Note: This article updates the article published on page 58 of the current edition of the flow annual

Regulatory reform, including Central Securities Depositary Regulation (CSDR), Target 2 Securities (T2S), Markets in Financial Instruments Directive II (MiFD II), and European Market Infrastructure Regulation (EMIR) have rearranged the post-trade landscape. This article provides an overview of the state of play as 2022 draws to a close.

Shortening settlement cycles

In recent years, there has been a global trend towards accelerated settlement cycles. However, the transition to a T+1 (settlement within one day of the trade) and potentially a T+0 cycle (settlement the same day) requires implementing new technological, operational and industry processes on a large scale.

Asia is a market of accelerated settlement cycles, with China Interbank Market’s (CIBM) government bonds on settlement cycles of T+0, T+1 and T+2. T+3, and a special service where settlement on the trade date plus four or more days, where four days is the minimum ((T+n (n >=4)), were subsequently rolled out to allow sufficient funding time for global investors, especially those unable to settle due to local holidays.

In 2021, India made a determined push for a T+1 settlement cycle for listed equities, and that has been live since February 2022. The new settlement cycle started with the bottom 100 stocks, and with a phased approach towards the goal of 5,000 equities by January 2023. The initiative has been heralded as a positive development from a domestic and regulatory perspective. There are a few challenges that foreign portfolio investors (FPIs) into India continue to face, which are expected to get ironed out as it goes live over the course of 2023. One example of this is the Obligation Transfer Request cut-off time for brokers which brokers are currently experiencing an increase in number of unconfirmed trades at 7pm on T date with the shift to settle on T+1. The industry is in close communication with SEBI and discussions are underway.

Accelerated settlement cycles are also being discussed in the Philippines (to move from T+3 to T+2). Challenges to the value chain caused by system outages in the country have accelerated discussions with migration testing, which is expected to come in 2023.

The US is also intending to transition to a T+1 settlement cycle, with rollout scheduled in the first half of 2024 with discussions underway.

If Europe (EEA, the UK, and Switzerland) does move to T+1, its implementation would be more complex than that of India and the US. This is because of the unique nature of European markets, which have a multitude of currencies, market infrastructures, and distinct legal frameworks. An open dialogue across participants in European securities markets is required and industry coordination will be essential for success.

Transition to accelerated settlement cycles can create operational challenges for cross-border investors when there are significant time zone differences, for example between Asia and the US. In June 2022, the ASEAN+3 Bond Market Forum (ABMF) and the Cross-Border Settlement Infrastructure Forum (CSIF) organised a webinar outlining accelerated securities settlement, and emphasised the need for industry-wide engagement, collaboration and support.¹

“Greater regulatory scrutiny falls on new digital asset classes”

Digitalisation and digital assets

Increasing digitalisation impacts the industry since greater regulatory scrutiny falls on new digital asset classes. Regulatory developments have mirrored the evolution of cryptocurrency – or ‘crypto asset’ – which means a digital asset that is secured and operated using a set of cryptographic keys.

The importance of regulating digital assets was evident when the European Commission published its digital finance package in 2020. This included a new digital finance strategy, a proposal for a regulation on markets in crypto assets (MiCAR) and a proposal for a regulation on a distributed ledger technology (DLT) pilot regime for market infrastructure, among others. MiCAR will be an anchor regulation for other initiatives that aim to provide legal certainty as it aims to create a holistic regulatory framework for the crypto-asset industry. We expect MiCAR to enter into force in the course of 2022 with a general application date 18 months later, whereby some provisions will already apply from the date it comes into force.

As regulatory certainty improves and mainstream users enter the market, the participants in traditional finance have continued to make preparation to enter the digital asset space. These preparations are amidst the 2022 “crypto crisis” aftermaths from Luna/Terra and FTX’s failures – with parallels in the history of traditional finance – that are fuelling heightened regulatory concerns on the cross-over risks of digital assets on traditional financial institutions, and the needs for more comprehensive governance. ²

Global standards bodies such as the Basel Committee on Banking Supervision, the Financial Stability Board (FSB), and the International Organisation of Securities Commissions (IOSCO) have embarked on a range of consultations designed to calibrate planned regulatory responses that range from balance sheet, systemic risks, market conduct, investor and asset protection, settlement soundness; covering both DeFi and crypto assets. Individual jurisdiction’s regulatory authorities such as Singapore MAS and Hong Kong SFC are also actively revisiting their existing legislations with a focus on specific digital asset classes like stablecoins. These activities are in parallel with market integrity regulations like Know Your Customer (KYC), Anti-Money Laundering (AML) and sanctions that are being implemented across the globe, driven by guidance from the Financial Action Taskforce (FATF).

In March 2022, the US Securities and Exchange Commission (SEC) published Staff Accounting Bulletin (SAB) No.121 that provided an interpretation related to financial reporting of crypto assets. Expressing concerns surrounding technology, legal and regulatory risks, SAB No.121 said that if an entity is responsible for safeguarding crypto assets held “for its platform users, including maintaining the cryptographic key information necessary to access the crypto assets…”, then that should be reflected as a liability on its balance sheet.

Regarding investor protection, Thailand’s Securities and Exchange Commission refined its regulation on ‘digital assets’ custody, reflecting a strong focus on client asset segregation and proper authorisation prior to transfer of fiat currencies. Australia and Singapore also published investor protection guidelines. For example, the Australian Securities and Investments Commission now requires social media influencers to be appropriately licensed before giving financial advice, and Singapore’s MAS has discouraged cryptocurrency trading by the retail public.

Law enforcement agencies continue to focus on crypto-facilitated crimes while bodies like UN Office on Drugs and Crime have organised capacity building sessions with public sector bodies in 2022.

A number of open questions remain, such as what the scope is of custodial liability according to MiCAR. The current EU Parliament and EU Council compromises, flowing from EU trialogue negotiations, predict that liability does arise unless the crypto custodian can prove that a loss did not result from an operational incident attributable to the custodian, such as a malfunction or hack. This is a diametric shift from the existing market standard, where custodians are generally free to limit their liability contractually to cases where a loss was caused by the negligence, fraud or wilful default of the custodian

The European landscape is driven by a harmonised approach across member states in the EU. As such, the bank sees a combination of regulatory and European Central Bank (ECB) driven initiatives across the region.

ECB-driven initiatives

The ECB is driving initiatives to promote market harmonisation. This includes the Eurosystem Collateral Management System (ECMS),³ which aims to harmonise current collateral management processes, where differences in business processes and messaging create operational barriers to efficient management. The ECMS will replace 19 different collateral management systems with a single system capable of managing the assets used as collateral in the Eurosystem credit operations for all jurisdictions. With go-live in November 2023, this is expected to increase efficiency in the management of collateral and level the playing field among Eurosystem counterparties. This is critical to the further integration of a pan-European market.

To facilitate the ECMS, the ECB Advisory Group on Market Infrastructures for Securities and Collateral (AMI-SeCo) endorsed standards for a Single Collateral Management Rulebook in Europe (SCoRE). SCoRE standards apply to debt instruments, equities and investment funds issued via European (I)CSDs, and should be implemented by all relevant actors in the AMI-SeCo markets (the EU, the UK and Switzerland).

The compliance date of corporate action standards is November 2023 with the exception of those events which are only relevant to equities and investment funds for which the implementation deadline is November 2025, although CSDs may indicate an earlier deadline.

Capital Markets Union

The Capital Markets Union (CMU)⁴ intends to ensure the success of a single capital market across the EU to increase competitive investment and financing opportunities. The CMU Action Plan, published by the EU Commission in November 2021, includes legislative proposals relating to the following areas:

1. European Single Access Point (ESAP)
2. Review of the European Long-Term Investment Funds (ELTIFs) regulation
3. Review of the Alternative Investment Fund Managers Directive (AIFMD)
4. Review of the Markets in Financial Instruments Regulation (MiFIR)

The CMU provides an opportunity to harmonise market practices and enhance technical integration of market participants. There will be the potential to resolve previous implementation challenges from the Shareholder Rights Directive II (SRDII), such as introducing a uniform ‘definition of a shareholder’ and introducing a harmonised framework for withholding tax, which will promote cross-border investment.

MiFID II/MiFIR Refit

In 2021, MiFID II Quick Fix was entered into force, with implementation by all EEA countries by 28 February 2022. This introduced changes related to the annual cost and charges settlement, quarterly statement of client financial instruments and electronic client reporting.

In November 2021, the European Commission published two proposals for the review of MiFID/MiFIR.⁵ The proposals will be subject to ordinary legislative procedure, with the final text expected between the end of 2022 and mid-2023. The European Commission focused on three priority areas:

1. Improving the transparency and availability of market data
2. Improving the level playing field between execution venues
3. Ensuring EU market infrastructures remain competitive internationally

Refits on the horizon

A revision of CSDR has been published by the EU COM on 16 March, introducing for Settlement Discipline amongst others a ‘two-step approach’ under which mandatory buy-ins could become applicable if and when the penalties regime alone does not improve settlement fails in the European Union. The bank also expects revisions, or "refits", to the SFD, FCD and potentially to UCITS V.

“Securities market liberalisation is happening across Asia”

During the pandemic, Asia Pacific securities regulators focused on ensuring industry operational resilience, facilitating global investors’ market access and repatriation via electronic means of administration and processes. This has been successful. And, with Covid-19 gradually treated more as an endemic, the modernising of Asia Pacific securities market infrastructure, and market access and repatriation practices, is gaining momentum again.

Market liberalisation

Securities market liberalisation is happening across Asia. South Korea is working towards being included on the MSCI’s developed market classification status watchlist. As part of this request, South Korean authorities have committed to improving the KRW FX market, moving to electronic infrastructure for greater efficiencies and reviewing related areas, like the Investment Registration Certificate scheme, to facilitate foreign investors’ access.

Foreign investors will be subjected to zero tax on their Korean Treasury Bond and Monetary Stabilization Bonds from Oct until Dec 2022, with further proposal to extend the tax exemption from January 1, 2023, pending approval from the National Assembly. Securities Transaction Tax will also be further cut to 0.20% in 2023⁶, down from the current rate of 0.23% in 2022. FTSE Russell has added Korea to watch list for WGBI inclusion, welcoming these initiatives taken by the government.

In a securities infrastructure modernisation drive and as part of its New Law of Securities, enacted in January 2021, Vietnam is implementing a new securities central counterparty (CCP) model to be established as Vietnam Securities Depository & Clearing Corporation (VSDCC). This change will encompass major revisions to registration, depository, clearing and settlement of securities transactions. New industry workflows are expected to be finalised by VSDCC, with a targeted live date of the end of 2023. The industry is working with the State Securities Commission and VSDCC to address asset safety and operational areas among others.

In April 2022, the People’s Bank of China issued a draft Financial Stability Law to improve financial risk management, enhancing market stability, risk resolution and clarifying the responsibilities in coordinating national financial stability and development.⁷ This law will represent a significant modernisation of the recovery and resolution regime in China’s growing capital market. China’s authorities also voted to adopt the PRC Futures and Derivatives Law to regulate the trading, clearing and settlement of futures and derivatives at the national level. Effective from August 2022, it is expected to contribute to a better operated and more open capital market.⁸

Furthermore, China unveiled a national pension reform, with a voluntary private pension scheme, that allows individuals to invest their pension into designated public funds and wealth products with an annual cap of CNY 12,000. More details of these pension reforms were released by China Securities Regulatory Commission on 04 Nov 2022⁹, and can increase institutional investment flows and deepen China’s capital market.

On 18^th November 2022, the People’s Bank of China (PBOC) and State Administration of Foreign Exchange (SAFE) had also jointly released Provisions¹⁰ on Capital Administration for Foreign Institutional Investors Participating in China Bond Market. These Provisions, which will be effective as of 1 January 2023, includes having further relaxed capital management requirements on repatriation, removing the limit of number of FX counterparties of foreign investors, facilitating foreign institutional investors to invest in China's bond market, and making China's bond market more attractive.

In India, the Securities and Exchange Board of India (SEBI) launched a new Business Responsibility and Sustainability report for the top 1,000 listed entities, introducing the mandatory disclosure of ESG-related information and improving transparency in the market.¹¹ The issuance of tradable electronic gold receipts on the gold exchanges, together with the Vault Managers Regulations 2021 also indicates efforts to modernise. To promote inclusivity and improving access to capital, SEBI released the framework on the Social Stock Exchange¹² that serves as an avenue for non-profit organisations to raise funds.

In the Philippines, tax reform continues with ‘Revenue Memorandum Circular 20–2022’, issued in February 2022 to guide the filing of Request of Confirmation, Tax Treaty Relief Application and Tax Sparring applications.¹³ It clarified and eased the documentary requirements of Non-Resident Foreign Investors/Corporations who have already been issued with a Certificate of Entitlement by the Bureau of Internal Revenue. Overall, the Philippines is improving on the ease of market entry and repatriation for cross-border investors.

In Oct 2022, Deutsche Bank Philippines co-hosted a forum together with the Securities and Exchange Commission on ESG regulations and challenges in the Philippines. The event brought together key stakeholders in the asset management industry to discuss the main considerations and challenges in establishing a comprehensive ESG framework in the country. Deutsche Bank is currently participating in focus group discussions with the regulators on this topic and is involved in a joint initiative in the market to encourage issuers to issue ESG compliant securities.

In Hong Kong, the Hong Kong Government made the announcement in October 2022¹⁴ that it plans to promote the issuance and trading of RMB stocks in Hong Kong and enhance the trading mechanism. This initiative has gained support from a number of listed issuers including Hang Seng Index constituent stocks and is proposed to go-live in 1H 2023.

Market transparency

Efforts have also been made to improve market transparency. In Malaysia, under Malaysia Bursa’s Reclassification of Investor Segment Initiative, a client needs to provide the business registration number of its corporate underlying clients that open segregated securities accounts.¹⁵ Deutsche Bank, together with other foreign custodian banks, asked Bursa to accept Legal Entity Identifier (LEI) and the proposal was accepted. This facilitates more efficient compliance by reusing accepted and already available identifiers.

Boon-Hiong Chan (Asia) and Britta Woernle (Europe) lead the Securities Market & Technology Advocacy team at Deutsche Bank’s Securities Services

Sources

¹ See asianbondsonline.adb.org
² See „New shades of custody for Asia’s booming investors“ at flow.db.com
³ See ecb.europa.eu
⁴ See finance.ec.europa.eu
⁵ See esma.europa.eu
⁶ See moef.go.kr
⁷ See pbc.gov.cn
⁸ See fia.org
⁹ See csrc.gov.cn
¹⁰ See pbc.gov.cn
¹¹ See sebi.gov.in
¹² See sebi.gov.in
¹³ See home.kpmg
¹⁴ See info.gov.hk
¹⁵ See bursamalaysia.com