New links in the regulatory chain

New links in the regulatory chain

Across the securities industry in Europe, profound regulatory changes are under way to meet the harmonisation agenda of the European Commission as well as the G20’s vision for a global regulatory framework to strengthen the financial system. Radar untangles the acronyms.

From trading through to clearing and settlement, directives and regulations are being rolled out in Europe that will affect financial institutions and investors. Business models, operations and systems are all under review and regulatory compliance has risen to the top of the agenda for all firms.


In October 2011, the European Commission published proposals for a review of the Markets in Financial Instruments Directive (MiFID, which was implemented in November 2007). The review takes into account the changes wrought on the financial markets by the global financial crisis and also the consequences of the original directive, such as a proliferation of trading platforms and changes in trading patterns and strategies.

When the proposals were released, the Commissioner for Internal Market and Services, Michel Barnier, commented that financial markets exist to serve the real economy – not the other way around. “Markets have been transformed over the years and our legislation needs to keep pace,” he said. “The crisis serves as a grim reminder of how complex and opaque some financial activities and products have become. This has to change.”

The European Commission (EC) has divided its proposal into two parts; a regulation and a revised directive, which are collectively known as MiFID II. The regulation will enable a uniform set of rules to be established that will prevent disparate interpretations by national governments as they adopt them into local law, while the directive element will allow for differences in national markets, legal structures and investor behaviour in other areas.

The proposal is with the European Parliament and the Council of the European Union for discussion. Implementation of the new measures is not expected until at least 2015. Among the main elements in the proposal are the following:

  • A new type of trading venue, the organised trading facility (OTF), will be created. Under the revised directive all trading venues will be subject to the same transparency rules.
  • New safeguards will be implemented for algorithmic and high frequency trading.
  • Requirements to gather all data in one place will bring increased transparency, giving investors an overview of all of their trading activities in the European Union.
  • In coordination with the European Securities and Markets Authority (ESMA), supervisors will be able to ban specific products, services or practices in case of threats to investor protection, financial stability or the orderly functioning of markets.
  • Stricter requirements will be introduced for portfolio management, investment advice and the offer of complex financial products such as structured products.

State of play

“The European Council is still negotiating on MiFID and there are some quite thorny issues. These include access from trading venues to CCPs and pre- and post-trade transparency for the OTFs,” says Alex Merriman, head of market policy, SIX Securities Services. “At the moment, member states are finding it difficult to come to a common position on such issues.”


Like the US Dodd-Frank Act, the European Market Infrastructure Regulation (EMIR), which came into force in August 2012, imposes central clearing of OTC derivatives through a central counterparty (CCP). Transactions that are not cleared centrally will attract a capital charge. Common governance standards for CCPs will be implemented as will interoperability for CCPs in the equities markets. EMIR will also increase margin and collateral requirements, although the details of what collateral will be acceptable are yet to be finalised. The main obligations under EMIR are:

  • Central clearing for certain classes of OTC derivatives.
  • Application of risk mitigation techniques for non-centrally cleared OTC derivatives.
  • Reporting to trade repositories.
  • Application of organisational, conduct of business and prudential requirements for CCPs.
  • Application of requirements for trade repositories, including the duty to make certain data available to the public and relevant authorities.

Operationally, financial firms will have to review the number and type of collateral relationships they have with clearing brokers in order to factor in all of the risk management aspects. Mandatory daily, independent valuation and collateralisation of trades that are not cleared through a CCP also will have to be undertaken. All contracts will have to be registered with the relevant trade repository and reported to them. Provisions within EMIR relating to client clearing could force firms to become a member of a clearing-house or a client of a clearing member. Firms will have to provide sufficient margin in liquid or near- liquid form for previously uncollateralised obligations and adapt their systems to incorporate risk management and reporting mechanisms.

State of play

Joséphine de Chazournes, senior analyst at Celent, says EMIR will have a dramatic impact on buy-side firms. “Buy-side players are clear supporters of EMIR because it decreases systemic risk exposure that their end-clients do not want to face again. At the same time, however, they will have to participate in the cost of the enormous market structure change the regulation triggers,” she says.

In a report published in April 2013, Impacts of EMIR for the Buy Side, Chazournes points out that some questions surrounding EMIR “have no answers” because the regulation is not final and the trading infrastructure itself is being affected by myriad post-crisis regulatory changes as well as illiquidity and uncertainty in some markets. Some EMIR technical standards are yet to be finalised: risk mitigation techniques for OTC derivatives that are not centrally cleared, contracts that are considered to have a direct substantial and foreseeable effect in the Union, or methods to prevent the evasion of EMIR. The EU Commission still needs to set a new deadline for the delivery of these standards, says Chazournes.


On 7 March 2012, the EC adopted a proposal for a central securities depositories regulation (CSDR). The regulation introduces an obligation of dematerialisation for most securities, harmonised settlement periods for most transactions in such securities, settlement discipline measures and common rules for CSDs. The Commission’s proposal is under consideration by the European Parliament and the Council.

Among the proposal’s key elements are:

  • Harmonisation of the settlement period to a maximum of T+2.
  • The imposition of penalties on market participants that fail to deliver their securities on the agreed settlement date.
  • A requirement for issuers and investors to keep electronic records for virtually all securities and to record them in CSDs if they are traded on regulated markets.
  • Strict organisational, conduct of business and prudential requirements for CSDs, to ensure their viability and the protection of their users. They will also have to be authorised and supervised by their national competent authorities.
  • A passport for authorised CSDs, enabling them to provide their services in other member states.
  • The ability of users to choose between all 30 CSDs in Europe.
  • Access for CSDs in the EU to any other CSDs or other market infrastructures such as trading venues or CCPs, in whichever country they are based.

Although CSDs performed their functions well during the financial crisis, legislation will provide a consistent and comprehensive framework along the value chain, says Soraya Belghazi, secretary general of the European Central Securities Depositories Association (ECSDA).

CSDs lobbied vigorously on some of the initial proposals for the CSDR. Belghazi says the current proposal has a more proportionate approach in terms of calibrating different requirements within the regulation to the risk level. “The amendments by the European Parliament reflect a more balanced approach, taking into account different levels of risk,” she says. The Parliament has also suggested changes to the authorisation process for new CSD services, which should facilitate CSD innovation. “Only services that have an impact on the risk profile of the CSD would require pre-authorisation,” she adds.

The same applies to CSD links – the initial Commission proposal did not make a proper distinction between different types of links, says Belghazi. Now, only links that involve a transfer of risk – such as the bridge between international CSDs Euroclear and Clearstream – will require pre-authorisation.

One of the more controversial aspects of CSDR, the separation of CSD and banking services, also has been amended by the Parliament. ECSDA argued for the possibility of all CSDs to offer limited banking services on an equal footing. The Parliament has recognised three possible scenarios for the provision of settlement services in commercial bank money: by a separate, external bank; by a bank that is part of the CSD’s corporate group; or by the same legal entity as the CSD, but with strict limitations. All these scenarios will occur in a risk-controlled environment that preserves the safety of the system and ensures market participants have choice. “In all three cases banking regulation will be complemented by additional requirements such as the full collateralisation of exposures,” says Belghazi.

State of play

Merriman says both EMIR and the CSDR harmonise and standardise the prudential requirements for CSDs and CCPs, putting “everyone” on a level playing field, with the same capital and risk management requirements. “In particular, apart from tending to be monopolies in their local market, CSDs are a disparate bunch and the way in which they are authorised and supervised varies enormously across Europe.

SIX Securities Services thinks a standard set of rules across Europe will be a good thing.” Tom Riesack, managing principal at consultancy Capco, says there is now a clear understanding and view among financial institutions that regulations are here to stay and must be adhered to. “I think there has been a change of mindset among firms,” he comments. “Rather than being seen only as a burden or additional cost, firms are trying to find revenue and business opportunities that will come out of these new regulations.”