CMU Reboot Improving the Post-Trade Infrastructure

On 24 September, the EU Commission released its plan to reboot the Capital Markets Union (CMU) project. The CMU fell short of its ambitions to create a single European capital market by the end of 2019; but the confluence of Brexit and COVID-19 has reinvigorated the project.

The three core goals of the plan are:

1. Make financing more accessible for European companies, in particular small and medium enterprises
2. Encourage individuals to save and invest long-term by increasing investor protection
3. Further integrate national capital markets into a genuine single European capital market

Through 16 action items, the Commission’s plan covers a wide range of issues, from securitization to investor protection.

Unblocking the Plumbing

A key component of the CMU is to tear down barriers that inhibit the functioning of a single European capital market. In its plan, the Commission identifies three key aspects of market infrastructure that could be improved

Withholding Tax Processing

While tax code harmonization remains the goal of many policymakers, it is essentially the third rail of EU politics. Under the current rules, member states maintain control of their tax policies and any attempt to harmonize rates requires unanimous consent to change the EU framework. So far, any attempt to harmonize tax codes has been met with stiff resistance from member states. Nonetheless, the Commission believes there are areas of taxation that can be addressed without harmonizing tax codes. Currently, there is wide divergence in the processing of withholding tax and many member states require taxes first be paid and then be reimbursed through the filing of tax reclaims. This has real economic consequences. In 2016, The Commission estimated that the withholding tax relief process cost investors €8.4 billion annually, including over €6 billion in unclaimed tax relief because investors find the process too burdensome.

Moving to a withholding at source model gives tax authorities the opportunity to modernize the process and rely more on digital information.

Reto FaberEMEA Head of Direct Custody and Clearing, Citi

To alleviate this burden and encourage more cross-border investment, the Commission has proposed creating a standard EU-wide system for withholding tax relief at source, which would eliminate the need for tax reclaim filings. Eliminating tax reclaims would also reduce the amount of physical paperwork in the withholding tax process, which could reduce the administrative burden on tax authorities. In many jurisdictions tax filings rely heavily on physical documents and signatures and removing the tax reclaim process in Europe could be an important first step in digitizing the tax process in Europe. “Moving to a withholding at source model gives tax authorities the opportunity to modernize the process and rely more on digital information,” explains Reto Faber, EMEA Head of Direct Custody and Clearing at Citi. “Beyond making the tax process more efficient, it would also help make tax authorities more prepared for another mass work from home incident.”

Post-Trade Consolidation

Despite the efforts for Central Securities Depositories Regulation (CSDR), the post-trade environment in Europe remains fragmented along national lines, with most securities settlement occurring in member state Central Securities Depositories (CSDs). To address this issue, the Commission is going to investigate ways to improve the CSDR passport and encourage CSDs to provide cross-border settlement services, which can help contribute to the development of a more integrated post-trade landscape in the EU. “The work on CSDs is aligned to other important initiatives in the EU post-trade services space, such as the harmonization of securities settlements, through the T2S platform and the forthcoming Eurosystem Collateral Management System that is designed to harmonize collateral management services across Europe,” says Marcello Topa, Director, EMEA Market Policy and Strategy at Citi Securities Services. “Once the core layer of CSDs providing basic custody and settlement is fully integrated, there will be opportunities for deployment of cross-border services that should increase competition and benefit investors.”

Once the core layer of CSDs providing basic custody and settlement is fully integrated, there will be opportunities for deployment of cross-border services that should increase competition and benefit investors.

Marcello TopaDirector, EMEA Market Policy and Strategy, Citi Securities Services

Separately, the Commission is reviewing the settlement discipline rules that usher in mandatory buy-ins and cash penalties in the event a trade settlement fails. The settlement discipline was originally slated to come into effect in 2021 but was delayed until 2022. The large spike in settlement fails, caused by the market volatility during the initial stages of COVID-19 outbreak, in March and April contributed to this delay. There are concerns that had the mandatory buy-in regime been in place during this tumultuous period, it could have created further instability and potential systemic risks. “It will be interesting to see if the reboot of the CMU will add to the pressure for the EU Commission to rethink the CDSR settlement regime,” notes Topa.

Consolidated Tape

Similar to the post-trade environment, European trading is fragmented across multiple exchanges. For example, Exchange-Traded Funds (ETFs) trade on over 20 exchanges, which makes it difficult to look at the trades across all the exchanges in the EU. The CMU reboot has revived the idea of creating a consolidated tape for European exchange-traded securities, which was originally mooted during the drafting of Markets in Financial Instruments Directive (MiFID) 2 but was ultimately abandoned. A consolidated tape would provide price and volume data for all equity and equity-like securities (e.g. ETFs) and is designed to increase price transparency across trading venues, to make it easier to trade across exchanges and increase competition.

There are two key challenges with creating a consolidated tape. The first is getting access to the required data, which is part of the long simmering debate about what information should be public and proprietary to the exchanges. Information services has been a growing revenue stream for the exchanges and in order to create a consolidated tape, European policymakers will have to make certain data available, free of charge. The other challenge is that there is no central supervisory body to oversee the consolidated tape and the responsibility would fall on the regulators of individual member states. To ensure harmonized oversight of the consolidated tape, supervisory responsibility would likely need to be transferred to a European regulator, such as the European Securities and Markets Authority (ESMA).  ESMA could then more easily enforce compliance with standards, resolve data issues, and penalize non-compliance.

Actions Speak Louder Than Words

The proposals to help eliminate these barriers to the internal markets have been welcomed by the industry. Though not as glamorous as some of the other elements of the CMU reboot, they address real industry pain points. The key challenge for policymakers is how they can make the Commission’s suggestions a reality, since the CMU is not a single piece of regulation. Instead, any proposals will require augmenting multiple existing regulations or creating new ones. This means that over the course of the next year there may be a number of consultations on all of these proposed improvements. It will be incumbent upon the industry to participate in them to help ensure its voice is heard in this important initiative.