CSDR – being disciplined in your settlement discipline
25 October 2019
The CSDR is not just for CSDs. The implications of Central Securities Depositories Regulation have an impact on investment firms and the market more broadly. With the regime due come in next autumn, it makes sense to identify changes needed and give yourself time to address them before the deadline.
Implementing the regulation includes the creation and operation of a detailed settlement discipline regime, to promote the timely settlement of transactions on CSDs. Underpinning the regime is a raft of measures to prevent settlement fails and to address them when they occur. These include:
- communications protocols for securities/cash allocations to transactions
- daily cash penalties for transactions that fail to settle on time
- mandatory buy-ins where securities are not delivered within four days of the intended settlement day
Due to be implemented in September 2020, the regime covers a wide range of asset classes and transaction types. It’s likely to have a significant impact on firms along the entire settlement chain including trading venues, CSDs and their participants and clients. Given the wide scope and potential operational, commercial and reputational impact of the regime, anyone affected should make sure they understand, and are ready for, the new rules.
Measures to prevent fails
As its first preventative measure, CSDR requires trading venues to establish procedures ensuring the confirmation of transaction details on the date of execution. CSDs such as Euroclear UK & Ireland are in turn, required to establish procedures facilitating settlement on the on the intended settlement date.
At the end user level, investment firms must implement measures to limit the number of settlement fails. They should do this by making arrangements with their professional clients to ensure the prompt communication of the securities/cash allocation to the transaction, and the timely confirmation of that allocation. This includes detailed rules that address a number of specific scenarios, such as where the firm and client are in different time zones, where orders are executed after 4pm on the business day of the firm, and where allocations and confirmations are received by a firm within one hour of its close of business.
It’s likely these changes will necessitate amendments to your client agreements, so it’s wise to review these sooner rather than later.
The regulators have introduced a ‘stick’ to make sure the regime is effectively implemented.
CSDs are required to levy cash penalties for each business day that a transaction fails to be settled after its original settlement date.
CSDR sets out detailed requirements regarding the calculation and application of cash penalties. These include requirements on the applicable rates – for example, 1 bp of the price of the transaction per day that the instruction fails to settle due to a lack of shares with a liquid market. They also cover the collection and distribution of such penalties (including monthly collection and distribution of net amounts to be paid by/to failing/receiving participants), and on the charging for the costs of building and running the penalty mechanism.
As well as to cash penalties, CSDR also imposes a mandatory buy-in process on ﬁnancial instruments that are not delivered within a set period. This period depends on the type and liquidity of the instruments and is up to four days for liquid securities, seven days for illiquid securities and 15 days for transactions on SME growth markets. If the buy-in fails or is not possible then the receiving participant or client can choose to be paid cash compensation or to defer the execution of the buy-in to an appropriate later date.
The buy-in regime is expected to have a significant impact on all firms in the settlement chain, including CSD participants, their clients and potentially their clients’ clients. So all parties are required to establish contractual arrangements with their counterparties that fully incorporate all applicable buy-in requirements and procedures and are enforceable in all relevant jurisdictions. These procedures must cover the nuts and bolts such as the execution of buy-ins, compensation payments etc, and also measures to ensure all relevant parties to the settlement process receive timely information on their rights and obligations.
What firms should do next
The implementation of CSDR will likely have a significant impact for the back office of all firms in active in the trading of CSD-settled securities. Firms should begin to identify the likely contractual and operational changes required now, to ensure they can be fully implemented in time for the implementation deadline.
We can help
We are currently helping a number of firms, including CSDs, get to grips with CSDR. We can help you to understand the impact of CSDR for your firm, and design practical implementation solutions.