📠 What are Central Securities Depositories (CSDs)? 📠

Good morning. Today we continue our series on market infrastructures with a look at Central Securities Depositories (CSDs). Each Wednesday we will share an article about the global custody industry and its complex and highly regulated landscape. Each Friday we share a roundup of key industry news and insights.

It’s Not Just One Big Database

Central Securities Depositories (CSDs) play a key role in modern financial markets by providing essential services for the issuance, safekeeping, and settlement of securities. These institutions act as the authoritative record-keepers of securities ownership, maintaining and updating critical databases that underpin trillions of dollars in financial assets.

CSDs emerged as a solution to the "paperwork crisis" of the 1960s, when the volume of trades overwhelmed manual record-keeping systems. Today, they serve as massive databases that record stock ownership for each company, updating these records whenever trades settle or companies process corporate actions like dividend payments.

The primary functions of CSDs include:

• Safekeeping of securities in dematerialized or immobilized form

• Facilitating deposits and withdrawals of securities

• Processing dividends, interest, and principal payments

• Enabling the settlement process through delivery versus payment (DvP)

• Managing the issuance of new securities

• Providing corporate action services

CSDs contribute to financial stability by reducing counterparty risk, enhancing market liquidity, and standardizing market practices. They ensure that the transfer of securities and corresponding payments occur simultaneously, minimizing the risk of one party defaulting on their obligations.

In recent years, CSDs have been adapting to technological advancements and regulatory changes. The integration of blockchain technology is being explored to potentially enhance operational efficiency and enable new services. For instance, CSDs could leverage distributed ledger technology (DLT) to tokenize securities and provide new custody services for digital assets.

Regulatory frameworks, such as the Central Securities Depositories Regulation (CSDR) in the European Union, aim to strengthen and protect CSDs while promoting standardization across jurisdictions. These regulations establish common requirements for CSDs operating securities settlement systems and introduce measures to prevent settlement fails.

As the financial landscape evolves, CSDs are expected to continue playing a vital role in maintaining market integrity and efficiency. Their ability to adapt to new technologies and regulatory requirements will shape the future of capital markets.

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How CSDs Work Today

Central Securities Depositories (CSDs) are essential to modern financial markets, maintaining electronic records that show who owns which securities. Rather than having investors physically hold paper certificates, CSDs digitally record ownership and oversee the transfer of securities when they are bought or sold—a process known as immobilization.

When you buy shares through a broker, the CSD updates its electronic ledger on settlement day (T+1 or T+2) to reflect the new ownership. This occurs either on a Delivery versus Payment basis or Free of Payment. CSDs also handle corporate actions such as dividend or interest payments, ensuring funds go to the rightful owners. To safeguard investors’ assets, CSDs strictly separate their own operations from the securities they hold, keeping these investments secure even if the CSD itself faces financial issues.

In light of their role in financial infrastructure, CSDs are heavily regulated. However, many still utilize decades-old legacy systems, which, while reliable, can be costly and cumbersome to maintain—and slow to evolve with current market demands or integrate new capabilities.

What Might a Future CSD Look Like?

T2S (TARGET2-Securities) shows us what the future might look like. But it's important to understand what T2S is and isn't. T2S is not a CSD - it's a technical platform that provides settlement services to CSDs across Europe. Think of it as a shared piece of infrastructure that different CSDs can connect to in order to settle trades in central bank money, while each CSD continues its core functions such as custody and corporate actions. Today, 24 European CSDs use T2S, demonstrating how markets can pool core settlement services while maintaining distinct roles.

Many CSDs are experimenting with distributed ledger technology (DLT) - the technology behind blockchain - to see if it could work better than today's central databases. Some big market players like the Singapore Exchange have tried building new systems using DLT. The promise is exciting: imagine being able to settle trades instantly and create "smart" securities that automatically handle things like dividend payments. But there's a catch - any new technology needs to handle millions of transactions every day without fail. That's why most CSDs are taking small steps, testing DLT for specific tasks while keeping their main systems running as usual.

Some industry leaders envision a single global CSD—a universal platform that would handle all securities worldwide. In practice, the closest entities to this are international CSDs such as Euroclear and Clearstream that operate across multiple jurisdictions. However, establishing a truly global CSD is daunting. Each country enforces its own securities regulations and seeks to retain oversight of its financial markets. While a single global CSD is unlikely in the near future, ongoing collaboration and standardized connectivity among CSDs are key steps toward smoother cross-border settlements

Key Takeaways

• CSDs form the foundation of financial markets through their critical role in maintaining ownership records and facilitating trade settlement

• Many CSDs operate on legacy technology platforms that are stable but difficult to modernize and upgrade

• As neutral custodians, CSDs protect investor assets and manage the distribution of dividends and interest payments

• CSDs face increasing pressure to modernize their infrastructure while preserving their essential security and reliability standards

What’s next?

Next week, our market infrastructure series continues with an examination of Central Counterparties (CCPs). Understanding how these various components interact is crucial for grasping the value chain that underpins the global custody industry. We encourage you to share any specific aspects of market infrastructure you'd like us to explore in future discussions.