DG Internal Market and Services

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1 DG Internal Market and Services INFO-LETTER ON POST-TRADING Issue 4 August 2012 Inside This Issue Recent Substantial International Progress on Post-Trading During 2012, further significant progress in the post-trading area has been achieved. These are indeed important steps. However, we are convinced that we must progress further. As you know, our vision is the removal of all barriers linked to post-trading. In the Internal Market, it must be as easy to buy, own and sell foreign shares and other securities as domestic ones. Page 3 Staying the Course The European Commission is determined in its commitment to a single market in post-trading. This, fourth, issue of the DG MARKT G2 Info-letter is designed to provide a clear picture of the key strands of our work. Page 4 Safer and more Efficient EU Securities Settlements A common regulatory framework for CSDs The Commission's proposal for a Regulation on Central Securities Depositories is expected to benefit both issuers, by increasing their ability to raise capital, and investors, by allowing them to place their funds more efficiently. The securities market in the EU would therefore become more efficient in supporting the financing of the economy and sustainable growth. Page 5 Adoption of the EU Regulation on OTC Derivatives, central counterparties and trade repositories EMIR - And What's Next? The adoption of EMIR is certainly more a commencement than the 'end of History' of the regulation of OTC derivatives. The next challenges will be the adoption of the numerous binding technical standards and delegated standards foreseen by EMIR and, last but not least the implementation of this Regulation. Page 8 Progress on Fiscal Compliance Procedures The Tax barriers Business Advisory Group -T-BAG has identified some areas, related to withholding tax procedures, were urgent problems still remain and require further action. The present procedures are often costly and time consuming for both investors, intermediaries and tax authorities. The T-BAG Group is now in its final phase to prepare concrete proposals for solutions. Page 9 Recognition of Close-Out Netting Agreements Close-out netting is a crucial risk mitigation tool for financial markets. It is universally used through industry master agreements for financial products (derivatives, repos, stock lending agreements, interbank deposits etc.). Contractual arrangements legally reduce exposures and therefore risks and capital requirements between two counterparties. Close out netting thus reduces risk and increases financial stability. Page 10

2 INFO-LETTER ON POST-TRADING PAGE 2 The Key Challenge in Securities Law - "Who owns What?" The need to provide an EU-wide framework for the ownership of securities was identified by the Giovannini Reports ten years ago as fundamental to creating a Single Market for Financial Services. Since then, it has become apparent that cross-border legal uncertainty over "who owns what" complicated and contributed to the financial crisis and continues to do so today. The Securities Law legislation proposal will address this. Page 11 CPSS-IOSCO: New standards for financial market infrastructures The Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) recently issued new and more demanding international standards for payment, clearing and settlement systems, including central counterparties. The standards will provide important support for the G20 strategy to make the financial system more resilient by making central clearing of standardised OTC derivatives mandatory. Page 12 Crisis Management of Financial Market Infrastructures Given the central and critical role that financial market infrastructures (FMIs) play in the functioning of financial markets, regulations aim to ensure that FMIs have strong risk management tools. However, despite robust controls and safeguards, the daunting scenario of an FMI failure cannot be precluded. It is a priority for the Commission to ensure the right tools are in place to appropriately respond to and manage the potential collapse of a systemic FMI, while minimizing costs to taxpayers. Page 13 Global regulatory work on strengthening the regulation and oversight of the shadow banking system The Commission is actively involved in the global regulatory work on shadow banking. First indications of the potential measures necessary to strengthen the regulation and oversight of the shadow banking could be expected by year end. Page 14 UNIDROIT - Committee on Emerging Market Issues, follow-up and implementation of the Geneva Securities Convention The 2nd Meeting of the Committee on Emerging Market Issues, follow-up and implementation, preceded by a Financial Markets Colloquium, organised in Rio de Janeiro from 27th to 28th March 2012 by UNIDROIT (International Institute for the Unification of Private Law) and Brazilian Securities and Exchange Commission (CVM). We discussed possible future initiatives as to complement the Geneva Securities Convention. Page 16 The G2 Newsletter The purpose of the Newsletter is to inform about, and to highlight, actual topics related to the EU and post trading: in particular on the work done by DG MARKT Unit G2. It provides updated information and describes the current state of play on issues related to post-trading and financial market infrastructure. Page 18

3 INFO-LETTER ON POST-TRADING PAGE 3 Recent International Substantial Progress on Post-Trading Dear Reader, Time flies. This is already our 4th edition of the Info Letter on Post-Trading prepared by the Financial Markets Infrastructure Unit-G2 in DG MARKT. During 2012, further significant progress in removing costly and burdensome barriers in the post-trading area has successfully been achieved. A political agreement on a Regulation on OTC derivatives, central counterparties and trade repositories (EMIR) was recently reached between the European Parliament and the Council of Ministers. The regulation requires standard derivative contracts to be cleared Nadia Calviño through central counterparties - CCPs - and establishes stringent organisational, business conduct and prudential requirements for these CCPs. The regulation, directly applicable and enforceable throughout the EU, will considerably increase financial stability and safety by preventing the situation where a collapse of one financial firm can cause the collapse of other financial firms. Another important step was the adoption by the Commission of a proposal for a Regulation on improving securities settlement in the European Union and on central securities depositories (CSDs). 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 central securities depositories (CSDs). These are important steps. However, we are convinced that we must progress further. As you know, our vision is the removal of all barriers linked to post-trading. In the Internal Market, it must be as easy to buy, own and sell foreign shares and other securities as domestic ones. To achieve this, we still have some key challenges ahead. Our current pipe-line includes legislative measures such as the Securities Law legislation and policy measures on Close-out netting. We also want to work further to abolish the fiscal compliance barriers related to post-trading, after the success with the Commission Recommendation in this field. These measures are all necessary steps to promote a policy that increases stability in the financial system, enhances legal certainty and brings more efficiency. We are fully determined to complete this agenda. We believe that we are well on track. However, I reiterate, that we need your contribution in form of critical and constructive comments to make the success! Nadia Calviño Deputy Director General, DG Internal Market and Services European Commission

4 INFO-LETTER ON POST-TRADING PAGE 4 Staying the course The European Commission is determined in its commitment to a single market in posttrading. This, fourth, issue of the DG MARKT G2 Info-letter is designed to provide a clear picture of the key strands of our work. Patrick PEARSON Head of Unit G2, Financial Markets Infrastructure G20 agenda The regulatory reform agenda of the G20 that is coordinated and monitored by the Financial Stability Board continues to focus the minds and efforts of the international regulatory community. Progress on implementation across jurisdictions is encouraging on the advancement of national legislation and regulation by a number of jurisdictions. But much remains to be completed by the end-2012 deadline to achieve the G20 commitments. EMIR Broadly speaking, the jurisdictions currently with the largest markets in OTC derivatives the EU, Japan and the US are the most advanced in structuring their legislative and regulatory frameworks. They expect to have regulatory frameworks in place by end-2012 and practical implementation within their markets is well underway. The EU's central regulatory effort in this field is, of course, EMIR. After reaching political agreement in the European institutions in March, the final text is expected to be published in all languages in the Official Journal shortly. ESMA has not bided its time and is already engaging in the preparation of some 20 draft regulatory technical standards which will need to reach the Commission on 30 September at the latest. We will then ensure that these standards become EUlaw before the end of the year. Work on margining requirements will follow shortly afterwards when international agreement has been reached. CSDR The presentation of the Commission's proposal for Regulation on CSDs and settlement has put these infrastructures at the centre regulatory attention. As EU- CSDs annually settle up to 1 Quadrillion of trades, their safety is at the forefront of international standard setters and the EU-legislature. The proposal also contains ample potential for increased cross-border services and competition between actors in this field. Shadow Banking The FSB has also engaged in identifying areas of regulatory concern as credit intermediation, involving leverage and maturity transformation, occurs outside the banking system in all its shades and colours. The Commission's consultation paper and subsequent conference on this topic have helped us to form a clearer view of the practices and challenges that shadow banking brings. Securities Law Legislation Linked to this, in more than one respect, our work continues on the harmonisation of securities law in the EU. The Commission still intends to respond to the call from the Ecofin Council to present a proposal in this field at the end of the year. Post trading conference The overall direction of regulatory reform in post-trading remains inspired by the input from the industry. Last October's post-trading conference organised by the Commission provided a good overview of remaining problems, many already identified in Alberto Giovannini's reports, that will not disappear through legislative proposals. The recent informal group comprising the ECB, ESMA, industry and the Commission provides a good basis to continue to monitor and map out areas of common concern. Info-Letter on Post-Trading This Post-Trading Info-Letter contains contributions from colleagues in the Commission's Financial Market's Infrastructure team who are working with great dedication on all of these issues. We hope that readers will find the contributions informative and that they will contact us directly if they require further information on this important work. Contact: Patrick PEARSON, tel , Patrick.Pearson@ec.europa.eu

5 INFO-LETTER ON POST-TRADING PAGE 5 Safer and more Efficient EU Securities Settlements A common regulatory framework for CSDs Andrei GURIN Felicia STANESCU Marcel-Eric TERRET The public perception of financial services tends to be one of stock exchanges and banks. The role played by exchanges and other trading platforms is the most visible part of Europe's market infrastructures. However, regardless of whether securities are traded on or off a trading platform, there are a host of complex infrastructures that sit behind the exchanges and beyond the public's view that are essential to the safe and efficient functioning of the markets. Any trade in securities is followed by a number of posttrade processes, including, for example, confirmation of the trade details by a trading venue or clearing by a central counterparty ('CCP'), leading to the settlement of the trade. Settlement is a key process that ensures the exchange of securities against cash following a securities transaction, such as a sale of securities. Although settlement may occur on the day a trade is agreed, it normally takes place a number of days later depending on the type of securities or trading venues. EU Securities Settlement The settlement of virtually all securities transactions in the European Union ('EU') occurs through Central Securities Depositories ('CSDs'): important financial institutions that operate the settlement infrastructures, called securities settlement systems. They also ensure the maintenance of securities accounts that record how many securities have been issued by issuers like companies or other economic operators, and each change in the holding of those securities. CSDs therefore act as gatekeepers to the primary markets by centralising the initial recording of newly issued securities and any subsequent changes in the holding of such securities. Finally, CSDs facilitate the financing of the economy because almost all the collateral posted by companies, banks and other institutions to raise funds ultimately flows through the securities settlement systems operated by CSDs. EU Settlement Infrastructure Europe's settlement infrastructure is very fragmented. There are over 30 CSDs in the EU, generally one in each Member State and two so-called international CSDs ('ICSDs'), Euroclear Bank and Clearstream Banking. ICSDs are an important sub-category of CSDs that specialise in the issuance of securities denominated in foreign currencies than are known as 'Eurobonds'. The two ICSDs are responsible for over one third of settlement volumes in the EU and are part of larger groups, which include national CSDs. Cross-border Settlement While generally safe and efficient within national borders, settlement across borders presents higher risks and costs for investors than domestic operations 2. Meanwhile, the importance of cross-border transactions in Europe continues to increase. It is therefore important to have a harmonised set of measures across Europe for settlement as well as for the institutions responsible for settlement, the CSDs. CSDs are currently regulated at national level and lack a common set of prudential, organisational and conduct of business standards at European level. These problems are important and need to be solved, as crossborder transactions in Europe, ranging from usual purchases/sales of securities to collateral transfers, continue to increase and CSDs become increasingly interconnected. These trends are expected to accelerate with the advent of Target2 Securities (T2S), a project launched by the Eurosystem to provide a common technical platform for securities settlement in Europe, which is scheduled to start in See the price monitoring studies commissioned by DG MARKT and conducted by Oxera Consulting Ltd. published at: 3 See for a description of T2S.

6 INFO-LETTER ON POST-TRADING PAGE 6 Safer and more Efficient EU Settlement The safety and efficiency of securities settlement systems operated by CSDs has been in the spotlight for many years in Europe and worldwide 4. However, only more recently the European Commission decided to harmonise the legal rules on settlement and CSDs for the first time at EU level in response to the financial crisis. The Commission's proposal for a Regulation ('the proposal') was adopted on 7 March and is currently being reviewed by the two co-legislators, the European Council and the European Parliament. The main objectives of the proposal are to increase the safety and efficiency of securities settlement, in particular for cross-border transactions, and of CSDs. To achieve these objectives, the proposal provides for common rules at EU level for securities settlement and CSDs. 1. Proposed measures for securities settlement Electronic Recording The proposed Regulation provides for the obligation for most securities to be recorded electronically, in bookentry form through a CSD, at least from the moment they are traded via a regulated trading venue (i.e. non OTC market) or posted as collateral. In certain Member States, mainly in the UK and Ireland, a certain number of securities are still held directly by the investors in paper form. The key objective of dematerialisation is to ensure a quicker settlement in line with the harmonisation of the settlement periods set at a maximum of two days after the trading day (T+2). However, current holders of paper securities, as long as they do not sell them through a regulated trading venue, will have the possibility to keep them in paper form until Harmonised Settlement Period In Europe most securities transactions are settled either two or three days after the trading day (T+2 or T+3), depending on each market. The settlement period will be harmonised in Europe and set at a maximum of two days after the trading day (T+2) for all transferable securities traded on regulated trading venues. A harmonised settlement period will reduce operational inefficiencies for cross-border transactions and counterparty risk, that is the period of time during which an investor runs a risk that its counterparty will default on its obligation to deliver cash or securities at the agreed settlement date. Settlement Fails The proposal provides also for a set of strict measures to address settlement fails. In particular, market participants that fail to deliver their securities on the agreed settlement date will be subject to penalties and a buy-in procedure whereby those securities shall be bought and delivered in a timely manner to the receiving market participants. These provisions expand the scope of the measures provided in the Regulation on short selling 6 and are consistent with those measures. 2. Proposed measures for CSDs Supervision CSDs will be authorised and supervised by national competent authorities specifically designated by the Member States. To ensure consistency in the supervisory practice, the national competent authorities should, however, consult and cooperate with other relevant authorities, which include the authorities from the Member States responsible for the oversight of each securities settlement system operated by CSDs and the central banks in whose accounts securities transactions are settled or those issuing the relevant currency of payment. The European Securities Markets Authority (ESMA) will have an important role in ensuring cooperation between national competent authorities and developing technical standards for the application of certain provisions of the proposed Regulation. Increased Safety The proposed Regulation will increase the safety of CSDs and their activities by providing, in line with international and European standards 7, for high quality prudential rules covering CSDs' services, their corporate organisation and conduct of business. Since central banks are usually unable to offer accounts and credit services in foreign currencies, the settlement of the cash leg of transactions in foreign securities currently takes place in the accounts of some CSDs 8 that offer specific intraday credit services to their participants to facilitate settlement. Such services expose CSDs to more risks and, therefore, to a greater likelihood of suffering a default or being subject to severe stress with dramatic consequences for the securities and payments markets. The requirement to provide banking services in a separate legal entity (acting as a so-called "settlement agent") foreseen in the proposal would, therefore, prevent the spill-over of risks from the banking services to the CSD services. 4 See the two Giovannini Reports from 2001 and 2003, the ESCB-CESR recommendations for securities settlement systems and central counterparties and the CPSS- IOSCO recommendations for financial market infrastructures published respectively at: The text of the proposal can be found at: 6 The CSD proposal covers not only shares, but all transferable securities, money market instruments, UCITS and emission allowances and include non-cleared trades. 7 See footnote 4 8 The most notable CSDs that offer limited banking services are the two ICSDs, Clearstream Banking Luxembourg and Euroclear Bank. Others in the EU are Clearstream Banking Frankfurt in Germany, OEKB in Austria and Keler in Hungary.

7 INFO-LETTER ON POST-TRADING PAGE 7 Efficiency CSDs will also benefit from important opportunities for EU cross-border activities as the proposed Regulation will grant authorised CSDs a "passport" to provide their services in the EU without the need for further authorisation and supervision. This means also that CSD groups can consolidate their operations in a much more efficient way. This opening up of the market for CSD services will be reinforced by the removal of the existing competitive distortions and obstacles in the functioning of the internal market resulting from the barriers of access of issuers to CSDs 9, of access between CSDs 10 and of access between CSDs and other market infrastructures such as Central Counterparties (CCPs) and trading venues 11. Benefits for Issuers and Investors The expected reduction in the costs of holding and settling securities, especially cross-border, would benefit both issuers, by increasing their ability to raise capital, and investors, by allowing them to place their funds more efficiently. The securities market in the EU would therefore become more efficient in supporting the financing of the economy and sustainable growth. More Competition The proposed Regulation is therefore likely to create more competition between CSDs, with expected benefits for the quality and price of cross-border services. In the medium to long term, the CSD market could become more consolidated and less fragmented. There could therefore be less intermediation for cross-border holding and settlement of securities, which would render these activities safer and cheaper. This would translate into lower costs for investors along the whole post trading chain. "Settlement is a crucial process for the securities markets and the financing of our economy, and as such its safety and efficiency needs to be ensured. The numbers speak for themselves: in the European Union, transactions worth over one quadrillion euro were settled by CSDs in the last two years". The CSD proposal "will introduce, in line with our international partners, common standards across the Union for securities settlement and CSDs to ensure a true single market for the services provided by national CSDs." The Commissioner for Internal Market and Services, Michel Barnier 9 Issuers will have the right to record their securities in any authorised CSD in the EU. 10 CSDs will have the right to become participants in a securities settlement systems of other CSDs based on non-discriminatory and risk-based criteria. 11 CSDs will have the right to receive transaction feeds from other infrastructures, and reversely will have to grant them access to their securities settlement systems on a non-discriminatory basis.

8 INFO-LETTER ON POST-TRADING PAGE 8 Adoption of the EU Regulation on OTC Derivatives, central counterparties and trade repositories- EMIR And What's Next? The adoption of EMIR is certainly more a commencement than the 'end of History' of the regulation of OTC derivatives. The next challenges will be the adoption of the numerous binding technical standards and delegated standards foreseen by EMIR and, last but not least the implementation of this Regulation. Nicolas GAUTHIER On 29 March 2012, the European Parliament adopted in plenary session the Regulation on OTC derivatives, central counterparties and trade repositories (EMIR). After 16 months of negotiation with the Council and the Parliament, this is a major achievement which enables the European Union to be on time to deliver the G20 commitments on OTC derivatives agreed in Pittsburgh in September The adoption of EMIR is certainly more a commencement than the 'end of History' of the regulation of OTC derivatives. The next challenges will be the adoption of the numerous binding technical standards and delegated standards foreseen by EMIR and, last but not least the implementation of this Regulation. Technical Standards In EMIR, the legislator has not used the technique of delegated legislation sparingly. The European Supervisory Authorities (ESAs) have been vested with the task to develop regulatory and implementing technical standards which will complement and specify many of the principles agreed upon in the Regulation. These standards cover diverse areas of the text from the criteria on the basis of which OTC derivatives will be declared eligible to the central clearing obligation, to the margining requirements for non-centrally cleared trades, the prudential requirements for central counterparties (CCPs) or the data to be reported to trade repositories. The ESAs and the Commission are working under tight deadlines: most of these draft technical standards have to be delivered to the Commission by 30 September 2012 with the objective of a final adoption by end International Convergence 'International convergence' will be our 'mantra' in this work. The Commission will have to adopt important decisions on the equivalence of Third-country legislative frameworks applicable to OTC derivatives. These acts are a crucial component in EMIR to facilitate its cross-border application and avoid costly duplicative requirements for EU OTC derivative markets players, CCPs and trade repositories. One of the key objectives is also ensure that the content of these provisions is aligned on existing or forthcoming international standards. For example, CPSS-IOSCO principles for financial infrastructures published in April 2012 is an important reference for the drafting of standards on CCPs. Likewise, future standards on margining requirements for non-centrally cleared OTC derivatives that are being developed under the auspices of the Basel Committee 12 will be an imperative guideline for the development of European standards on this issue. Implementation The time of implementation will come once the adoption of these standards and delegated acts is finalized. In the course of 2013, CCPs will have to apply for authorization or recognition under the new framework introduced by EMIR, and once EU regulators will have verified the safety and soundness of these infrastructures, the first decisions imposing clearing obligations will be adopted and enforced. No doubt, a lot of work for the regulatory community and the industry is on the way. But, at the end of these efforts, the best of financial stability is (hopefully) to come... The political agreement on EMIR was a big step for financial stability. "We are substantially reducing the risk of a future financial crisis, with all its consequences on the real economy, growth, jobs and public budgets. The Commissioner for Internal Market and Services, Michel Barnier 12 The Working Group on Margining Requirements (WGMR) is a joint BCBS-CGFS-CPSS-IOSCO working group. Contact: Nicolas GAUTHIER, tel , Nicolas.Gauthier@ec.europa.eu

9 INFO-LETTER ON POST-TRADING PAGE 9 Progress on Fiscal Compliance Procedures The Tax Barriers Business Advisory Group - T-BAG - has identified some areas, related to post trading withholding tax procedures, were urgent problems still remain and require further action. The Group is now in its final phase to prepare concrete proposals for solutions to these problems. "One problematic area is the lack of standardised documentation. More than 54 different documents are, for instance, necessary today to claim tax relief in the EU. This often results in indeed costly, time consuming and bureaucratic procedures for both investors, intermediaries and tax authorities." Tomas THORSÉN The Commission Recommendation on withholding tax relief procedures 13 outlines how EU Member States could make it easier for investors resident in one Member State to claim entitlements to relief from withholding tax on securities income (mainly dividends and interest) received from another Member State. The Recommendation also suggests measures to eliminate tax barriers for the securities investment activities of financial institutions. This is important because a study by the Commission services shows that at present the costs related to the present reclaim procedures are estimated to a value of 1.09 billion annually whereas the amount of foregone tax relief is estimated at 5.47 billion annually. The Recommendation the first one in the tax area since approximately nine years was an important step forward in trying to solve fiscal barriers in the posttrading environment. The Recommendation is based on the ( ) reports of the EU Clearing and Settlement Fiscal Compliance Experts' Group (FISCO) to address Giovannini barriers 11 and 12 on withholding- and transaction tax procedures. In order to structure the future work, the Commission created an expert group on fiscal compliance procedures related to post-trading the Tax barriers Business Advisory Group -T-BAG. The 23 Members of the Group are high level Experts, mainly from private bodies and the academic society. The Commission is providing a Chair and Secretariat of the Group. The T-BAG Group has identified some areas, related to withholding tax procedures were urgent problems still remain and require further action. One such problematic area is the lack of standardised documentation. More than 54 different paper documents are for instance necessary today to claim tax relief in the EU. This often results in indeed costly, time consuming and bureaucratic procedures for both investors, intermediaries and tax authorities. In order to provide suggestions on how to solve the actual problems, the T-BAG Group is now concretely working on how to standardise the present documentation. This work includes both proposals for standardised documentation for making refund claims and electronic filing and documentation to prove the investors' entitlement to tax relief. The work also includes comprehensive solutions based on a relief at source system, improving exchange and the use of Taxpayer Identification Numbers (TINs). A linked issue also dealt with is the liability for financial intermediaries. The legal basis of tax practices, corresponding OECD work and the FATCA reform in the US are other topics planned to be covered. The T-BAG Report is planned to be finalised during We hope to discuss this report and its recommendations at a conference that we are planning to organize together with DG TAXUD at the end of More information will soon be available on our website. 13 The Commission's Recommendation (COM (2009) 7924 final), the underlying study on "The Economic Impact of the Commission Recommendation on Withholding Tax Relief Procedures and the FISCO Proposals" and other background documents related to fiscal compliance procedures have been published on the Europa website: Contact: Tomas THORSÉN, tel , Tomas.Thorsen@ec.europa.eu

10 INFO-LETTER ON POST-TRADING PAGE 10 Recognition of close-out netting agreements Close-out netting is a crucial risk mitigation tool for financial markets. It is universally used through industry master agreements for financial products (derivatives, repos, stock lending agreements, interbank deposits etc.). Contractual arrangements legally reduce exposures and therefore risks and capital requirements between two counterparties. Contracts state that, if one party defaults, all future claims and contractual relations between the two parties are brought forward, calculated, netted and then set off. What finally remains for actual payment is only a small fraction of the initial gross positions and claims between those two parties. Close out netting thus reduces risk and increases financial stability. Rogier WEZENBEEK By way of example, the BIS calculated that in 2011 the gross market value of credit derivatives was $19.4 Trillion, but that after netting arrangements the net credit exposure for banks worldwide was reduced to $3 Trillion. The advantage is of course that credit risk and transaction costs (e.g. cost of credit lines and margin collateral) are much lower. Similarly banks' capital requirements against credit risk are substantially lower than they would be against their gross exposures (by around $500bn in mid-2009 on one estimate) and they are less constrained by large exposure ceilings. The legal protection of close-out netting provisions is mainly regulated by the Financial Collateral Arrangements Directive (Directive 2002/47/EC as amended by Directive 2009/49/EC). It provides that a close-out netting provision can take effect according to its terms, notwithstanding the onset of insolvency or other similar proceedings and events and without regard to certain other matters that might otherwise affect close-out netting. The adoption of the FCD 2002 marked an important step forward because, until then, close out netting was not possible in all Member States. Since the financial crisis in 2008, however, it has become clear that the automatic use of close-out netting provisions can also have significant disadvantages in times of severe market stress. In some cases, rather than closing-out, it might be preferable to transfer the debtor's financial contracts to a solvent third party, bridge bank or similar entity and to wind the insolvent entity down in an orderly fashion while saving the viable contracts and avoiding shock waves to the market. As it stands now, the FCD does not allow regulators to delay automatic close-out and termination rights in order to allow a decision on transferring a distressed party's financial contracts to a solvent institution. That's why the Commission proposal of 6 June 2012 for a directive establishing a framework for the recovery and resolution of credit institutions and investment firms (COM /3) includes specific provisions that give regulators the power to impose a stay on close-out netting provisions, subject to certain conditions and with appropriate safeguards for CCPs and security settlement systems. This proposal is in line with recommendations of the Basel Committee on Banking Supervision and the G-20, which also foresee the strengthening of enforceable netting arrangements. In fact, these are two sides of the same coin. There is also an on-going discussion on the enforceability of close-out netting within the EU, looking in particular to the substantive provisions of the Financial Collateral Arrangements Directive and the conflict of law rules under the Insolvency Directive (2001/24/EC), which is up for revision at the end of this year. Some believe that improving legal certainty should go hand in hand with an extension of the scope of the Financial Collateral Arrangements Directive, whereas others are reluctant to do this because an extension would inevitably be at the expense of other creditors. In this respect last year's establishment by the International Institute for the unification of private law (UNIDROIT) of a study group on close-out netting is much welcomed. The working group was recently promoted into a Governmental Committee that will meet for the first time in October (1-5). Its task will be to finalise the "Draft principles regarding the enforceability of close-out netting provisions" that were prepared by the study group. DG MARKT contributed to work of the study group and will also participate in the Governmental Committee. Once adopted, perhaps already in 2013, the principles should become an important tool for the IMF and other organisations to assess financial stability throughout the world. Contact: Rogier WEZENBEEK, tel , Rogier.Wezenbeek@ec.europa.eu

11 INFO-LETTER ON POST-TRADING PAGE 11 The Key Challenge in Securities Law "Who owns what?" The Securities Law legislation holds the key to resolving major obstacles to a safer, more efficient Single Market for Financial Services. "An economy is simply the sum of the transactions made and a transaction is a simple thing. A transaction consists of the buyer giving money (or credit) to a seller and the seller giving a good, a service, or a financial asset to the buyer in exchange. A market consists of all the buyers and sellers making exchanges for the same things e.g. the wheat market consists of different people making different transactions for different reasons over time. An economy consists of all the transactions in all of its markets. So while seemingly complex, an economy is really just a zillion simple things working together, which makes it look more complex than it really is." 14 Chris REDMOND Securities law. Just reading that phrase has your eyes glazing over, right? It s a boring subject that full of complex, arcane technicalities of interest only to lawyers and the clinically insane isn't it? Only the clinically insane could claim that securities law doesn't have complex, arcane features. But it's equally insane to ignore it as boring. It's essential. It governs the very fabric of our financial markets. Re-read the opening quote from Ray Dalio. Transactions are the DNA of an economy. In securities markets, these transactions are increasingly dematerialised they exist as the 1's and 0's that make up the records in book-entry systems. The financial assets are intangible they don't physically exist. "Who owns what?" is the ultimate question on which all else depends. In the securities markets, the pixels on the computer screen are the only evidence of this. Technology has developed at a rapid pace so that systems that allow for securities to be held and transferred are operated by a complex, sophisticated, international network of financial intermediaries. Unfortunately, our legal systems have struggled to keep pace with this change, leaving us all exposed to the risks created by legal uncertainty over who owns what. In Europe, member states have developed their own solutions to this problem, which has helped to improve domestic legal certainty. But this has come at the cost of adding to the fragmentation of the EU's financial markets. The need to provide an EU-wide framework for the ownership of securities was identified by the Giovannini Reports over ten years ago as fundamental to creating a Single Market for Financial Services. Since then, it has become increasingly apparent that crossborder legal uncertainty over "who owns what" complicated and contributed to the financial crisis and continues to do so today. In reaction to the financial crisis, we committed to strengthen our market infrastructure. Key legislative initiatives like EMIR, the CSD Regulation, and the MiFID/MiFIR are the building blocks of the new system. The legal certainty that will be provided by the Securities Law Legislation is the cement that will bind them together. The main challenge we face is identifying "who owns what" in Europe's financial markets because they are complex and opaque. This presents several key problems: How can we protect and empower investors? How can we give lenders certainty, and the wider market confidence? How can we ensure that regulators can track developing risks resulting from fast moving, complex interactions to protect taxpayers? This is not an academic exercise. It has an immediate realworld impact. For example, collateral is now king of the financial system. In Europe, collateral is mainly provided as securities. However, the crisis has also shrunk the pool of high quality, liquid collateral. Market participants are being forced down the collateral curve, widening the range of securities being used. Clarifying ownership rights to securities has never been more vital, especially in a cross-border context. Another everyday example is the extreme difficulty that issuers and investors have in establishing an on-going relationship. We will ensure that investors can control their assets and can exercise their rights, such as voting at an AGM, regardless of where they are located in the EU. Addressing this legal uncertainty will help to remove a major cause for the fragmentation of the EU's financial markets. We know that this fragmentation makes it more expensive to invest and hold securities across borders. Given the volume of transactions that occurs every day, even a small improvement would free up significant capital to help grow Europe's economy. If we can resolve these key challenges using our Securities Law Legislation, we will have taken a major step forward to a safer, more efficient Single Market for Financial Services that works to the benefit of us all. 14 "A Template for Understanding How the Economic Machine Works and How it is Reflected Now", Ray Dalio, Bridgewater, created 31 October 2008, updated March Contact: Chris REDMOND, tel , Chris.Redmond@ec.europa.eu

12 INFO-LETTER ON POST-TRADING PAGE 12 CPSS-IOSCO issue new standards for financial market infrastructures The Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) issued in April 2012 new and more demanding international standards for payment, clearing and settlement systems, including central counterparties. The standards will provide important support for the G20 strategy to make the financial system more resilient by making central clearing of standardised OTC derivatives mandatory. The new standards (called "principles") replace the three existing sets of international standards set out in the Core principles for systemically important payment systems (CPSS, 2001); the Recommendations for securities settlement systems (CPSS-IOSCO, 2001); and the Recommendations for central counterparties (CPSS-IOSCO, 2004). CPSS and IOSCO have strengthened and harmonised these three sets of standards by raising minimum requirements, providing more detailed guidance and broadening the scope of the standards to cover new risk-management areas and new types of FMIs. The new principles are designed to ensure that the infrastructure supporting global financial markets is robust and thus well placed to withstand financial shocks. They apply to all systemically important payment systems, central securities depositories, securities settlement systems, central counterparties and trade repositories (collectively "financial market infrastructures"). These FMIs collectively clear, settle and record transactions in financial markets. Compared with the old standards, the new principles introduce new or more demanding requirements in many important areas including: the financial resources and risk management procedures an FMI uses to cope with the default of participants; the mitigation of operational risk; the links and other interdependencies between FMIs through which operational and financial risks can spread; achieving the segregation and portability of customer positions and collateral; tiered participation; and general business risk. CPSS and IOSCO members will strive to adopt the new standards by the end of Financial market infrastructures (FMIs) are expected to observe the standards as soon as possible. The new principles are designed to ensure that the infrastructure supporting global financial markets is robust and thus well placed to withstand financial shocks.

13 INFO-LETTER ON POST-TRADING PAGE 13 Crisis Management of Financial Market Infrastructures Given the central and critical role that financial market infrastructures (FMIs) play in the functioning of financial markets, regulations aim to ensure that FMIs have strong risk management tools. However, despite robust controls and safeguards, the daunting scenario of an FMI failure cannot be precluded. It is a priority for the Commission to ensure the right tools are in place to appropriately respond to and manage the potential collapse of a systemic FMI, while minimizing costs to taxpayers. Muriel JAKUBOWICZ Financial market infrastructures (FMIs) are at the heart of the functioning of financial markets. They provide services that underpin financial market activities, such as the recording, clearing and settlement of financial transactions. FMI service providers might be the sole providers of such specialized services in the market they operate, and are therefore often seen as essential utilities providing a service of common interest. Among FMIs, the systemic importance of central counterparties (CCPs) will increase even more with the implementation of the G20 reforms. Indeed, as agreed by the G20 (Pittsburgh, 2009), all standardized over-thecounter (OTC) derivatives will be cleared through CCPs with the entry into force of the regulation on OTC derivatives, central counterparties and trade repositories (EMIR) in Europe this year. This will bring vastly more OTC derivatives into clearing houses, which will manage and concentrate global financial risk yet more, in a business already concentrating hundreds of trillions of euros. Given their central and critical role in the functioning of financial markets, regulations aim to ensure that FMIs have strong risk management tools. In Europe, the activities of CCPs will soon be governed by EMIR, which imposes new requirements to ensure central counterparties are safe, sound and efficient. The Commission also made a legislative proposal this year to introduce common rules for central securities depositories (CSDs) which should improve the safety and soundness of CSDs. The failure of an FMI that occupies a critical size or position in a market could have immediate systemic implications: its disorderly collapse would lead to considerable uncertainty that would destabilize markets; some segments might simply cease to operate; and the failure of a FMI would cause significant losses to other financial institutions. The contagion from a failure could spread rapidly, since FMIs are interconnected with its users and/or other FMIs. In this context, it is a priority for the Commission to ensure the right tools are in place for authorities to appropriately respond to and manage the potential collapse of a systemic FMI, while minimizing costs to taxpayers. In parallel to the proposal made on recovery and resolution for banks, the European Commission is working on a possible broader framework for crisis management of systemic financial institutions other than banks, with a focus on CCPs and CSDs in particular. The Commission is closely involved in the international work-stream conducted on these issues, mainly by the G10 Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO). We hope to have a legislative proposal ready by early 2013 in this area. But what if a CSD, or a CCP, encounters operational difficulties and has to interrupt its operations? What if defaults of participants fully exhaust a CCP's resources and drive the CCP into insolvency? Or what if a CCP made wrong investment decisions that severely hit its capital? Despite robust controls and safeguards, one cannot preclude the daunting scenario of an FMI failure. Contact: Muriel JAKUBOWICZ, tel , Muriel.Jakubowicz@ec.europa.eu

14 INFO-LETTER ON POST-TRADING PAGE 14 Global regulatory work on strengthening the regulation and oversight of the shadow banking system The Commission is actively involved in the global regulatory work on shadow banking. First indications of the potential measures necessary to strengthen the regulation and oversight of the shadow banking could be expected by year end. Anita WIEJA-CARUBA In order to fully address the underlying causes of the recent financial crisis and to be able to design adequate regulatory measures in response to it, an opaque and little known area of financial markets known as 'shadow banking' needed to be included in the regulatory agenda globally. The need to strengthen regulation and oversight of the global shadow banking system was highlighted at the G-20 summit in Seoul. This was further reinforced by the declaration of the G-20 leaders at the summit in Cannes in November 2011 which stated: "The shadow banking system can create opportunities for regulatory arbitrage and cause the build-up of systemic risk outside the scope of the regulated banking sector. To this end, we agree to strengthen the regulation and oversight of the shadow banking system and endorse the FSB initial eleven recommendations with a work-plan to further develop them in the course of 2012, building on a balanced approach between indirect regulation of shadow banking through banks and direct regulation of shadow banking activities, including money markets funds, securitization, securities lending and repo activities, and other shadow banking entities." Shadow Banking Task Force Accordingly, the G-20 leaders have entrusted the task of analysing the shadow banking system to the Financial Stability Board (FSB). The FSB has formed a Shadow Banking Task Force to conduct the in-depth analysis of the shadow banking system. The Task Force has in the first place undertaken to clarify the meaning of shadow banking. In the absence of an established definition of shadow banking prior to the crisis, the FSB (following the G-20 views) has proposed a definition which describes shadow banking as activities and entities outside the regulated sphere which are involved in credit intermediation - including liquidity and maturity transformation. Targeted Work Streams The next stage of the Task Force's activities concentrates around setting out potential approaches for monitoring the shadow banking system and exploring possible regulatory measures to address the systemic risk and regulatory arbitrage concerns posed by the shadow banking system. The work focuses around five targeted work streams which have been mandated to examine and report on the following shadow banking aspects, as laid out by the G-20 Cannes Declaration: relationships between banks and the shadow banking system; money market funds, other shadow banking entities (such as mortgage and finance companies and special purpose vehicles), securitisation, and securities lending and repo markets. The FSB work streams are currently working under a tight schedule in order to report to the FSB and the G- 20 leaders at their summit in November 2012, and, where necessary, propose recommendations for future regulatory actions, by the end of Some of the work streams have published interim reports on the progress of their work and invited the financial industry and stakeholders to comment on their findings 15. The FSB Task Force will analyse and consider the submissions carefully in view of the prospective recommendations. On the European side, the European Commission actively participates in the FSB work and DG MARKT/Unit G2 is a member of the work stream on repo and securities lending. 15 See for example: Contact: Anita WIEJA-CARUBA, tel , Anita.Wieja@ec.europa.eu

15 INFO-LETTER ON POST-TRADING PAGE 15 Commission Initiatives As stated by Commissioner Michel Barnier on a number of occasions 16, the Commission has made the work on shadow banking as one of its priorities for 2012 and is committed to conducting an in-depth analysis of the shadow banking system in the EU in parallel with the FSB. In order to achieve this task in a balanced way it is also keen to consult the stakeholders on the subject of shadow banking in Europe. To foster the debate, the Commission has recently come up with two important initiatives. On 27 April, the Commission published the Green Paper on Shadow Banking which broadly reflects the FSB s line on the matter 17. It is anticipated that the questions asked in the Green Paper will stimulate the stakeholders' thinking on the matter. Around 150 submissions have reached the Commission when the consultation period closed on 15 June Conference webcast: To conclude, the results of the FSB work on shadow banking should be known before year-end as will be the recommendations of the European Systemic Risk Board, which is also currently conducting analysis of the various systemic issues raised by shadow banking in Europe. At the same time, the Commission will have had an opportunity to reflect on the results of the work of these bodies and the evidence gathered in this consultation. As a result, any clear indication of the Commission thinking on the measures necessary to strengthen the regulation and oversight of the shadow banking system in the European Union could therefore be expected in the second half of 2012 and early Moreover, the publication of the Green Paper also coincided with the Commission conference on shadow banking which was held in Brussels at the end of April. Many eminent speakers, representing regulators, central banks, financial institutions and academics, presented their views on the threats and opportunities created by the shadow banking system. 16 See for example: 17 Full text available at: Contact: Anita WIEJA-CARUBA, tel , Anita.Wieja@ec.europa.eu

16 INFO-LETTER ON POST-TRADING PAGE 16 UNIDROIT - Committee on Emerging Market Issues, follow-up and implementation of the Geneva Securities Convention The 2nd Meeting of the Committee on Emerging Market Issues, follow-up and implementation preceded by a Financial Markets Colloquium, organised in Rio de Janeiro from 27th to 28th March 2012 by UNIDROIT (International Institute for the Unification of Private Law) and Brazilian Securities and Exchange Commission (CVM). We discussed possible future initiatives as to complement the Geneva Securities Convention. Olga TYTOŃ The Commission services recently attended the second meeting of the Committee on emerging market issues, follow-up and implementation set up by the Diplomatic Conference of the Geneva Securities Convention. The first day was devoted to a colloquium on "Promoting investor confidence and enhancing legal certainty for securities trading in emerging markets" that offered informative insights into third country jurisdiction 18. The most impressive was the Brazilian Final Beneficiary Model applied by the BVFM, which is the 4th largest exchange in the world (as measured by market capitalisation). Their CSD and CCPs know in almost real time who owns what, how much, where and under which intermediary. The Emerging Markets Committee met on the second day. It began with a solemn presentation of the Official Commentary on the Geneva Securities Convention, which was ceremonially distributed to negotiating parties. The discussion then concentrated on the best way to provide guidance to national law-makers on how to implement the principles enshrined in the Geneva Securities Convention. One of the outcomes was to prepare a legislative guide on policy options on the areas of law outside the convention. The meeting also revealed the status of the implementation process. Although no jurisdiction has started the ratification process yet, most delegates reported that the convention was under review within governmental structures and was being consulted upon with stakeholders (CHINA, CHILE, INDIA, PAKISTAN, NIGERIA, KOREA, USA). Several countries indicated that they were currently re-examining their internal securities legislation and would draw inspiration from the convention principles (AUSTRALIA, BRAZIL, CAMEROON, QATAR, TURKEY). SOUTH AFRICA appears to be the most advanced. Their draft Financial Markets Act has been approved by the State Law Advisers and will now go through the Parliament. RUSSIA has completed its own securities law reform in 2011 and has taken the core convention principles into consideration. JAPAN has also introduced a new statute recently which was compatible with the convention. SWITZERLAND, which adopted the Federal Intermediated Securities Act in 2008, regards its new legislation as being broadly in line with the convention. The Swiss government intends to introduce the few required legislative amendments together with the ratification process in a few years' time after sufficient experience with the new law has been gathered. The European Union's position was presented by the European Commission. At the moment we are focusing on drafting an EU securities law, rather than initiating the process of signature of the convention. However, we do not regard the convention and a future EU securities law as substitutable, but as complementary. Any future EU securities law should fit within the global standard set by UNIDROIT. 18 The detailed program and the presentations of the speakers can be found at the UNIDROIT website: Contact: Olga TYTOŃ, tel , Olga.Tyton@ec.europa.eu

17 INFO-LETTER ON POST-TRADING PAGE 17 The G2 Secretariat Anne-Catherine GALLANT Assistant to the Head of unit Katarzyna CZAJKOWSKA Assitant to the administrators

18 INFO-LETTER ON POST-TRADING PAGE 18 The G2 Info-letter The purpose of the Newsletter is to inform about, and to highlight, actual topics related to the EU and post trading: in particular on the work done by DG MARKT Unit G2. It provides updated information and describes the current state of play on issues related to post-trading and financial infrastructure. The newsletter is available in both electronically and printed paper form. It is distributed 1-2 times a year, inter alia, to Commission services, Council, Parliament, Member States, stakeholders, Industry, Press and interested citizens. You can subscribe/unsubscribe to the mailing list by sending an to: MARKT-G2-NEWSLETTER@ec.europa.eu Photo of G2 colleagues (from left): Louisiana de Smet, Rogier Wezenbeek, Nicolas Gauthier, Muriel Jakubowicz, Felicia Stanescu, Anne-Catherine Gallant, Anita Wieja-Caruba, Katarzyna Czajkowska, Chris Redmond, Patrick Pearson, Olga Tytoń, Tomas Thorsén and Andrei Gurin. Contact: Tomas THORSÉN, tel , Tomas.Thorsen@ec.europa.eu