The purpose of the Settlement Discipline Regime (SDR), which is the next big phase of the Central Securities Depositories Regulation (CSDR), is to increase settlement efficiency in Europe. For those transactions which do not settle within the mandated timeframe, market participants will be liable to pay penalties/charges or may be subject to a mandatory buy-in process.
The recent volatility during March and April of this year during the height of the COVID-19 pandemic highlighted the need for greater efficiency in post-trade processes which are the main drivers of efficient settlement.
The European Securities and Markets Authority’s (ESMA) recent Trends, Risks and Vulnerabilities report published in September 2020 highlighted a large increase in failing equities trades – March and April saw failed trades increase by 10% and 12%, respectively. In the context of SDR, trades such as these would be unlikely to settle on time as counterparties require additional time to identify the cause of the issue and then to address it. However, the threat of financial penalties and buy-ins as mandated by SDR should incentivise market participants to address upstream operational inefficiencies and increase automation in order to create settlement efficiency. Interestingly, during a recent event held by the Association for Financial Markets in Europe (AFME), the majority of audience members confirmed their firms need to make improvements in their trade capture, confirmation and affirmation processes, to help them avoid the SDR’s failed trade penalty and buy-in regimes.
While the rate of failed trades incurred during the height of the pandemic exposed post-trade weaknesses, the pandemic also created the need for a delay to the implementation of the regulation as market participants grappled with new working practices and directed resources towards such needs. ESMA’s announcement that there would be a recommended one-year delay to the implementation of SDR to February 2022 was received with relief by the industry, however it also highlighted different rates of preparedness among different segments of market participants.
Unsurprisingly, the world’s top 15 investment banks that have the largest front-, middle- and back-office resources among market participants, are the best prepared for the regulation, along with the large interdealer-brokers and buy-side firms. Smaller regional brokers in Europe, that know what is required of them, but which have fewer resources to implement the requisite changes, are not as advanced in their preparations.
As regards region-wide SDR readiness, overall in Europe, knowledge levels are relatively high. However, during a series of educational roadshows which we conducted in Europe at the start of the year, it became apparent that market participants in the Nordic region were less prepared for the regulation than in other European countries. This could be partly due to the fact that there are much fewer trade associations in this region, resulting in lower awareness levels around the upcoming mandate.
Among the majority of UK market participants, we are seeing preparations continue at the same pace as before, despite the announcement by the UK Treasury that the UK will not be implementing SDR. This is because most UK-domiciled institutions and funds trade European securities which are settled by EU-domiciled depositories and therefore for these in-scope trades, compliance with SDR will be required.
Looking outside of Europe, market participants’ plans are progressing well. In the US, there has been a huge increase in awareness around SDR, and market participant preparations have moved forward as a result of this. In Asia, interest and awareness has risen over the course of the year. Furthermore, with the Asian market being structured in a slightly different way, firms in the region are relatively well positioned to cope with SDR, due to the need to comply with other settlement discipline regimes that have been in place in Asia for some time. In fact, we have been trying to encourage firms in this region to engage with their European counterparts in order to make them aware of what is required for the regulation in 2022.
So, what kind of timeline should all types of clients be following in order to be ready for SDR implementation in February 2022? We expect at the end of the first quarter of 2021 that most firms should have made their decisions on post-trade providers, leaving Q2 and Q3 for the onboarding process. After this, October 2021 should kick off three months of testing, which is crucial to ensure readiness for the February 2022 deadline.
Irrespective of market participant type or location, the industry now has an additional year to implement the necessary changes for SDR and therefore can be more thorough in their process of analysing post-trade weaknesses and addressing them, than was possible previously. This extra time will also provide market participants plenty of time for testing which is essential to ensure smooth SDR implementation.