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The purpose of rating a Central Securities Depository (CSD) is to determine the extent to which the depository minimises risk and maximises asset safety for participants and investors.
A CSD Rating assesses the risk exposures for investors in the post trade capital market infrastructure when transactions are settled while securities are held in a particular depository. It assesses the effectiveness of a CSD and the processes used in post-exchange settlement and safekeeping to minimise investor risk exposures. CSD Ratings can be compared across markets. It should be noted that a CSD Rating does not assess trade execution risk but the settlement, safekeeping and asset servicing risks after trade execution.
The CSD Rating assesses the key processes and procedures required to hold, settle and service securities and includes an analysis of custody, clearing and settlement procedures within a CSD.
Investment risks, legal risks and macroeconomic, political and social trend analyses are not incorporated into the ratings.
CSDs vary country by country. Components that may be found in a CSD include:
- Matching systems
- Central counterparty or clearing house
- Settlement and safekeeping mechanisms
- Asset servicing mechanism
- Cash settlement systems
The procedures for settlement and safekeeping can be highly automated or can also be largely manual operating outside of the CSDs (for example, where OTC trades settle between brokers). The CSD Ratings only assess mechanisms operated by CSDs, although they take account of market mechanisms and market regulations that support the mitigation of risk exposures.
Central counterparties or clearinghouses are often separate from the CSD (but in some countries these operations are combined into a single legal entity). Only a few CSDs are actually banks that can carry out cash settlement on their own behalf. Typically, CSDs instruct cash settlement either via appointed settlement banks or directly to the central bank. In some cases, central banks operate the CSD function, usually for the safekeeping and settlement of government securities.
The CSD Rating and associated individual Risk Exposure Assessments (REAs) enable an investor to compare CSD risk exposures across markets. The CSD Ratings are risk exposure ratings based on an absolute and, therefore, comparable scale. The assessments measure the risk exposure an investor has to other participants using the system, as well as to the CSD itself. Irrespective of the particular method adopted to settle and safe-keep securities there may be different settlement methods available within a CSD. For example, it is impossible to directly compare the settlement processes of DTCC in the USA with those of CBLC in Brazil. However, it is possible to compare the risk exposures which investors in the USA and Brazil are exposed to when buying, selling or holding securities in the respective CSDs in those markets. For example, the particular methods chosen to prevent failing settlements (auto-borrowing, buy-ins or blocking of securities/cash) is not as important as the effectiveness of the chosen methods to minimise risk exposures arising from failing settlements.
CSDs traditionally administer securities, either in immobilised or dematerialised form and in many cases, co-ordinate the delivery versus payment (DvP) of securities against cash. CSDs are often monopolies and are run as market utilities. Surpluses are often used either to reduce fees or provide rebates to members/participants. Many CSDs have completed the process of demutualisation in recent years and now engage in commercial activities which frequently impact their risk profiles. In addition, many have broadened their participation criteria which may impact the counterparty risk associated with their use.
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