By Gert Raeves, Senior Research Director, CEB TowerGroup
First came immobilization, then dematerialization. What’s next for Central Securities Depositories? – Gert Raeves from CEB TowerGroup describes the way forward for CSDs under Target2Securities.
Central Securities Depositories (CSDs) are a fascinating example of evolution at work. Before CSDs, buyers and sellers of securities had to shuffle papers, send couriers, and arrange transfers of physical securities certificates. The introduction of CSDs immobilized those certificates by having them placed in physical vaults at a shared location and operated by a neutral market utility. With immobilization, buyers and sellers could transact more efficiently, without having to manage the movement of physical certificates.
The next stage was dematerialization, which eliminated the need for physical certificates entirely. With dematerialization, securities certificates turned into mere entries on an electronic ledger. Yet despite losing some of their original benefits of physical security, in most markets CSDs have remained an entrenched part of the legal ownership transfer process. If you buy or sell a security today, that change of legal and beneficiary ownership is recorded in the electronic accounting platform of a CSD.
Throughout the capital markets industry, participants from fund managers to custodians and clearing banks still rely upon CSDs every time that security n moves from ledger a to ledger b.
Are CSDs still fit for purpose?
At the barebones level, a CSD is just an accounting platform that receives and sends messages to its members. That seems like a much thinner value proposition than the original one of physical security and convenient transfer of ownership. After being a great tool for reducing friction in the market for so long, CSDs have become a source of friction. With over 40 different CSDs in Europe alone, cross-border investors need to employ a long and expensive chain of intermediaries to manage this maze of connectivity, standards, as well as legal and operational nuances.
The balkanized European settlement landscape compares unfavorably with other mature markets, especially the United States, where DTCC (the US CSD) in its various guises has managed to smooth the path to more efficient and cheaper settlement and account servicing.
Enter Target2Securities, the European Central Bank (ECB) project to harmonize European settlement flows by using a single settlement system across all CSDs. When it was first announced, there was much gnashing of teeth about what it would mean for CSDs, custodians, and investors. The answer is becoming clearer by the day. Scale and integration are the only way to create efficiencies in a market where every incentive is now aligned: Make it simpler and cheaper to settle trades and service investors’ accounts.
Single-purpose vehicles are on the way out. If a CSD services just one country or jurisdiction, or offers just a subset of 21st-century securities services, it’s headed on a one-way cruise to the Galapagos Islands.