The new regulation imposes obligations on CSDs in Europe. Part of this is the requirement to increase settlement discipline. Initially the regulation was planned to come into force in February 2021 but was postponed by the European Commission on 23 October 2020 and will now come into effect on 1 February 2022.
The regulation will affect a wide range of market participants. In addition to the Central Securities Depositories (CSDs), it will also affect, among others, trading venues and the asset managers of active and passive funds that trade in securities via a European CSD, regardless of where the participant is domiciled in the world.
These are the key impacts from an asset management perspective:
- Settlement discipline
- Buy-In Agent
Cash penalties will be incurred if a trade will not settle on the intended settlement date (ISD). From ISD to final settlement, penalties ranging from 0.1bp to 1bp are payable, depending on the instrument type and liquidity.
How can the asset manager avoid failing the settlement on ISD? Wrongly delivered SSI can be a driver for settlement fails. Corporate Actions could force a failure. The Securities Lending and Repo business could also trigger settlement fails.
Does the asset manager have controls in place to warn the fund manager before the start of the penalty or the Buy-In process? Can the asset manager track which counterparties fail more often than others in order to deal with more reliable counterparties in the future? Is there a need to modify existing agreements between asset manager and counterparty or with custodians?
Regarding the general calculation of the penalties, the asset manager is not in the driver seat. The calculation has to be done by the CSD and communicated to the custodian of the asset manager. A completely new process has to be established between the custodians and the asset managers to deliver the details of the penalties which will be debited/credited on a monthly basis. How often, which details and via which channel will the custodian deliver it? No standard process is agreed between all parties.
Are all custodians ready for it? And what happens if you have more than one custodian?
How can the asset manager monitor the penalties? Some market participants want to make a netting of all positions between all funds of the asset manager and the counterparty. Does a fund earn the credits and the debits?
The penalty calculation is based on the classification of the Financial Instruments Reference Data System (FIRDS) database. Is this implemented at the asset manager or does the custodian provides this information and if yes how (and how accurate)?
On top of the penalties, if the ISD runs over 4,7 or 15 business days depending on instrument type and liquidity the receiving party is obligated to initiate the Buy-In process. That means via a Buy-In Agent the receiving party has to ask for the unsettled Security and the Agent will start an auction with his network partners to offer the securities for price x and Intended Settlement Date (ISD) y.
There are two possibilities to avoid Buy-In:
Bilateral Cancellation or Partial Settlement. Are the custodians and asset managers ready for these flows? Are the systems in front, middle and backoffice ready for it?
On the second of February the consultation from the European Commission ends and one of the main concerns from the market participants is the buy-in process. Associations like the International Capital Markets Association (ICMA) or the Bundesverband Investment und Asset Management (BVI) recommended postponing the Buy-In process to a later date and make it discretionary rather than mandatory.
There are several reasons for addressing major issues with the mandatory Buy-In. The ICMA pointed out that the Buy-In process will have negative impacts for the bond market. The BVI refers to high implementation costs and liquidity issues for the Buy-In process. Besides that, at the moment only one company offers the Buy-In service, the EUREX STS. Legally it is unclear who has to pay for the service. They are in an early stage of negotiations with the market participants.
There are a couple of open questions in the market and much more clarification needed, but time is running out. In the best case scenario, during the summertime, the ESMA will publish level 3 guidelines that will shorten the time for the projects.
We are supporting major CSDs and asset managers to implement CSDR, and we can help you to find solutions. If you’d like to discuss or just share knowledge, we’re always happy to have a virtual coffee break!