ESMA issues advice on CSDR settlement fails 10 August 2015Paris Reporter: Stephanie Palmer
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The European Securities and Markets Authority (ESMA) has issued its technical advice on appropriate penalties for settlement fails under the central securities depository regulation (CSDR).
The report also includes technical advice on determining the “substantial importance” of a CSD, all as a response to the European Commission’s request to assist on the contents of the regulation.
Under CSDR, failed settlements will lead to penalties. The European Commission asked ESMA for technical advice on: parameters for calculating a cash penalty; the circumstances in which a penalty can be increased or reduced; and how to adapt the parameters for independent transactions, or in cases where a chain of independent transactions may not be visible.
Failed settlements can also lead to mandatory buy-ins, which act as additional security for the buyer. The ESMA advice suggests that failed settlements should be allowed a 15-day extension, after which a buy-in process would kick in, however the penalty for this should be specified.
According to ESMA’s research, the more preferred method of assessing the cost of a failure is using a reference price based on either the closing price of the most relevant market, the price of the most liquid trading venue for the particular financial instrument, or a pre-determined methodology based on criteria related to market data.
This method means that penalties will be proportional, similar instruments will be subject to similar penalties, and they can be applied using an automated system.
The ESMA report said: “This will ensure that all fails on the same instruments occurring on a particular date are treated equally, irrespectively of the trading venue or CSD used. This avoids potential regulatory arbitrage and provides for a clear methodology for determining the reference price with limited possibilities for conflicting interpretations of the relevant price to use in these situations."
There should be a distinction in rates between liquid and illiquid shares, while the rate for bonds should be lower, considering the larger size of related transactions. According to ESMA, if a failure is due to a lack of cash, the rate should be related to the cost of borrowing.
Rates should also be subject to regular recalibration in order to properly take in to account the changing market conditions, and also to monitor the overall efficiency of the measures.
With regards to assessing the substantial importance of a CSD, the report concluded that if 15 percent of a CSDs services is deemed important, then it should be considered ‘of substantial importance’.
It stated that if a CSD is established in an EU member state and has a physical presence, that doesn’t mean it is of substantial importance. According to ESMA, there is no guarantee that such a CSD will see significant activity, and classifying all branches as significantly important would be too much of a burden for both the CSDs involved and the regulators.
Only those that end up generating significant activity should be subject to the advice designed to mitigate the risk of not meeting the measures of substantial importance.
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