Subject: Harmonization of the CDCC's business operations with EU Regulation (CSDR)

Transcription

1 MANAGEMENT BOARD Ref. No.: U-101/00-551/VR Zagreb, 1 February 2017 Subject: Harmonization of the CDCC's business operations with EU Regulation (CSDR) Dear Sirs, Hereby we would like to inform you about the activities being taken by the Central Depository and Clearing Company Inc. (Hereinafter: the CDCC), and in connection with the harmonization of business operations with Regulation (EU) no. 909/2014 of the European Parliament and Council of 23 July 2014 on improving securities settlement in the European Union and the central securities depository, and amending Directive 98/26/EC and 2014/65/EU and Regulation (EU) no. 236/2012. (Hereinafter: CSDR), as well as adopted technical standards based on it. Given the fact that due to harmonization with CSDR there will be changes in business operations of the CDCC which will to some extent reflect on the members of the CDCC; below specified are the extent of changes, a general timetable of implementation of these changes, and the expected impact on the members of the CDCC. CSDR in general CSDR entered into force on 17 September 2014, with the obligation to adopt implementing acts and related technical standards, in the form of regulatory technical standards (Hereinafter: RTS) and implementing technical standards (Hereinafter: ITS). In November 2016, the European Commission adopted the technical standards, and they shall take effect 20 days after publication in the Official Journal of the European Union, except for technical standards on settlement discipline that are available in final draft, and which shall enter into force 24 months after the official publication. According to available information, technical standards will be published in the Official Journal of the European Union no earlier than February of 2017, while the adoption and publication of the technical standards on settlement discipline is expected in the first half of 2017, with a delay of application of 24 months. CSDR's aim is to improve and facilitate the settlement of financial instruments, with increased safety and efficiency through the unique rules of settlement across all markets of the EU. Consequently, all central depositories in the EU are obliged to harmonize their operations with the provisions of this Regulation, to ensure the safety and reliability of central depositories, and to continuously meet the stringent requirements for organization, business operations and prudential requirements established by CSDR, and carry out licensing procedures i.e., obtain authorization from the competent authority. CSDR requirements do not only apply to central depositories that provide services in the EU, but also, directly or indirectly, to members of Heinzelova 62a Zagreb, Croatia Registered at The Commercial Court in Zagreb Reg.No Issued capital: ,00 HRK (fully paid) Number of issued registered shares: President of the Management Board: Vesna Živković Member of the Management Board: Stjepko Čičak President of the Supervisory Board: Tanjica Liktar Bank: Hrvatska poštanska banka d.d., Zagreb; Acc.No.: , IBAN HR

2 systems managed by central depositories and market participants (e.g., trading venues, investment firms). Harmonization with the requirements of CSDR is a prerequisite for obtaining authorization of the CDCC as a central depository, and the continuation of providing services of managing the central depository of dematerialized securities and of the securities settlement system. According to CSDR, the CDCC is obliged to submit the request for authorization to the Croatian Agency for Supervision of Financial Services (Hereinafter: HANFA) as the competent authority, within 6 months from the date of entry into force of technical standards on the requirements for central depositories which, according to the above, implies that the deadline for submitting applications for authorization could be in September Scope of CSDR In addition to regulating the business operations of central depositories on the territory of the European Union, and the corresponding obligations for market participants, CSDR includes other elements focused on harmonizing processes related to the dematerialization of financial instruments, standardization of the settlement period, measures related to settlement discipline with the aim of improving settlement efficiency, and other measures aimed at harmonizing processes and rules of the single market, of which the following are more significant: authorization of central depositories at European Union level; harmonization of licensing procedures, rules of service and operational rules for central depositories; registration of all transferable securities, which are traded on trading venues, in a dematerialized form (starting with 01/01/2023 all newly issued securities must be issued in a dematerialized form, while the process of dematerialization for existing securities should be carried out no later than 01/01/2025); intended settlement date for transactions of transferable securities which are carried out on trading venues is no later than the second business day after the trade (T+2 is implemented in almost all EU member states); standardization in terms of depository capital requirements; unique prudential requirements, in order to ensure the solvency of the depository; application of the CPSS-IOSCO principles of risk management; introduction of the Intended Settlement Date, in relation to which failures to fulfill obligations may be measured, the obligation to introduce buy-in procedures and fines for failed settlement; existence of business continuity policies and recovery plans, in order to ensure continuity of critical operations of central depositories; the CSD links i.e., arrangements between central depositories under which one central depository becomes a participant in the securities settlement system of another central depository; establishing the User Committee as an independent body consisting of representatives of issuers and participants in the securities settlement system. 2

3 Changes in business operations of the CDCC and CSDR's impact on members of the CDCC and market participants With the objective of harmonization with the provisions of CSDR and the related technical standards, during 2016, a project team was created within the CDCC that prepared a detailed time schedule of all activities, responsible persons per each activity as well as time limits in which the operational rules and related software are to be prepared. Below is an overview of the planned changes in part of the CDCC's business operations and prescribed obligations for market participants under the provisions of CSDR which have an impact on members of the CDCC and market participants. Taking into consideration that certain provisions enter into force with a delay, the implementation plan of the CDCC was prepared accordingly. In addition, it is necessary to take note of the final deadline in which HANFA has to decide on the request, which is 6 months from the filing of an orderly application, and the fact that the technical standards on settlement discipline were, at the time of defining of activities, available in final draft form, and are subject to change. Much of the specified changes stem from the prescribed requirements concerning settlement and settlement discipline especially, and which refer to the CDCC but also to members of the CDCC and other market participants and that in the part of the buy-in process, penalties for settlement fails, the valuation of financial instruments, supervision of timely settlement, as well as activities concerning instructions matching, the hold and release mechanism, partial settlement, tolerance level for cash settlement amounts and the like. Other planned activities arise from provisions governing business operations of central depositories and the prescribed requirements for conducting activities of the central depository. The implementation of changes in business operations of the CDCC due to harmonization with the provisions of CSDR and RTSs is intended to be carried out in phases, as follows: i) for all changes resulting from the provisions of CSDR and RTSs (except for the RTS on settlement discipline), the operating rules shall be ready by the deadline for submission of application for authorization, with the application and implementation of specified changes after obtaining authorization by HANFA; ii) for all changes arising from the provisions of RTS on settlement discipline, the predicted timeline for implementation is no later than the date of application of the RTS on settlement discipline. It should be noted that technical standards on settlement discipline have not been officially adopted yet, and amendments may be possible, which may in turn have an impact on the planned volume of changes in business operations of the CDCC, as well as the deadlines for their implementation. The CDCC shall promptly notify all members and interested parties of all details and important information related to activities and implementation of changes in business operations of the CDCC, which shall reflect on business operations of the CDCC's members and market participants, primarily those anticipated to require tweaks for applicative solutions or changes to business processes on their end. 3

4 An overview of major changes with direct impact on business processes of the CDCC's members and market participants: Keeping records of transactions, settlement instructions and positions (of securities) (CSDR Art. 29, RTS regarding regulatory technical standards on authorization, supervisory and operational requirements for central securities depositories Art. 54, Art. 55) The CDCC is obliged to keep data on the LEI (Legal Entity Identifier) for participants and issuers of securities in order to identify them, therefore the participants and issuers will have to submit their LEI to the CDCC, in the timeframe that will be subsequently published by the CDCC. For the purposes of record keeping of transactions and instructions under Article 54 of RTS, participants shall, when entering settlement instructions, also have to enter data on: - transaction type: (i) purchase or sale of securities - TRAD; (ii) collateral management (COLI, COLO, CNCB); (iii) repurchase transactions (REPU; RVPO, TRPO, TRVO, BSBK, SBBK); (iv) other types of transactions other than those referred to in points (i) (iii) - OTHER. - place of trading, if the instruction is resulting from a trade concluded on a trading venue; - place of clearing, if the transaction is cleared by a CCP; - trade date. Measures to prevent settlement fails in relation to participant s clients (CSDR Art. 6, final draft of RTS on settlement discipline Art. 2 and Art. 3). Article 2 of the RTS on settlement discipline prescribes measures that investment firms are obliged to undertake in order to prevent settlement fails, in relation to their clients - professional investors. Investment firms are obliged to ensure that their clients - professional investors provide all information necessary for the allocation (settlement) of transactions and written confirmation of the client's consent to the terms of the transaction, in the manner and within the time limits prescribed in Article 2 of RTS on settlement discipline. Article 3 of the RTS on settlement discipline prescribed measures that investment firms are obliged to undertake in order to prevent settlement fails, in relation to their clients - small investors. Investment firms are obliged to ensure that their customers - small investors provide all the information necessary to settle the transaction, under the conditions and within the time limits prescribed in Article 3 of the RTS on settlement discipline. Processing and matching of settlement instructions (CSDR Article 6, final draft of the RTS on settlement discipline Article 5 and Article 6) RTS on settlement discipline defines the required fields / parameters for instruction matching. Considering that, the following new mandatory fields for instruction matching shall be introduced in the securities settlement system of the CDCC: - transaction type designation: (i) purchase or sale of securities; (ii) collateral management; (iii) repurchase transactions; (iv) other transactions, - trade date. Also being introduced are additional fields for instruction matching, which become mandatory fields for instruction matching, if entered on both sides, and these are: - place of trading, 4

5 - place of clearing. For the purpose of instruction matching, a tolerance level for cash settlement amounts is introduced, which represents the maximum difference between the amount of money for settlement in two corresponding instructions, which still allows matching of these instructions. According to Article 6 of the RTS on settlement discipline the level of tolerance is 2 EUR for a settlement amount of up to 100, EUR and 25 EUR for a settlement amount over ,00 EUR. It is also prescribed that for instructions with the settlement amount in other currencies; the tolerance level is to be calculated as the corresponding equivalent at the official exchange rate of the ECB, which requires a daily update of the amount of the tolerance level in HRK. Hold and release mechanism and partial settlement (CSDR Art. 6, final draft of RTS on settlement discipline Art. 8 and Art. 10) The CDCC, in the process of harmonization with the provisions of the CSDR, will not introduce the hold and release mechanism which would allow participants to hold an instruction and release it for settlement, nor the possibility of partial settlement, due to the fact that the conditions laid down in Article 12 of the RTS on settlement discipline have not been met. The CDCC shall monitor the fulfillment of prescribed conditions from Article 12 of the RTS on settlement discipline, and shall, within one year from determining that they have occurred, introduce the functionalities described in Article 8 and 10 of the RTS on settlement discipline (instruction hold and release mechanism, and the possibility of partial settlement). Also, there is a possibility of introducing the specified functionalities sooner, regardless of the fulfillment of prescribed conditions, in which case the CDCC shall submit detailed information. Measures to address settlement fails - cash penalties (CSDR Art. 7, final draft of RTS on settlement discipline Art.16 to Art. 20) Based on the provisions of CSDR and RTS on settlement discipline, the CDCC shall establish a mechanism of penalties for settlement fails which should serve as an effective deterrent for participants causing settlement fails. For each working day on which the transaction failed to settle, from the intended settlement date to the actual settlement date or the end of the buy-in process, cash penalties shall be calculated on a daily basis. The penalty amount shall be calculated in such a way that the prescribed penalty rate (in base points) is to be applied to the value of the failed settlement. The penalty rate to be applied shall depend on the type and liquidity of the security. Cash penalties shall not be a source of income for the CDCC. They shall be reallocated to participants affected by settlement fails. CSDR allows central depositories to collect fees from participants regarding the establishment and management of the penalty mechanism. Details on establishing this mechanism and related operational processing, as well as fees associated with the same, shall be published subsequently. Consistent and systematic failure to deliver securities (CSDR Art. 7 par. 9, final draft of RTS on settlement discipline Art. 39) In accordance with Art. 7 par. 9 of CSDR, the CDCC may decide to suspend the participant that consistently and systematically fails to deliver securities in the settlement system of the CDCC on the intended settlement date, and publish his identity. It shall be deemed that a participant consistently and systematically fails to deliver securities in the CDCC settlement system when its rate of settlement efficiency, whose basis for calculation are exclusively settlement fails caused by that participant, which is determined according to the 5

6 number or the value of settlement instructions, is at least 15% less than the rate of settlement efficiency of the CDCC settlement system in the last 12 months, over the relevant number of days. The relevant number of days is determined for each participant, as 10% of the total number of days of that participant s activity in the CDCC settlement system, in the last 12 months. Buy-in (CSDR Art. 7, final draft of RTS on settlement discipline Art. 21 to Art. 38) CSDR imposes the obligation to implement the buy-in process for settlement fails, initiated by the central counterparty (CCP) or the parties to the trade affected by the failure to deliver the financial instruments, in a defined period of time from the intended settlement date. Buy-in procedures and obligations shall apply to transactions in financial instruments admitted to trading or traded on trading venues or cleared by a CCP, as follows: (a) for transactions cleared by CCP, the CCP is the entity that executes the buy-in in accordance with the provisions of CSDR and the RTS on settlement discipline; (b) for transactions not cleared by CCP, but executed on the trading venue, the trading venue shall incorporate in its internal rules the obligation for its members and participants to implement measures prescribed by CSDR and the RTS on settlement discipline; (c) for all other transactions, the CDCC shall include in its operational rules the obligation for its participants to be subject to measures prescribed by CSDR and the RTS on settlement discipline. In cases under (a) the buy-in procedure is initiated by the CCP, whereas in cases under (b) and (c) it is the obligation of the receiving party to the trade (receiving participant or receiving trading venue member). The buy-in process is carried out by the buy-in agent, whose activities fall within the scope of investment services according to MiFID, or is carried out by an auction. In order to better control the processes and avoid multiple deliveries of financial instruments, the buy-in procedure implies a change of status, or the subsequent cancellation of initial settlement instructions for settlement in the settlement system, and the entry of new of settlement instructions for financial instruments obtained in the buy-in procedure. The period to initiate the buy-in process depends on the type and liquidity of a financial instrument, and is: - 4 working days for stocks that have a liquid market, - 7 working days for all other financial instruments, - 15 days for financial instruments traded on SME growth markets. If the buy-in may not be performed or in case of a price difference between the failed settlement and the performed buy-in, it is foreseen that a corresponding cash compensation is to be paid. It is important to mention that CSDR does not provide for an active role or responsibility of central depositories and/or trading venues in the buy-in procedure, but the sole responsibility for the buyin remains at the trade level i.e., the parties to the trade. The central depository provides the CCPs and trading venues with the information necessary for settlement to enable them to fulfill their obligations in the buy-in procedure. 6

7 Acceptance into membership (CSDR Art. 33 and Art. 49, RTS regarding regulatory technical standards on authorization, supervisory and operational requirements for central securities depositories Art. 88, Art. 89 and Art. 90) For the securities settlement system it operates, CDCC is obliged to publicly disclose conditions for membership that will ensure the realization of the principle of equality and equal treatment to all legal persons that will apply for acceptance into membership. Membership terms must be transparent, objective and non-discriminatory. The CDCC is obliged to decide without delay on the application for admission to membership and the application for inclusion of a security to depository services and clearing and settlement services, and no later than one month or three months, respectively. The process of deciding on the application for admission to membership is public. When deciding on the application for admission to membership and application for inclusion of a security to depository services and clearing and settlement services, the CDCC is obliged to make a comprehensive risk assessment particularly taking into account the legal, financial and operational risks. The CDCC is obliged to, after the completed procedure and comprehensive risk assessment, if it has determined that not all conditions for membership or for inclusion of a security to depository services and clearing and settlement services are met, make a decision where it shall determine that the conditions for membership or for inclusion of securities to depository services and clearing and settlement services of the applicant have not been met and explain the reasons for refusal and the perceived risks. A written copy of the decision shall be sent to the applicant who is authorized, within one month from the date of receipt of the decision, to file a complaint to the competent authority. The competent authority may, after the completed procedure, if it considers that the application for admission to membership or for inclusion of a security to depository services and clearing and settlement services was unjustifiably rejected, order the central depository that manages the settlement system that in a certain period of time the applicant must be approved to become a member or to include a security to depository services and clearing and settlement services. User committee (CSDR Art. 28) In accordance with the requirements of CSDR, the User committee is established as an independent body, consisting of representatives of the issuers and participants of the CDCC, in order to enable them to express views and opinions on issues of significant influence to them, especially on key mechanisms affecting members of the CDCC, including the criteria for admission into membership of the CDCC. The mandate of the User committee, the management mechanisms of the User committee, its operational procedures, as well as mechanisms for selecting User committee members will be regulated by an act of the CDCC which will be published and available on the website of the CDCC. Requirements related to operational risks that may be posed by key participants (CSDR Art. 45, RTS regarding regulatory technical standards on authorization, supervisory and operational requirements for central securities depositories Art. 67) Requirements related to the identification of operational risks impose an obligation to the CDCC to identify, track and manage the risks that key participants in securities settlement systems it manages might pose to its operations. In this sense, criteria is prescribed on the basis of which 7

8 central depositories continuously determine key participants in the securities settlement system they manage, and ensure that key participants meet operational requirements. For risk management purposes, a possibility of gathering all relevant information about clients of key participants is foreseen, and central depositories include into agreements with its participants all conditions that are necessary to facilitate collection of that information. CDCC fee schedule Within harmonization of the CDCC s business operations with the provisions of CSDR, in the part of harmonization with the activities or services specified by CSDR that central depositories provide (Section A and B of the Annex to CSDR Regulation), there will be a corresponding change to the fee schedule, on which the CDCC shall subsequently provide detailed information. PRESIDENT OF THE MANAGEMENT BOARD Vesna Živković, B.Econ 8