measures, organisational, conduct of business and prudential requirements for CSDs and provided for a passporting regime allowing authorised CSDs to provide their services across the EU.

Between December 2020 and February 2021 the Commission conducted a targeted consultation on the CSDR which resulted in a report that was published in June 2021 which concluded that in broad terms the CSDR was achieving its original objectives to enhance the efficiency of settlement in the EU and the soundness of CSDs. For most areas, the report considered that significant changes to the CSDR were premature although it did note stakeholder concerns regarding the implementation of certain rules including those relating to the cross-border provision of services.

Subsequently, in March 2022, the Commission issued a legislative proposal amending the CSDR and the Short Selling Regulation as part of the 2020 Capital Markets Union Action Plan. The aim of the proposal was to make selected amendments to the CSDR in order to make securities settlement in the EU more efficient and improve the attractiveness of the EU's capital markets. The proposal is known as the CSDR REFIT.

The CSDR REFIT focused on amending the CSDR in five key areas: settlement discipline (including the pre-conditions for applying mandatory buy-ins), the passporting regime, banking-type ancillary services, oversight of third country CSDs and cooperation between supervisory authorities. It also amended the Short Selling Regulation by re-introducing a provision about buy-in procedures.

The CSDR REFIT took just over a year in trilogue before the Council of the EU (Council) and the European Parliament reached provisional agreement on the text on 27 June 2023. On 27 December 2023, the CSDR REFIT was published in the Official Journal of the EU as Regulation (EU) 2023/2845.

This briefing note summarises the key changes introduced by the CSDR REFIT and also touches on the position in the UK.

Settlement discipline

One of the key elements of the CSDR is the introduction of an obligation on CSDs to impose cash penalties on participants in their securities settlement systems that cause settlement fails. The CSDR also introduced mandatory buy-in rules although these have been criticised in the past for their lack of clarity and concerns that they may have a negative impact on the market. The CSDR REFIT introduces changes to these provisions.

Settlement discipline - mandatory buy-ins

The CSDR REFIT provides that the Commission may introduce mandatory buy-ins by means of an implementing act. The implementing act will specify to which financial instruments or categories of transactions mandatory buy-ins are to be applied.

The recitals to the CSDR REFIT note, however, that mandatory buy-ins could have negative effects, both in normal and stressed market conditions. Therefore the CSDR REFIT makes clear that mandatory by-ins are to be a measure of last resort and the Commission should only consider this when they constitute a necessary, appropriate and proportionate means to address the level of settlement fails in the EU.

For the purposes of reaching this decision, the Commission shall take into account the potential impact of the mandatory buy-in process on financial markets in the EU, the number, volume and duration of settlement fails and whether a particular financial instrument or category of transactions in that financial instrument is already subject to appropriate contractual provisions that provide a right for receiving participants to trigger a buy-in.

In addition, the Commission must only adopt an implementing act when the following two conditions are met:

• The application of other measures, such as cash penalties or the suspension by CSDs, central counterparties or trading venues, of participants that cause settlement fails consistently and systematically, has not resulted in a long-term sustainable reduction of settlement fails in the EU or in maintaining a reduced level of settlement fails in the EU.
• The level of settlement fails has or is likely to have a negative effect on the financial stability of the EU.

In addition to these conditions the Commission, will consult the European Systemic Risk Board and ask the European Securities and Markets Authority (ESMA) to provide a cost benefit analysis.

The list of transactions excluded from the mandatory buy-in regime includes securities financing transactions, corporate actions, reorganisations or the creation and redemption of fund units, realignment operations or other types of transactions that render the buy-in process unnecessary. ESMA is to develop draft regulatory technical standards (RTS) to specify further which types of transactions render the buy-in process unnecessary.

A pass-on mechanism has also been included in the CSDR REFIT to allow buy-ins to be applied along a chain of transactions. Furthermore, payment asymmetry has been removed to ensure that trading parties are restored to the economic terms that would have applied had the original transaction taken place.

Where the Commission has adopted an implementing act it is to review its decision on a regular basis and at least every four years in order to assess whether the conditions remained fulfilled.

Settlement discipline – cash penalties

Like mandatory-buy-ins, cash penalties will not apply to settlement fails where the underlying cause is not attributable to the participants in the transaction or operations that are not considered as trading. This is on the basis that applying these measures to such settlement fails and operations would not be practicable or could lead to detrimental consequences for the market.

The CSDR REFIT provides that the Commission is empowered to supplement the CSDR by adopting delegated acts specifying the parameters for the calculation of a deterrent and proportionate level of cash penalties based on all of the following: asset type, liquidity of the financial instrument, type of transaction and duration of the settlement fail.

Cash penalties will also need to be calculated on a daily basis for as long as the fail persists. The Commission is to reassess on a regular basis the parameters used to calculate cash penalties and should further consider possible changes to the method used for the calculation of those penalties, such as setting progressive rates.

The Commission is mandated to review the parameters for the calculation of the level of the cash penalties on a regular basis and at least every four years in order to reassess its appropriateness and effectiveness in achieving a level of settlement fails in the EU deemed to be acceptable, having regard to the impact on the financial stability of the EU.

Settlement cycle

There is no requirement for implementing a T+1 settlement cycle.

ESMA will submit a report to the European Parliament and to the Council on the potential shortening of the settlement cycle in order to inform potential future developments on the topic. ESMA's report is due by 17 January 2025.

Banking-type ancillary services

The CSDR REFIT adjusts the conditions under which CSDs can access banking-type services. This includes amendments to the CSDR which enable CSDs to seek the provision of banking-type ancillary services not only from designated credit institutions but also from other CSDs authorised to provide these services.

Also, certain amendments are made to the CSDR's provisions which provide for a specific threshold under which CSDs can use a credit institution to provide settlement cash and other banking-type ancillary services. The European Banking Authority (EBA), in cooperation with ESMA, is to develop RTS which will set an appropriate threshold below which credit institutions can provide banking-type ancillary services and specify any appropriate risk management and prudential requirements.

Passporting regime

The CSDR REFIT clarifies certain aspects of the CSD passporting process. In particular, where a CSD wishes to provide notary or central maintenance services in relation to financial instruments constituted under the law of another EU Member State it must take into account both the law of the EU Member State where the issuer is established and, where different, the governing corporate or similar law under which the securities are issued. In order to ensure that issuers who arrange for their securities to be recorded in a CSD established in another EU Member State can comply with the relevant provisions of the corporate or similar law of that EU Member State, EU Member States are to regularly update a list of such key relevant provisions of national law and communicate it to ESMA for the purposes of publication. EU Member States shall communicate that list to ESMA by 17 January 2025 and then update it at least every two years.

Third country CSDs

The amendments introduced by the CSDR REFIT include that a third country CSD must notify ESMA where it intends to provide settlement services in relation to financial instruments constituted under the law of an EU Member State.

ESMA is to inform the EU Member State competent authority under whose law the financial instruments are constituted. ESMA is to develop draft RTS specifying the information that the third country CSD is to provide to it in the notification. ESMA is to submit these draft RTS to the Commission by 17 January 2025.

Supervisory cooperation

While the CSDR provides for the possibility of setting up colleges of supervisors it has rarely been used.

The CSDR REFIT provides that colleges become mandatory under either of the following conditions:

• Colleges should be established for CSDs where a CSD's home EU Member State authority determines that the activities carried out by the CSD in at least two host EU Member States are of substantial importance.
• Where the competent authority of the home EU Member State is notified by one of the following that the activities carried out by the CSD in at least two host EU Member States are of substantial importance:
  • ESMA.
  • The competent authorities of the host EU Member States in which the CSD's activities are of substantial importance.
  • The EBA (where the CSD has been authorised pursuant to Article 54 of the CSDR).
  • The authority responsible for the oversight of the securities settlement system operated by the CSD in the EU Member State whose law applies to that securities settlement system.
  • The central banks in the EU issuing the most relevant currencies in which settlement takes or will take place and where relevant.
  • The central bank in the EU in whose books the cash payments of a securities settlement system operated by the CSD is or will be settled.

Timing

The CSDR REFIT entered into force on 16 January 2024 although some of its provisions apply from 1 May 2024 and 17 January 2026. Article 3 of the CSDR REFIT provides further information.

United Kingdom

The CSDR was onshored into UK legislation as it stood at the end of the transition period.

However, the CSDR settlement discipline regime had not begun to apply before the end of the transition period. Consequently, it could not be included in the UK CSDR as part of the onshoring process. HM Treasury could therefore decide whether and how the UK implemented the settlement discipline regime. Consistent with FCA advice, HM Treasury decided not to implement the EU CSDR settlement discipline regime in the UK. For many years, the UK had argued in relevant EU fora that the case for introducing the regime, in particular the buy-in provisions and arrangements for resolving failed transactions, was not strong. Both HM Treasury and the FCA feel that the Short Selling Regulation is the better, more direct and more effective vehicle for setting regulatory parameters around that market.

The UK CSDR will be revoked under the Financial Services and Markets Act 2023 (FSMA 2023). Its revocation forms part of the UK Government's wider work programme relating to retained EU law. Schedule 1 to FSMA 2023 sets out a list of the legislative acts that will be repealed under this framework, including UK CSDR.

Under the FSMA 2023, the Bank of England (BoE) has received a general rule-making power over CSDs (and CCPs). The BoE will use this to set requirements through its rulebooks. The BoE is exploring proposing 'fundamental rules' that would underpin the whole regime and help firms anticipate how the BoE will assess their compliance with more specific rules. The FSMA 2023 also gave the BoE the power to issue requirements to recognised UK CSDs (and recognised UK CCPs and systemic third-country CCPs). This power will allow the BoE to require such entities to take, or refrain from taking, a specified action. On 21 December 2023, the BoE issued a consultation paper on its approach to statutory notice decisions for use of its requirements powers. The deadline for comments on the consultation paper is 21 March 2024.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.