The regulatory recap
CSDR – setting standards to drive settlement discipline
The Central Securities Depositories Regulation (CSDR) aims to make the securities markets of the European Economic Area (EEA) more efficient and transparent, largely by standardising post-trade processes.
Following the European Market Infrastructure Regulation (EMIR) and Markets in Financial Instruments II (MiFID II), CSDR is the third leg of reforms to the region’s securities market structure. All are aimed at greater harmonisation, transparency, consumer choice and protection, and systemic stability.
CSDR standardises many aspects of securities settlement, but its biggest impact on market participants is settlement discipline rules designed to eliminate trade fails.
Initially scheduled to come into force in September 2020, the European Commission had accepted the European Securities and Markets Authority’s (ESMA) proposal to delay the settlement discipline regime until February 2021. However, at request of the European Commission, the ESMA is working on a proposal to further delay the coming into force of the CSDR by another 12 months until February 2022. This extension of delay is to take into account the COVID-19 pandemic’s ongoing impact on implementation of other regulatory projects and IT deliveries being undertaken by central securities depositories (CSDs)1.
Scope, scale, structure
Targeting trade fails and traversing beyond Europe
All entities along the European securities value chain are touched by CSDR, from the initial issuers of securities to the custodians and CSDs that hold them in safe-keeping, as well as the buy- and sell-side firms and intermediaries in between. CSDR also introduces common regulatory and business conduct rules for EEA CSDs and includes rules on internal settlement and dematerialisation.
Except for issuers, all parties in the securities settlement chain are directly impacted by the settlement discipline regime, including non-EEA based entities. Market participants and intermediaries must adjust to the regime’s four pillars
- allocation and confirmation policies to support timely settlement;
- fails monitoring and reporting requirements;
- cash penalties;
- and,mandatory buy-in rules.
CSDs are tasked with monitoring and reporting settlement efficiency rates and facilitating matching and related processes to support trouble-free settlement.
Many types of firms operating outside of the EEA are in scope – including asset owners and managers, broker-dealers, private banks and wealth managers – if they are or their clients trade EEA securities because the settlement discipline rules apply to all transactions intended for settlement on an EEA CSD. This covers transferable securities, money-market instruments and UCITS; exemptions include shorter-dated securities financing transactions.
Thus, although CSDR is a European regulation, its impacts are global, requiring relevant market participants and intermediaries to review settlement-related processes to avoid cash penalties and other costs for themselves or their clients.
Building the blueprint for your firm
Review, re-evaluate and respond – avoiding the cost of failure
Under CSDR’s settlement discipline regime, market participants deemed responsible by a CSD for a settlement-failure face cash penalties, calculated daily by the CSD; then, if not resolved within a specified time frame per instrument, a mandatory buy-in. This will incur further costs to the failing trading member, including appointment of a buy-in agent, and potentially higher market prices, to replace the original transaction. As well as immediate costs, high failure rates may cause longer-term reputational damage, harming relationships with counterparties.
Asset owners and managers, broker-dealers, other intermediaries and custodians are likely to need to make adjustments in one or more of the following securities processing areas:
- Look for weak links. All firms buying and selling EEA securities must have clear oversight over their entire securities processing transaction chain from pre-trade to execution to post-trade processes, including settlement and payment. CSDR requires them to understand and manage the whole trade lifecycle in an efficient, timely and compliant manner in partnership with trading counterparties and service providers.
- Dig deep, reduce risks. Firms should review their existing post-trade processes to assess fails ratios and identify underlying causes of trade fails, such as repeated incomplete / incorrect fields when trading with a frequent counterparty. Firms may look to tilt transaction flows toward counterparties and service providers with most robust settlement operations. Some may also adjust their trading operations, avoiding certain higher-risk activities, e.g. short sales or leveraged trades.
- Keep talking. Communicate effectively with internal and external parties involved in post-trade processes, particularly regular counterparties, broker-dealers and custodians. Firms must understand how service providers intend to communicate on settlement fails, cash penalties and buy-in processes, and factor this into their own communications flows, including, if necessary, to end-clients.
- Can you prove it? As securities buyers from third-party jurisdictions, some clients may be net beneficiaries of failed trade penalties. But they must also reassess their processes to validate fails-related communications, and to challenge penalties if necessary, providing well-documented evidence to resolve disputes quickly.
- New partners. Market participants may need to select a buy-in agent, as the receiving party is responsible for sourcing replacement securities, before passing the cost to the failing party. Buy-in agents may be in short supply due to multiple regulatory requirements.
- Check your paperwork and processes. Firms may need to revisit invoicing processes, to isolate payments relating to settlement discipline costs, and keep abreast of upgrades to SWIFT message formats. Industry working groups are exploring potential repapering needs.
Building the blueprint for the industry
Collaboration and consultation
CSDR will establish more harmonised, standardised and efficient securities settlement processes in the EEA. Post-trade harmonisation and integration has been a long-term EU goal, especially since the launch of the euro. The 2008 global financial crisis also highlighted the need for more efficient and secure cross-border securities settlement.
Settlement failure has long been tolerated in Europe, but CSDR’s preventative measures and related reforms should deliver greater standardisation and automation. Greater speed, reliability and transparency will cut back-office costs for market participants and allow them to better serve end-investors, potentially offering newer and lower-cost services.
But ongoing collaboration and consultation is needed to streamline and accelerate any extended transaction chain. As with EMIR and MiFID II, industry bodies are continually working to provide feedback to regulators, develop new best practices and support cost-effective compliance.
Championing change with Standard Chartered
Facilitating the fail-safe for your CSDR plan
CSDR’s settlement discipline rules may influence the shaping of future standard practice beyond the EEA, meaning firms that prepare their operations now will be ahead of the curve in terms of pro-active failed trade management and improved ‘big data’ management to optimise post-trade operations.
At this point in time, several elements of the regulation – and the industry’s response – remain uncertain. Whether trading EEA-issued securities daily or less frequently, CSDR’s settlement discipline regime could require extensive preparations to handle new and unfamiliar processes. For many, the three biggest priorities will be: finding out your level of fails and tackling underlying causes; engaging with clients and counterparties on process changes to accommodate penalties and buy-ins; establishing dispute resolution procedures.
As an intermediary for EEA securities transactions, Standard Chartered has mobilised a coordinated bank-wide response to ensure clients are fully supported. We are helping clients to improve settlement discipline, implementing new processes and improving communication flows to ease compliance. This includes working bilaterally with clients and collaboratively at an industry level to understand further changes and support best practice and compliance.
To reduce costs and disruption, speak to Standard Chartered about your CSDR preparations.
1Asset Servicing Times, ‘ESMA confirms preparations to further delay CSDR’. 28 July 2020