By Tony Freeman, executive director of industry relations at DTCC
The small and exclusive band of post-trade geeks (present company included) got a surprise present this month when the European Securities and Markets Authority (ESMA) completed the draft technical standards for the Central Securities Depositories Regulation (CSDR). The long-awaited standards, from the 2015 publication, address the knotty and complex issue of settlement discipline: the treatment of failed trades. Yet to be defined on this topic include: incentives, penalties and buy-in rules.
It’s been a long time coming, and there are many questions remaining. How does it affect market participants? Does it serve as a template for markets outside the E.U., who also want to improve settlement performance?
CSDR has a somewhat confusing name in that it not only includes stipulations for a harmonized regime for CSDs, it also mandates T+2 settlement and introduces a whole new set of rules to address settlement performance. This target has been stated as 99.5% efficiency and the rules are referred to as ‘SDR’ – the Settlement Discipline Regime.
But, was it worth the wait? Yes. The issues raised were genuine and well-articulated by the market. In particular, the focus on buy-in rules has been productive – with a more workable solution now proposed. The concerns about time-frames and the scope of mandatory processes have been considerably relaxed for both repo and securities lending trades. This is a good example of productive collaboration by the financial industry.
So, how does it affect the industry? In a number of ways. The biggest impact, aside from the CSDs, is probably going to be on the broker/dealers. They will be responsible for operating the buy-in process for non-CCP trades.
Does it work as a global template? Probably not. Not because it’s lacking in its recommendations, but, because the CSDR is designed for the European market. With the governments of the 28 E.U. member states, the European Parliament and the European Commission all involved, E.U. legislation is bound to be a compromise. As a result, there are lessons about the process used to build new legislation that could benefit other global markets. The E.U. process of defining the framework in a Level 1 text, which is strongly influenced by political requirements, means that the Level 2 technical standards (i.e. rules) have quite limited flexibility. The ESMA staff has, from a legal perspective, no means to change the scope. An example in the CSDR is the inclusion of collateral movements in the scope. There is clearly a concern that certain types of transactions should be excluded, but the Level 1 text allows for no exceptions. The European Central Securities Depository Association (ECSDA) has recently published very cogent arguments on this issue.
It’s likely that overall market reaction to the publication of the SDR will be cautiously positive. A lot of analysis still needs to be done – especially for investors outside the E.U. who are fully impacted by the new rules and may not be familiar with much of the unusual terminology used (the E.U. appears to be the only organization that refers to a trade as a ‘transfer order’). There are also still some open issues, for example, there is no definition of a ‘failed trade’. CSDs are being required to build extensive new reporting capabilities on the value and volume of failed trades – so a standard like-for-like definition is essential.
Perhaps the biggest sigh of relief will be about timing. ESMA is proposing a two year implementation window following final legislative procedures, meaning a big bang go-live could be expected in mid-2018. While this seems like a reasonable amount of time, it overlaps considerably with MIFID II implementation in January 2018. There’s a lot to do, and everyone needs to start now.