‘Too Big to Reform or Too Important to Miss?’ Why the EU Needs More Consistency on the Rules on Collateral and Custody of Client Assets and Client Money as Part of CMU 2.0

Abstract

The impending departure of the UK from the EU makes progress on Capital Markets Union all the more urgent. Unless the EU-27 takes action soon, its capital market may leave the EU along with the UK as early as the end of next year, when the transition period in the UK-EU Withdrawal Agreement (assuming agreed) is (currently) scheduled to end. The foundation of any capital market is its infrastructure, including its arrangements for the “collateral ecosystem” (the regulatory, institutional and operational arrangements for collateral, custody, client assets and client money). Capital market infrastructure should work in an integrated fashion across the market so that issuers, investors and intermediaries can transact seamlessly. If the collateral ecosystem is the plumbing of the financial markets then it needs to be laid out in a uniform manner as opposed to a patchwork. That is not the case today in the EU. In particular, there is no uniform single EU-wide collateral ecosystem. Although various EU Directives and Regulations have improved the workings of individual aspects of the ecosystem, such legal instruments have neither been uniformly applied across the EU nor integrated with one another. As Member States transposed EU Directives into national law, they did so in national terms in the context of national institutions. This creates gaps in protection for market participants, particularly where they document, transact and/or hold assets in different jurisdictions. That in turn increases risk as well as transaction costs. This lowers the attractiveness of the EU capital market and hampers growth. Creating an integrated, uniform EU-27 regime for the collateral ecosystem should therefore have high priority. Although institutional-led operational-based and thus non-legal driven changes have provided jurisdiction agnostic solutions that work across multiple jurisdictions free from national influences this is not a panacea to plugging the (potential) problems in the plumbing. While the Eurosystem's work on the operational system known as TARGET2 Securities is very much a step in the right direction in terms of operational-led cross-border functionality, more is needed. Some hope that new technologies (such as distributed ledger technology) and/or new entrants (e.g. FinTech) will supply what is missing. They cannot. Legislative and regulatory changes will also be required. The question is what form they should take. Economically, the most effective measure would be the harmonisation across the EU of the laws and regulations affecting the collateral ecosystem, ideally along the lines of the most commonly used regime. Politically, however, such an approach is likely to encounter severe challenges. The question is whether EU-27 policymakers, in light of the UK's changing relationship with the remaining bloc, will take the plunge and move the discussion on fixing the plumbing from too big to reform to too important to miss. In answering that question, this Working Paper summarises some proposals, discussed in fuller detail in the Main Paper, on how that might be achievable. The Annexes to this Working Paper support the conclusions by assessing conceptual gaps and what is discussed in the Main Paper as conceptual translation risks in relation to the EU, Irish and UK rules on collateral, custody of client asses and client money.