After already being delayed from September this year until February 2021, it is understood that the European Commission is in advanced discussions to further delay the Central Securities Depositories Regulation (CSDR) settlement discipline regime (SDR) by one year, taking the deadline to 1 February 2022.
Speculation about a further one-year delay emerged when Euroclear sent out a client memo on 20 July, which said the European Securities and Markets Authority (ESMA) is set to publish an amendment after the summer holiday period proposing a further delay to the current February 2021 deadline.
However, with the slow lull of summer, clarification from ESMA could take up to three months or more. At this point, the industry is quite possibly left with more questions than answers.
The drive for an additional delay follows persistent lobbying efforts by industry groups that have repeatedly voiced concerns that the mandatory buy-in regime, which comes as part of the regime’s framework, would significantly damage market liquidity as well as the participants it is meant to protect.
The spotlight further intensified on the flaws within the regime in June when the UK confirmed it would not on-shore CSDR after the Brexit transition period, which ends on 31 December.
One industry expert, Neil Vernon, CTO at Gresham Technologies, said that the UK’s exclusion of CSDR’s SDR as part of its adoption of EU regulations post Brexit will “undoubtedly create new challenges for firms in the UK”.
The already extended deadline was pushed back due to “technical impossibilities” around the implementation of IT solutions of industry stakeholders, and the fact that an essential ISO update due from SWIFT would not be in place until its annual November update.
The Euroclear memo explained that the new postponement will be subject to the legislative processes at the EU level which involves the commission, parliament and council, and could take “some months to complete”.
Tony Freeman, consultant for post trade and middle office, indicates that the process of creating EU law is complicated.
Freeman says: “This is particularly true of financial legislation, which is hugely important for some member states (the UK, Ireland, Luxembourg) but much less prominent for others. Some member states without any significant financial sector will occasionally barter their votes for agreement in completely unrelated sectors, such as fish for financial services. France and Germany, which have a much lower dependency on financial services than the UK both aspire to replace the UK as the EU financial capital. So, they’re also heavily involved.”
The wildcard
Although a year’s delay would most likely be welcomed by the majority of industry participants, it could expose industry stakeholders to the prospect of having to commit to several more months of dedicated work to meet the February deadline only to be given additional bandwidth in the final quarter.
Weighing in on this, Freeman highlights that at first glance this sounds like positive news, but it provides mixed messages.
The decision making of the EU is “complex” with the commission, council and parliament all having to sign-off. Freeman says: “It looks as if the commission (and ESMA) are happy to move forward with a further delay but the council is very unlikely to have a view.”
He suggests parliament is a possible wildcard with them often taking a political – rather than technocratic – perspective so their views can be “unpredictable”. Additionally, Freeman says “parliament can be very ambivalent about input from the industry”.
For example, looking at the formulation of the SDR in 2013/14, Freeman explains: “It was probably the political influence of the parliament that caused the highly contentious aspects of the SDR to be mandated in the Level 1 legislation. Nobody can explain how or why this happened and we are all still living with the consequences.”
There should be no assumptions made around parliament falling into line. Freeman highlights the possibility that the failed trade penalty regime may go ahead on 1 February 2021, with only the mandatory buy-in regime receiving a one-year delay.
The buy-in process is something that is continuing to cause confusion within the industry, with conversations still ongoing all over the globe as to how it would be triggered.
In a recent interview with Asset Servicing Times, Brown Brothers Harrimans’ Derek Coyle explained that from one perspective, the role of the third-party buy-in agent seems to need further clarification, with only one confirmed buy-in agent in place, and perhaps one or two others in consideration.
The scope coverage in which buy-in agents can support is also to be determined, both in terms of operational needs and time-zone coverage, and then also when it comes to supporting buy-ins of various instrument types and asset classes, according to Coyle.
Meanwhile, Freeman suggests that arguments presented by the industry have persuaded ESMA to make changes.
He says: “This is because the feedback has three compelling factors: it is data driven, it has been presented from trade associations across Europe and, crucially, it has come from all sides of the industry including the buy side.”
“The inclusion of mandatory buy-ins was intended to protect the buy-side. But, tellingly, the buy-side doesn’t want it.”
Reflecting on the past, Freeman observes that there are lots of lessons we can learn from.
He explains: “Perhaps the biggest is that the industry has to live with the Level 1 text. Once the Level 1 text, which is EU law, comes into force ESMA has to implement it. It cannot pick and choose which parts of a Level 1 text it implements. Influencing the trialogue participants is crucial. It’s much better to prevent the torpedo being launched than trying to evade it when it’s in the water.”
Suspicious minds
Another particular challenge is the involvement of parliament and the suspicions they may have on the input from the market. Additionally, parliament is the least predictable of the three elements because they are politicians, not technocrats. Freeman points out that if you reflect on the origins of this, the inclusion of the content of the SDR of Level 1 which makes it law was probably done at the insistence of the politicians involved in the discussions, rather than the commission or the council.
He says: “The member state government very rarely gets involved in the detailed level but when they resolve Level 1 they go through a process called trialogue.”
At this point, the process becomes opaque, meaning it is not a public process at all and there are no experts in the room with no trade associations, industry bodies or lobbyists in the room who could provide detailed technical advice.
The big issue with parts of SDR stems from that trialogue process, such as the issues with buy-ins not being protected.
“Indeed, what we can take from previous results, is that if there is something horrible in the Level 1 text then ESMA has no choice but to implement it. They are obligated to execute it because it is the law and this is where the difficulty comes from.”
Further to this, politicians are sometimes very suspicious about the input they are given from the market. Freeman observes that they can think the market frequently complains about processes being too complicated. As such, parliament may believe the market has a negative impact. However, Freeman outlines that the market is protecting itself and doesn’t want to spend the money or become even more transparent.
“[Parliament] is possibly rightfully suspicious about some of the input they get from the market. In this case, the input was correct in that mandatory buy-ins will have a very negative impact on liquidity especially in the bond market,” he adds.
Possible extension
With the extension still unconfirmed and many unanswered questions, the delay is understood to represent an acknowledgement by EU regulators that the SDR is not optimal in its current form. The delay is also aimed at giving industry stakeholders and lawmakers the necessary time to re-open the CSDR rulebook in the context of a highly-disrupted regulatory implementation timeline caused by the ongoing COVID-19 pandemic.
The market still has a long way to go in terms of being ready for the buy-in regime. Freeman notes: “ESMA understands that implementation would be more risky now than in a year’s time. It would be much better to put it in a year’s delay than force the issue right now.””
Amid the ongoing challenges around COVID-19, Freeman asserts that within the financial services industry, the apocryphal evidence is that processes are working well and trade volumes have been quite high. However, he highlights that we do not know how the longer-term impact of the enforced working from home will affect new initiatives and projects.
Freeman concludes that keeping the lights on is the mantra for everybody, particularly the market infrastructures.
He adds: “Keeping the systems processing and ensuring reliability is important but it is far too early to access the longer-term impacts as of yet.”
