CSDR: Could the implementation of the future settlement discipline regime be pushed back by a year?
The new regulation on central securities depositories (CSDs) is a constant topic of discussion. After the alarm was sounded in early 2020 by 14 professional associations in a letter to the European Commission (see our article from 5 March 2020), it now appears that the planned date for implementation of the settlement discipline regime may be pushed back by a year. Our expert, Sylvie Bonduelle – Senior Advisor for the Regulatory Projects Department at SGSS – answers our questions.
Sylvie, some CSDs have announced that the settlement discipline regime imposed by the CSDR, currently set to likely take effect on 01 February 2021, could probably be pushed back by a year. Can you tell us a bit more about that?
Indeed, the Euroclear group surprised many people by being the first, through its CSDs, to publicly address this rumour that had long been circulating. Initially set to take effect on 14 September 2020, then pushed back by nearly six months, the settlement discipline regime may ultimately not take effect until 01 February 2022.
This announcement has just been confirmed (on the 28th of July) via an ESMA1 newsletter where the European regulator says he was currently working, as requested by the European commission, on a delay until the 1st of February 20222.
Remember, however, that for such a decision to become official, it will have to go through a very specific legislative process: it will have to be adopted by the European Commission, then face no objections from the European Parliament or Council, and finally be published in the Official Journal of the European Union.
You’re right to call for caution, but this is still good news, right?
First of all, for the penalty component. If this extra year is approved by legislators, it will allow the industry to calmly finish implementing the new regime. While most of the new developments (calculation mechanism, new SWIFT messages, application of penalties, etc.) will be ready by the 2021 deadline, there remain pending issues that need to be resolved, as well as special cases that still require deeper analysis. For example: should penalties be applied to the asset manager or to the fund, and in such a case, how would MiFID II and PRIIPs requirements for ex-post disclosure of information on costs and charges be affected? How do you operationally process a penalty involving a CCP3 (the information will be exchanged between the CSD and its participant, but the financial payment will pass between the CCP and its clearing member)? Will the regime dedicated to SME growth markets really apply to all settlements tied to a transaction executed on such a market? What will happen to existing settlement fails when the new regime takes effect?
The additional lead time would also be welcome for requirements related to the allocation/confirmation phase. Their implementation is still under discussion with platform providers.
However, it’s true that the greatest hope is for the mandatory buy-in portion. Beyond its operational complexity, this measure’s terms of application raise questions and make it difficult to implement:
Those subject to this obligation don’t have any real experience with buy-ins (currently, it’s mainly a process managed by the CCPs and thus limited to clearing members). The trader for uncleared trade transactions, or the buyer for non-intermediated transactions, must find a buy-in agent, determine the quantity to be sourced by the latter -, figure out the counterparty to be bought-in buy-in, etc.
This obligation applies to a settlement fail, taken singly, however it is well known that a settlement does not exist in isolation; it is often part of a complex chain of operations connected by optimisation rules from the settlement algorithm. A simple lack of securities may lead to multiple settlement fails, and thus just as many buy-ins, most of them pointless. Here’s an example: I buy and re-sell securities on the same day. I don’t receive them, so I can’t deliver them. I will have to initiate a buy-in against my seller, while also being bought-in by my buyer!
The penalties regime takes these “chains” into account (the penalty is paid to the participant not at fault). It’s unfortunate that no such measure has been planned for buy-ins.
You mentioned a bit of hope… To what extent can we hope?
At the very least, this one-year deferment may allow ESMA4 and the European Commission to respond to the numerous issues (currently no less than 30) brought up by the associations5 and thus help the associations make progress on implementing standardised practises.
Among the major topics are:
Establishing a mechanism that can limit (if not prevent) pointless buy-ins, while remaining compliant with the regulation.
Obtaining an exemption for certain transactions, notably those that don’t correspond to a true transaction, such as portfolio transfers (in this case, the owner of the securities would have to initiate a buy-in against himself or herself) or transactions for which other mechanisms exist (like buyer protection for corporate actions).
That said, even with responses moving in the direction desired by the industry, the complexity and negative impacts caused by this mandatory buy-in will remain.
The fact that CSDR (which dates back to 2014) is entering its revision process this year could provide the opportunity to make significant changes to the settlement discipline regime.
Of course, the goal of the regulation (in the absence of 100% on-time settlement—every regulator's dream) would still be to bring an end to settlement/delivery fails as soon as possible. However, where CSDR1 considers the buy-in obligation to be the only possible solution, the revised CSDR2 could lead to more contextually appropriate solutions that are less radical, yet just as effective.
1 European Securities and Markets Authority
3 CCP: central counterparty clearing house
4 European Securities and Markets Authority