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Last week, the European Commission released its market integration package of legislative proposals, which includes a proposal for a new Settlement Finality Regulation (SFR) replacing the existing Settlement Finality Directive (SFD) and amending the Financial Collateral Directive (FCD).
The current SFD protects designated payment and securities settlement systems governed by the law of a Member State, including those operated by central securities depositories and central counterparties, from the effects of insolvency proceedings against their participants. The proposed SFR aims to achieve several objectives:
Definitions and scope
The SFR would update the definitions in the SFD, particularly to include systems using DLT. For example, it would expand the classes of entities that can participate in designated EU systems to include any entity permitted by the system's rules (so long as the entity meets qualifying criteria specified in the SFR).
Designation regime for EU systems
A new harmonised regime would govern how Member States designate EU systems for insolvency protection. Existing designated systems would have five years to obtain re-designation under the new framework.
Registration regime for non-EU systems
The SFR would protect non-EU systems registered in a Member State from insolvency proceedings against a qualifying participant in that Member State in relation to transfer orders entered in the system by that qualifying participant.
However, only credit institutions, investment firms, public authorities, publicly guaranteed bodies and payment and electronic money institutions would be qualifying participants. In addition, registered systems would only benefit from insolvency protections in relation to transfer orders entered by a qualifying participant and not the wider insolvency protections conferred on EU systems (which could restrict the value of the new regime). Non-EU systems would need to register in each Member State where they want protection in respect of qualifying participants in that Member State.
The SFR would set out common conditions for registration by a Member State's authority, including that the non-EU system has a qualifying participant in the Member State, the system is supervised or authorised in the non-EU country, the system operator is adequately structured and financed, the governing law upholds settlement finality, the system's rules and procedures specify relevant moments of finality as defined under the SFR and the system materially complies with global standards for financial market infrastructure. However, registration would not be conditional on a Commission equivalence decision in respect of the non-EU country or reciprocal treatment for EU systems in the non-EU country.
The new framework would replace the national regimes in some Member States extending SFD protections to non-EU systems. Non-EU systems that benefit from existing national regimes would have five years to become registered under the new regime.
The SFR does not extend to registered non-EU systems the same protection from the exercise of resolution powers afforded to designated EU systems, authorised EU central counterparties or EU-recognised non-EU central counterparties under the Bank Recovery and Resolution Directive or Single Resolution Mechanism Regulation.
Insolvency protections
The SFR would restate the existing insolvency protections in SFD with limited changes. The new rules would clarify when settlement is final and ESMA and the EBA would develop harmonised rules on settlement finality moments.
Conflict of law rules
The proposal would restate the rule that rights to financial instruments provided as collateral to a participant, system operator or EU central bank and recorded on a register located in a Member State are governed by the law of that Member State. However, the SFR would also provide that the location of registers, accounts, or deposits held by a legal entity would be determined by the registered office of the entity and that, if it is not possible to determine the location of a register, account or deposit, the governing law would be the law of the relevant system.
Amendments to FCD
The SFR would update the definitions in the FCD to cover cash, financial instruments, and credit claims issued or recorded using DLT. Member States would be able to extend the coverage of the FCD to any financial instruments within the scope of the Markets in Financial Instrument Directive that are negotiable on the capital market. However, the SFR would not implement other changes to the FCD discussed in the Commission's 2023 report on its targeted consultation on its FCD review.
Unlike other proposals in the Commission's package, the SFR would not confer new supervisory powers on ESMA. Member States would retain responsibility for designating EU systems and would be responsible for registering non-EU systems. However, ESMA would establish a centralised platform to facilitate communication between applicants and authorities.
The SFR will follow the ordinary EU legislative process and may be amended by the European Parliament and the Council before its adoption, publication in the Official Journal and entry into force.
The SFR would apply from entry into force, with Member States given 18 months to implement the changes to the FCD.
Authors: Caroline Dawson, Marc Benzler and Chris Bates
