Asset Segregation Rules for Central Securities Depositories: Maximizing Investor Protection while Ensuring a Level Playing Field

Central securities depositories (CSDs) are of systemic importance for financial markets. In Europe, for instance, the European Association of CSDs (ECSDA) documented that in 2017 the total value of securities held in custody with a CSD amounted to 54.9 trillion EUR. European CSDs also processed around 440 million delivery instructions, representing 1.10 quadrillion EUR. Because of their importance, legislators want to subject CSDs to prudential and conduct requirements, in order to protect financial stability and their clients. In reaction to the call of the Financial Stability Board in 2010 for more robust market infrastructures, the Committee on Payments and Market Infrastructures (CPMI) and the International Organization on Securities Commissions (IOSCO) published in 2012 the Principles for Financial Market Infrastructures. The latter was the basis for the European CSD-Regulation, that entered into force on 17 September 2014.

In a recent paper, I provide a holistic overview of one important investor protection requirement applicable to CSDs: the segregation of assets. I describe the general segregation rules that CSDs need to be compliant with, regardless of the type of security they hold in custody. Moreover, in addition to the relevant segregation rules in case of CSD links, I discuss the segregation requirements applicable when a depository bank delegates its custody function to a CSD.

Furthermore, my article contributes to the ongoing debate about the harmonization of securities laws between European member states, to ensure an integrated financial market and a level playing field between CSDs. Over the last few decades, various legislative initiatives have been undertaken, both at the European level (e.g. the work conducted by the Giovannini Group in 2001 and 2003, the Legal Certainty Group in 2008, and the European Post Trade Forum in 2017) and at the global level (e.g. the securities conventions of The Hague and Geneva, respectively in 2006 and 2009). However, a complete harmonization of securities laws has not yet been reached.

In the paper, I stipulate that in general, omnibus segregation - where a securities account holds the securities that belong to different customers of the CSD’s client - is likely to be preferred by CSDs and their clients to individual client segregation – where the securities of any of the client’s customers are separately held in  different accounts. The main reason is that in most European countries, especially those with a ‘co-ownership of a pool of securities model’, the use of individual client segregation is deemed more costly (because of the numerous accounts that the CSD needs to open and maintain) without generating additional benefits in terms of investor protection.

Nevertheless, because national securities laws are not harmonized, this does not hold true for every European member state. In certain countries, individual client segregation is a condition for the end investor to be recognized as the legal owner of the securities, and the comingling of the assets on an omnibus account could lead to a situation where the assets of the end investor are considered owned by the defaulting intermediary in the custody chain. Taking into account that individual client segregation is expected to be costlier, and that CSDs might have to reflect these costs in the settlement fees charged to their customers in order to stay profitable, CSDs located in those member states with a higher likelihood of individual client segregation are likely to face a competitive disadvantage vis-à-vis CSDs domiciled in jurisdictions where omnibus segregation is deemed protective. A true level playing field between CSDs may thus be dependent on further harmonization of national securities laws.

Furthermore, there is no level playing field between CSDs and global custodians offering similar services. Indeed, an investor CSD and a global custodian, to which a depository bank delegates its custody function, may both be subject to the AIMFD and UCITS V asset segregation requirements. However, only the investor CSD is also subject to the stringent CSDR rules, while global custodians are rather subject to general banking regulation. The divergent services that various market participants (e.g. CSDs, custodians, and depositories) execute could thus be mapped and regulated accordingly.

Randy Priem is doctor of Business Economics (Finance) and market infrastructures expert at the Belgian Financial Services and Markets Authority (FSMA).