Trade bodies unite to call for CSDR buy-in delay
24 January 2020 Paris
Image: Shutterstock
Fourteen trade associations including ISLA, ICMA and AFME, have joined forces to present a united front to EU regulators in calling for radical amendments to the settlement discipline regime of the Central Securities Depositories Regulation (CSDR), which is due to enter force in September.
A letter from the group was sent to Steven Maijoor, chair of the European Securities and Markets Authority (ESMA) and Valdis Dombrovskis, executive vice-president at the European Commission on Wednesday, and aims to highlight the scale of the concern from affected parties that CSDR’s mandatory buy-in regime and cash penalties for settlement fails will significantly damage market liquidity and stability.
“We [the associations] are extremely concerned that if the buy-in regime is implemented as it stands, there will be a significant negative impact on market liquidity, operational processes, and ultimately, end investors,” the letter reads.
The associations also highlighted a lack of detailed technical specifications available to market participants that are presenting significant challenges to market participants looking to meet the current timetable.
Other signatories include the Association Française des Professionnels des Titres, the Association of Global Custodians, the Association française des marchés financiers, Assogestioni, Assosim, the German Investment Funds Association (BVI), The European Banking Federation, the Electronic Debt Markets Association, and Dutch Advisory Committee Securities Industry.
What are the concerns?
Although the letter opens with the associations reinforcing their support for the EU’s mission to improve settlement efficiency and the introduction of a penalty regime, several issues have been flagged regarding CSDR’s current model for achieving these aims.
The letter warns that the costs for in-scope market participants that will come directly or indirectly from the settlement regime’s have not been satisfactorily modelled by ESMA or the commission and not enough time has been taken to ensure the market is comfortable and ready for the framework to be implemented.
Elsewhere, the letter’s key concern relates to the buy-in feature. The associations note that although buy-in rules already exist in the clearing space, the mandatory nature of CSDR’s version for over-the-counter trades sets it apart and potentially makes it not fit-for-purpose.
The letter explains that the primary issue is that this creates an asymmetrical dynamic between counterparties that could see potentially uncapped costs for the failing party, as well as other affected parties in the settlement process.
What do they want?
The letter includes a comprehensive list of reforms that the associations say must be made in order to avoid major market upheaval in September. It includes:
A delay to the mandatory buy-in regime until the effects of penalties and other measures to promote settlement efficiency are implemented, as well as an in-depth impact analysis is undertaken on the potential effects of a mandatory buy-in.
Moreover, the mandatory nature of the buy-in should be amended to become an optional right of the receiving trading party, underpinned by law, to allow a buy-in of a non-delivering counterparty.
Additionally, the asymmetrical issues relating to buy-in costs should be amended so that each party is restored to its original position. The topic of cash compensation should be thoroughly reassessed.
For cash penalties to only be introduced once market infrastructures, banks and their clients have built the technology required to process the fines, and not before the market has had an opportunity to test the required new messaging and technology.
The letter adds that regulators should consider conducting a ‘live testing’ period, in which penalties are calculated and reported but not charged to participants, should be considered to ensure a successful implementation of the penalty regime.
Finally, the associations say they would welcome a monitoring process to measure the impact of the penalty regime on settlement efficiency going forward
To support their requests, the associations referred to the “extensive consultation process and market engagement” ESMA undertook ahead of the post-trade transparency framework of the Markets in Financial Instruments Directive and encouraged a similar approach to be taken now.
Where’s the evidence?
To back up their claims, the associations’ letter leans on market research conducted by the International Captial Market Association (ICMA) in 2019 which showed that, with respect to bond markets, 100 percent of sell-side responders and 80 percent of buy-side responders expect mandatory buy-ins to negatively impact overall efficiency and liquidity.
Moreover, the impact study shows that market makers expect to widen bid-ask spreads by at least 100 percent, with a greater impact expected on illiquid asset classes, and full withdrawal from market making in some instances.
Elsewhere, traditional lenders are expected to hold more buffers, or even withdraw inventory, thus limiting liquidity for short covers. Finally, ICMA’s study included a comment from sell-side practitioners stating that “there will be no choice but to widen pricing in the High Yield and illiquid spaces to the detriment of investors”.
Although not mentioned in the letter, independent research by Pirum Systems has also shown that its clients could be facing costs as high as €300 million annually in fines and fails management costs.
What next?
Many of the concerns raised in the letter were repeatedly raised by the associations and their members. The commission itself has also acknowledged that a delay may be inevitable as far back as November last year for an entirely unrelated reason that would see the regime be pushed back until
after SWIFT’s November update for technical reasons.
The letter did not offer a fixed alternative timetable but did reference the need for a push-back until at least November as a starting point for negotiations if they are offered by the commission and ESMA.
A letter from the group was sent to Steven Maijoor, chair of the European Securities and Markets Authority (ESMA) and Valdis Dombrovskis, executive vice-president at the European Commission on Wednesday, and aims to highlight the scale of the concern from affected parties that CSDR’s mandatory buy-in regime and cash penalties for settlement fails will significantly damage market liquidity and stability.
“We [the associations] are extremely concerned that if the buy-in regime is implemented as it stands, there will be a significant negative impact on market liquidity, operational processes, and ultimately, end investors,” the letter reads.
The associations also highlighted a lack of detailed technical specifications available to market participants that are presenting significant challenges to market participants looking to meet the current timetable.
Other signatories include the Association Française des Professionnels des Titres, the Association of Global Custodians, the Association française des marchés financiers, Assogestioni, Assosim, the German Investment Funds Association (BVI), The European Banking Federation, the Electronic Debt Markets Association, and Dutch Advisory Committee Securities Industry.
What are the concerns?
Although the letter opens with the associations reinforcing their support for the EU’s mission to improve settlement efficiency and the introduction of a penalty regime, several issues have been flagged regarding CSDR’s current model for achieving these aims.
The letter warns that the costs for in-scope market participants that will come directly or indirectly from the settlement regime’s have not been satisfactorily modelled by ESMA or the commission and not enough time has been taken to ensure the market is comfortable and ready for the framework to be implemented.
Elsewhere, the letter’s key concern relates to the buy-in feature. The associations note that although buy-in rules already exist in the clearing space, the mandatory nature of CSDR’s version for over-the-counter trades sets it apart and potentially makes it not fit-for-purpose.
The letter explains that the primary issue is that this creates an asymmetrical dynamic between counterparties that could see potentially uncapped costs for the failing party, as well as other affected parties in the settlement process.
What do they want?
The letter includes a comprehensive list of reforms that the associations say must be made in order to avoid major market upheaval in September. It includes:
A delay to the mandatory buy-in regime until the effects of penalties and other measures to promote settlement efficiency are implemented, as well as an in-depth impact analysis is undertaken on the potential effects of a mandatory buy-in.
Moreover, the mandatory nature of the buy-in should be amended to become an optional right of the receiving trading party, underpinned by law, to allow a buy-in of a non-delivering counterparty.
Additionally, the asymmetrical issues relating to buy-in costs should be amended so that each party is restored to its original position. The topic of cash compensation should be thoroughly reassessed.
For cash penalties to only be introduced once market infrastructures, banks and their clients have built the technology required to process the fines, and not before the market has had an opportunity to test the required new messaging and technology.
The letter adds that regulators should consider conducting a ‘live testing’ period, in which penalties are calculated and reported but not charged to participants, should be considered to ensure a successful implementation of the penalty regime.
Finally, the associations say they would welcome a monitoring process to measure the impact of the penalty regime on settlement efficiency going forward
To support their requests, the associations referred to the “extensive consultation process and market engagement” ESMA undertook ahead of the post-trade transparency framework of the Markets in Financial Instruments Directive and encouraged a similar approach to be taken now.
Where’s the evidence?
To back up their claims, the associations’ letter leans on market research conducted by the International Captial Market Association (ICMA) in 2019 which showed that, with respect to bond markets, 100 percent of sell-side responders and 80 percent of buy-side responders expect mandatory buy-ins to negatively impact overall efficiency and liquidity.
Moreover, the impact study shows that market makers expect to widen bid-ask spreads by at least 100 percent, with a greater impact expected on illiquid asset classes, and full withdrawal from market making in some instances.
Elsewhere, traditional lenders are expected to hold more buffers, or even withdraw inventory, thus limiting liquidity for short covers. Finally, ICMA’s study included a comment from sell-side practitioners stating that “there will be no choice but to widen pricing in the High Yield and illiquid spaces to the detriment of investors”.
Although not mentioned in the letter, independent research by Pirum Systems has also shown that its clients could be facing costs as high as €300 million annually in fines and fails management costs.
What next?
Many of the concerns raised in the letter were repeatedly raised by the associations and their members. The commission itself has also acknowledged that a delay may be inevitable as far back as November last year for an entirely unrelated reason that would see the regime be pushed back until
after SWIFT’s November update for technical reasons.
The letter did not offer a fixed alternative timetable but did reference the need for a push-back until at least November as a starting point for negotiations if they are offered by the commission and ESMA.
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