What does your role as head of regulation involve, and how has it helped you understand the ruling around CSDR?
At Meritsoft, we are very focused on two key elements of The Central Securities Depositories Regulation (CSDR) Settlement Discipline rules - penalties and fines. We’re currently talking to our clients and the industry as a whole about the CSDR requirements and demonstrating that we understand the intricacies involved in complying with the regulation.
In my role as head of regulation, the key is understanding which regulations are equally applicable to our clients and ourselves. For example, impending financial transaction tax changes in Europe and globally will impact our clients and therefore will need to be incorporated into our product roadmap.
CSDR is a great example of this, as eighteen months ago we identified the need for a solution and that we should provide it. We’ve been talking to clients, reading the press, and engaging with service providers such as PwC, EY and Deloitte, as it’s important to continually review and understand what’s going on, and what the impact will be. We are doing this in a very timely manner to make sure that we’re not sitting here with a week to go waiting for CSDR to come into force. With any new regulation, such as CSDR, we typically look two to three years down the road, knowing that the regulation is coming. Even if we are not yet sure of the specifics we will monitor and maintain our development roadmap.
As CSDR is going to impact our clients, it’s something we needed to address. We needed to engage with financial houses as early on as possible, much as we did for the introduction of the IRS 871m taxation rules. It was important to increase awareness of CSDR while appreciating that firms have been focused on other regulatory projects such as Brexit and, to a lesser extent, the aftermath of the second Markets in Financial instruments Directive (MiFID II).
spend a lot of time learning about and then sharing our understanding of the impact legislation has, as much as we do addressing problems and providing solutions.
Our background of experience has put Meritsoft in a good place regarding CSDR. It is scheduled to come into operation next September, but flexibility is key from a solution providers perspective.
Understandably, banks take a while to figure out the impact of any new regulation or changes. As you can imagine, assessing the impact can be extremely complicated. First and second tier global banks have multiple divisions and business lines within their organisations that need to assess the different impacts across asset classes before assessing the options and costs and applying this to their budget and resources. This includes considering the extra-territorial aspect across entities.
There’s a positive quantity and a value point here, because fails and penalties are derived from a basis point. If you incur a $1 penalty, then that’s not a problem. However, a $100,000 penalty is very important. Our teams are looking at automation and working with banks to really understand the impact and negate the risk and cost where possible, because it’s not just a back-office operational issue; it’s also a front-office financial issue that could have huge ramifications on client profitability and contractual arrangements.
What would you advise to investment banks and asset managers if they do not yet understand the ruling around CSDR standards? What are the consequences of non-compliance?
The obvious and immediate consequence is receiving a penalty. By definition, that is an impact and a cost and will impact your profit and margin.
Obviously, companies are trying to avoid the penalty fees incurred from fails and the buy-in costs. The time a penalty is outstanding determines the value of the penalty (a daily calculation, payable monthly). Penalties are a substantial issue from an identification, tracking, validation and fault allocation basis for houses, whereas the buy-ins, while fewer in volume, attract a large element of risk and value. This is in addition to potentially substantial processing costs (previously managed manually as volumes typically are very low).
As an example, if you are a custodian and a CSD brings a penalty against you, you have to potentially allocate that penalty accountability to your counterparty if they failed to perform the correct actions within the right timeframes. With this in mind, the consequences of fails are financial and cost administration.
There’s also a reputational risk associated with non-compliance and consistent fails which could paint you in a negative light within the market.
There will always be fails from an operational perspective, but what people are looking to do is reduce that number of fails and, where appropriate, accurately resolve and account for fails.
How are you assisting your clients with CSDR?
The majority of our work has been focused around education and improving the understanding among our clients in terms of what impact to expect in different areas of their business. There’s also the education of showing them the software and how to use software solutions to address CSDR, as opposed to using manual efforts.
Everyone is well aware that these activities are relatively manual but this process will now have to become automated because the volume will increase.
A benefit of being independent is that we can talk to several banks to gain different perspectives from the teams that are engaging with us and as a result we’re also getting feedback from our clients during the preparation and assisting process. There is usually a general consensus between the banks, even if they don’t know the other’s opinions, and we can use this to complete the picture on our side and incorporate into our work with houses.
Now that we are part of a substantial global organisation, Cognizant, we have the technology and people to enable us to become a key business process outsourcing (BPO) provider, while leveraging our software. This type of engagement is becoming more common and is something that corporations are interested in looking at strategically; as opposed to buying software in-house.
The market infrastructure offering is becoming especially relevant for addressing buy-in processing as one of the things that comes off the back of this regulation is the “netting off” on a chain of buy-ins, which still needs to be agreed as an industry. In a chain of transactions, one fail can lead to a chain of multiple buy-ins with associated costs. If the houses in this chain are using our market infrastructure offering then they can theoretically loop the ends of the chain so there is only one buy-in. This will substantially reduce the underlying cost of doing business. This is a strategic ecosystem that we are targeting delivery of in the next 24 months.
What are the essential points of CSDR?
What CSDR is essentially trying to do is regulate and improve settlement processing, by penalising the houses that persistently fail to settle their transactions on time, which impacts a house’s profitability. There is always a cost associated with a system change, but the industry standard penalty structure is designed to demonstrate that non-compliance and buy-ins for profit is no longer an acceptable practice because it disadvantages the counterparty, even if it’s easier, cheaper and more convenient for you to fail.
What the regulation is doing in this instance is saying that, actually, everyone should be treated in the same way, and because it’s awkward for a small house to complain to a big house, now there will be a standard approach with associated standardsed fees/penalties.
People will examine their fails processing in a big way to work out why they occurred, with a view to reducing – but not eradicating – the overall number of fails to a more manageable size, as there is now a financial imperative and incentive to do so.
The problem everyone will have is attempting improvements across multiple systems, and tracking information and activities to manage it centrally. However, we do expect to see a reduction in the number of fails, which will be a benefit to everyone.
How does CSDR differ from other regulations that the industry has been preparing for in recent years, especially from an investment bank and asset management perspective?
They all have slightly different impacts as they try to address different issues. MiFID II, as a case in point, fundamentally aimed to improve transparency in areas such as research and trading. MiFID II determined that it was unacceptable to obfuscate and pass on costs. For example, if you’re looking at a research billing invoice, under MiFID II you must tell clients what each piece of research was and the associated fees.
CSDR differs from MiFID II and SFTR because it is focused around internal best practices rather than improving outcomes for external customers. It focuses on how to improve the whole industry’s approach to settlement and trading from an internal back-office perspective, rather than just the buy-side.
The regulations that are coming into force link back to territorial transparency because many of them, particularly FTTs and CSDR, take a global stance by considering international discrepancies among industry standards. This in turn should encourage national reciprocity and a recognition of where there are loopholes that should be improved or closed.
What are your predictions for regulation within asset servicing for 2020? Do you think regulations such as CSDR and MiFID II have refreshed or will reset industry standards?
Our background is historically very much on the sell-side, but there is a plethora of different things happening on the buy-side, depending on which asset classes you are in. For example, European Market Infrastructure Regulation legislation is predominantly focused on derivatives.
Asset servicing legislation also affects tax reclaim, so over the coming years, we will see more transaction taxes, as we’ve seen recently in Europe with equities and derivatives. There have been press announcements in Germany about what they are going to do, while Spain has already got permission to move ahead with their transaction tax, and the UK has stamp duty. There is also the real likelihood of an EU-wide FTT while Democrats in the US are talking about introducing one as part of their electoral platform in 2020.
The tax regulations are set to have the biggest, and most intrusive, longer term financial impact when you start to look at the money that is involved, especially when you consider double taxation treaties (withholding tax regimes and tax reclaim processing). There are definitely going to be more taxes – it’s a way of generating revenue for governments and is directly attributable to trade transactions.
In summary, there’s a lot of tax and a drive to increase transparency right now.
Outside of CSDR we are aware of other items, but I think it’s safe to say that the bulk of a financial house’s budget tends to go towards regulatory change requirements and compliance that will impact their business in the near future. This is where they have to put their money and their priority.
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