The EU’s Central Securities Depositories Regulation (CSDR) – introduced along with its more famous cousin MiFID II in 2014 – aimed to refine and improve the timeliness of trade settlements.
But seven years on, it is estimated 10 to 15 percent of the trades within the regulation’s scope are still failing to settle on time – that’s millions per day. The European regulator’s aim is for at least 99 percent to settle on time.
Enter, the 1 February 2022 (partial) introduction of the Settlement Discipline Regime (SDR), a set of rules for central security depositories (CSDs) which will impose daily penalties for every day a trade fails past its due date.
This regulation will result in financial charges by CSDs against any firms – including international ones – that buy EU-listed securities and are late settling.
To properly understand the new rules, it pays to recap what CSDR has meant so far: namely that it aimed to improve timeliness with the introduction of schemes including the ‘consistent settlement cycle’ (the trade date plus two business days (TD+2)) across all CSDs.
The regulation has also encouraged the use of electronic trade matching to avoid manual intervention and mismatch of settlement data.
So why do trades continue to settle late?
Data shows the vast majority of failed trades are due to the broker in question not having sufficient shares to fulfil delivery. This is a clear reason of fault and, once penalties are in force, any costs associated with these failed trades would have to be covered by the delivering broker.
The next main reason for a trade to fail is the broker not having settlement instructions in place with the CSD on the correct date. Again, this can be proven and will be used by all CSDs when raising penalties and applying responsibility. Others fail due to reasons such as ‘detail discrepancy’, where the fault could lie on either buy or sell side. These failed trades would need to be investigated more thoroughly.
It would be remiss of me to discuss SDR without mention of the fact that its so-called ‘mandatory buy in provision’ rules – initially also set to come into force in February – were delayed late last year following months of speculation and industry opposition.
These rules will involve an appointed third-party buy-in agent who will, after a trade has failed for four days, fulfil the undelivered stock in the market and pass on all costs to the failing party. Once the buy-in process is complete, the original trade is cancelled.
The mandatory buy-in rules will be put on hold while impact analysis can be carried out by the European Commission. This will then inform a decision on whether there should be a further 36-month delay to the implementation to allow market participants to prepare fully. There may also be further amendments to the guidelines.
This delay is a result of rallying of market participants across the EU, who sought the delay due to there still being a lot of uncertainty surrounding the regime as an end-to-end process, and a general lack of clarity on certain aspects within the guidance. There is also concern that the proposed buy-in programme will negatively impact market liquidity, as well as the operational cost of managing such an initiative far exceeding any benefit gained from it.
Despite this hiccup, the penalties to be issued from February are a tried and tested method across many global markets to encourage timely settlement of trades, and therefore should have the desired effect within the EU.
When the new rules come into force, we may see a drop in trade fail numbers due to brokers effectively ‘pulling their socks up’ and more closely monitoring their inventory levels when executing market trades.
Nonetheless, affected firms should prepare based upon historical data, which can then be reviewed post-implementation.
- Louise Reason, Senior Manager – Client Services Management, Maitland Fund Services