It is very rare to see so many industry bodies speak with a single voice as they have recently about the implementation of settlement disciplines under Central Securities Depository Regulation (CSDR). It is perhaps an indicator of the far-reaching implications of implementation and the level of uncertainty before the market has had time to prepare properly and implement appropriate messaging functions.
The letter details a number of potential impacts to the wider markets, not least of all the potential impacts on end investors. Implementation will have the biggest impact in the least liquid asset types, and the cash settlement requirement after a failed buy-in means that firms may choose not to invest unless settlement is guaranteed, and in illiquid [bond] markets this may be impossible.
Currently an investor may be aware that settlement is unlikely for a period of time, but they can still gain economic exposure from trade execution, so will buy knowing settlement will fail under CSDR. The possibility of a cash settlement close out will mean that the investor cannot be sure of their economic exposure until settlement has occurred and so may chose not to invest in the first place.
From a securities finance market the risks are numerous, both to market participants and market liquidity.
ICMA’s impact study suggests 80% of the market expects to see a negative impact on liquidity in bond markets, with some investment categories being withdrawn from investment strategies and therefore further impacting liquidity supply ‘a self-fulfilling circle’. For securities lending it is almost certain increased buffers will be required to mitigate impacts and this will, again, impact the liquidity in lending markets with a potential knock – on effect to the secondary markets.
We have written before about how securities finance could mitigate some of the risk and the industry work that needs to be done in order to prepare, much of which is invaluable and will undoubtedly improve processes and settlement rates. However, it has to be recognised that fails are inevitable in securities lending and in fact the changes required to eradicate fails may lead to reduced efficiency, even if settlement rates improve and will certainly increase the cost of doing business for the investor.
Whilst the settlement penalties may be painful for the market, the industry bodies do not ask for these to be delayed, but that the buy-in regimes are deferred whilst there is a full market consultation and the impact of the settlement penalties can be assessed. This seems a very reasonable approach, despite the potential costs to business of implementation prior to technology implementations. Let’s hope the regulator is prepared to compromise also.
One issue concerning the broader financial markets is a lack of clarity around the responsibilities, calculation and application of the rules. It is still unclear at what level penalties should be applied, how firms should develop their operating models, how penalties will be collected and re-distributed, and how exceptions will be defined and applied. It feels very late in the day, given the technology build and process changes potentially required, for this not to have been clarified.
The concerns with CSDR have been documented and highlighted by individual firms and individual industry bodies for some time and yet there has been little movement.
Hopefully the unusual step of this level of collaboration across so many industry bodies representing so many aspects of the market will have a more positive impact.
5th February – update
Its all in the timing!…. yesterday European Securities and Markets Authority (ESMA) announced a postponement of the CSDR settlement regime until February 2021, recognising the significant IT developments, legal changes and process change that will be required by market participants – exactly as described and recommended in the letter from the industry bodies. There is much work to be done by the industry but with this deferment at least there is a possibility of readiness. Hopefully the delay will allow for market consultation and time for implementation.