Financial Stability Standards for Securities Settlement Facilities – December 2012 Standard 9: Central Securities Depositories

Guidance

A securities settlement facility may operate a central securities depository. A central securities depository provides securities accounts, central safekeeping and asset services, which may include the administration of corporate actions and redemptions, and plays an important role in helping to ensure the integrity of securities issues. Securities can be held at the central securities depository either in physical (but immobilised) form or in dematerialised form (that is, as electronic records). The precise activities of a central securities depository vary based on its jurisdiction and market practices. A central securities depository, for example, may be the official securities registrar and maintain the definitive record of legal ownership for a security; however, in some cases, another entity may serve as the official securities registrar. Further, the activities of a central securities depository may vary depending on whether it operates in a jurisdiction with a direct or indirect holding arrangement or a combination of both.^[24] A central securities depository should have clear and comprehensive rules and procedures to ensure that the securities it holds on behalf of its participants are appropriately accounted for on its books and protected from risks associated with the other services that the central securities depository may provide.

9.1.1 The preservation of the rights of issuers and holders of securities is essential for the orderly functioning of a securities market. The rules and contractual arrangements of a securities settlement facility that operates a central securities depository that relate to title to securities should ensure that the securities settlement facility and its participants have a high degree of certainty regarding their rights and interests in securities held and recognised by the facility. The legal arrangements put in place by the facility should clearly state the title or interest held by participants. This Standard does not require that the securities settlement facility's rules address all forms of title, interest or dealing available, merely those it purports to recognise.

9.1.2 A securities settlement facility should, in particular, maintain robust accounting practices and perform end-to-end auditing to verify that its records are accurate and provide a complete accounting of its securities issues. If a securities settlement facility records the issuance of securities (alone or in conjunction with other entities), it should verify and account for the initial issuance of securities and ensure that newly issued securities are delivered in a timely manner. To further safeguard the integrity of the securities issues, a securities settlement facility operating a central securities depository should conduct periodic and at least daily reconciliation of the totals of securities issues it records for each issuer (or its issuing agent), and ensure that the total number of securities recorded for a particular issue is equal to the amount of securities of that issue held on the securities settlement facility's books. Reconciliation may require coordination with other entities if the securities settlement facility does not (or does not exclusively) record the issuance of the security or is not the official registrar of the security. For instance, if the issuer (or its issuing agent) is the only entity that can verify the total amount of an individual issue, it is important that the securities settlement facility and the issuer cooperate closely to ensure that the securities in circulation in a system correspond to the volume issued into that system. If the securities settlement facility is not the official securities registrar for the securities issuer, reconciliation with the official securities registrar is required.

9.1.3 The procedures of a securities settlement facility that operates a central securities depository should address the legal and operational mechanisms governing the transfer of title or interests between participants. The mechanisms for transfer should ensure that participants know with a high degree of certainty the timing of transfers, and the role of encumbrances, where relevant. Further, custody records should not be affected by any operational failure. Sufficient backup arrangements should be in place to ensure records are not lost even under extreme circumstances, and that they can be accessed in a reasonably timely fashion.

9.1.4 The rules and arrangements relating to title to securities should ensure an effective separation between the assets of the securities settlement facility and assets that the facility holds on behalf of its participants through its operation of a central securities depository. In the event of a securities settlement facility's insolvency, participants should have a high degree of certainty that securities held by the facility are immune from the claims of the securities settlement facility's creditors. Furthermore, effective separation will allow the transfer of assets from the insolvent securities settlement facility to participants or to an alternative securities settlement facility.

9.2.1 A securities settlement facility operating a central securities depository should prohibit overdrafts and debit balances in securities accounts to avoid credit risk and reduce the potential for the creation of securities. If a securities settlement facility were to allow overdrafts or a debit balance in a participant's securities account in order to credit another participant's securities account, the securities settlement facility would effectively be creating securities and would affect the integrity of the securities issue.

9.3.1 A securities settlement facility can maintain securities in physical form or dematerialised form. Securities held in physical form may be transferred via physical delivery or immobilised and transferred via book entry. The safekeeping and transferring of securities in physical form, however, creates additional risks and costs, such as the risk of destruction or theft of certificates, increased processing costs, and increased time to clear and settle securities transactions. By immobilising securities and transferring them via book entry, a securities settlement facility can improve efficiency through increased automation and reduce the risk of errors and delays in processing. Dematerialising securities also eliminates the risk of destruction or theft of certificates. Where possible, a securities settlement facility should therefore maintain securities in an immobilised or dematerialised form and transfer securities via book entry.^[25] To facilitate the immobilisation of all physical securities of a particular issue, a global note representing the whole issue can be issued. In certain cases, however, immobilisation or dematerialisation within a central securities depository operated by a securities settlement facility may not be legally possible or practicable. Legal requirements, for example, may limit the possible implementation or extent of immobilisation and dematerialisation. In such cases, a securities settlement facility should provide incentives to immobilise or dematerialise securities.

9.4.1 A securities settlement facility should protect assets against custody risk, including the risk of loss because of the securities settlement facility's negligence, misuse of assets, fraud, poor administration, inadequate recordkeeping, or failure to protect a participant's interests in securities or because of the securities settlement facility's insolvency or claims by the securities settlement facility's creditors. A securities settlement facility should have rules and procedures consistent with its legal framework and robust internal controls to achieve these objectives. Where appropriate, a securities settlement facility should consider insurance or other compensation schemes to protect participants against misappropriation, destruction and theft of securities.

9.5.1 A securities settlement facility that operates a central securities depository should employ a robust system that ensures the segregation of its own assets from the securities belonging to its participants. In addition, the securities settlement facility should segregate participants' securities from those of other participants through the provision of separate accounts. While the title to securities is typically held in a securities settlement facility (as operator of a central securities depository), often the beneficial owner, or the owner (depending on the legal framework), of the securities does not participate directly in the system. Rather, the owner establishes relationships with the securities settlement facility's participants (or other intermediaries) that provide safekeeping and administrative services related to the holding and transfer of securities on behalf of customers. Where supported by the legal framework, a securities settlement facility also should support operationally the segregation of securities belonging to a participant's customers on the participant's books and facilitate the transfer of customer holdings to another participant.^[26] Where relevant, the segregation of accounts typically helps provide appropriate protection against the claims of a securities settlement facility's creditors or the claims of the creditors of a participant in the event of its insolvency.

9.6.1 Since a securities settlement facility operating a central securities depository will typically provide services ancillary to central safekeeping and administration of securities, it should identify, measure, monitor and manage the risks associated with those activities, particularly any credit and liquidity risks, consistent with the SSF Standards. For example, subject to SSF Standard 1.1, a securities settlement facility may provide a centralised securities lending facility to help facilitate timely settlement and reduce settlement fails, or may otherwise offer services that support the bilateral securities lending market. If the securities settlement facility acts as a principal in a securities lending transaction, it should identify, monitor and manage its risks, including potential credit and liquidity risks, under the conditions set in SSF Standard 4 on credit risk and SSF Standard 6 on liquidity risk. For example, the securities lent by the securities settlement facility may not be returned when needed because of a counterparty default, operational failure or legal challenge. The securities settlement facility would then need to acquire the lent securities in the market, perhaps at a cost, thus exposing the securities settlement facility to credit and liquidity risks.