The Brexit Issue No One Is Talking About
By Sean M. Tuffy, Brown Brothers Harriman
Originally published at the On the Regs blog
Policymakers in the U.K., Ireland, and Brussels should consider the potential impact Brexit will have on security settlements.
We’ve covered a number of Brexit topics over the last few months, all of which have focused on the implications to asset managers and funds. There has also been near endless speculation in the press about whether Brexit will force euro-clearing out of London. However, there is another more niche issue that has received little attention –Brexit will cause a real headache for the securities settlement world.
Irish securities settle in the U.K.’s Central Securities Depository
Brexit has the potential to be quite disruptive in the usually sedate world of security settlements, where ownership of a security is exchanged. The disruption won’t be in the U.K., rather it would be felt across the Irish Sea in Dublin. Brexit may present a problem for Ireland because it does not have its own CSD (Central Securities Depository), which is a piece of market infrastructure that holds securities on behalf of investors. Instead, primarily due to the relatively small size of the market, Irish securities settle in CREST, the U.K.-based CSD.
Under the E.U.’s CSDR (Central Securities Depositories Regulation), a CSD must be authorized by a local E.U. Member State regulator. Since the U.K. will no longer be part of the E.U. post-Brexit, the question is whether this cross-border arrangement will be allowed to continue when Brexit is all said and done. There is an equivalence regime in CSDR, which allows ESMA (European Securities and Markets Authority) to authorize non-E.U. CSDs to provide services to E.U. market participants and establish links with other CSDs. For a non-E.U. CSD to be recognized by ESMA, various conditions must be met and approved by the European Commission —including that the non-E.U. CSD must be subject to regulation that is equivalent to CSDR.
Is equivalence the likely solution?
On the face of it, equivalence seems like the easiest answer. The U.K. has already adopted the CSDR, so the regulations are not only equivalent, they are, in fact, the same. However, equivalence has its drawbacks. The U.K.’s regulation would need to keep pace with all future E.U. changes to ensure that its equivalence is not revoked.
As we’ve discussed before, the other challenge with equivalence is political. If there is a hard Brexit, which is looking increasingly likely, there is no guarantee that CREST would be granted equivalence, even if the rules are the exactly the same. In fact, there are reports that the Commission is reconsidering its approach to equivalence in light of Brexit. E.U. policymakers want to make sure that, in the event of a hard Brexit, equivalence isn’t simply a backdoor into the E.U. market.
Or does Ireland need its own CSD?
If CREST is not granted equivalence, Ireland will have two possible options. The first is that another CSD operator could take advantage of the passporting rights under CSDR and settle Irish securities in another E.U. CSD. Alternatively, Ireland could establish its own CSD. In either case, it would mean that Ireland could also connect to the European Central Bank’s T2S (TARGET2-Securities) platform. T2S is a real-time securities platform that is designed to harmonize security settlements across Europe and provide centralized settlement in central bank money. Due to objections from U.K. policymakers, CREST is not participating in T2S. Participation in T2S would allow Ireland to take advantage of the efficiencies provided by the new platform’s economies of scale, which should reduce settlement costs. T2S also eliminates the need for banks to hold collateral and liquidity buffers in silos across E.U. markets.
While not as glamorous as the Brexit issues associated with asset management passports, the potential impact of Brexit on security settlement is nonetheless important. It is something that policymakers in the U.K., Ireland, and Brussels should consider as they enter the Brexit negotiations.