Concern has long been voiced over CSDR’s Settlement Discipline Regime (SDR), notably the impact of mandatory buy-ins on market liquidity and overall industry readiness. While a level of uncertainty will continue due to key issues such as solving for asymmetrical payments, a pass-on mechanism and transaction scope, the consultation provides a final opportunity to fix the SDR.
Implementation of the SDR has been pushed back twice due to technical issues and the impacts of the COVID-19 pandemic. The regime is expected to come into force on 1 February 2022, subject to non-objection by the European Parliament and the European Commission.
The CSDR targeted consultation document published as part of the review includes forty-two questions, six of which are for respondents to propose amendments to the SDR, although the Commission is not committed to adopting any proposals. The targeted amendments cover changes to mandating buy-ins, the rules of using a buy-in agent, introducing a pass-on mechanism, clarifying scope, eliminating asymmetry in the reimbursement for changes in market prices and revising penalty rates.
Industry stakeholders have until 2 February 2021 to reply to the questionnaire in an attempt to drive meaningful change to SDR. A post consultation report covering the findings is anticipated to materialise during Q2 next year with any legislative changes likely to be adopted in Q4.
Given the timelines surrounding the consultation, market observers have already started flagging concerns around the potential challenges for market participants to make the necessary changes to their systems in time for 1 February 2022.
The delay and ongoing consultation should not prompt market participants to lose momentum or even cease their implementation efforts, but rather take the opportunity to think more strategically about their solutions. We believe that participants should look across their post-trade processes beyond just the management of settlement fails. Their focus should be on improving operational efficiency and addressing legacy issues that in turn will address the requirements of CSDR at a global level, rather than just across EU markets.
The industry must continue to collaborate and use this time wisely to identify a joined-up solution for the management of buy-ins. There is still no consensus on how buy-ins will be processed, and this remains the key area where collaboration is critical to finding the right solution, balancing the requirements of regulators and industry participants.
The additional time afforded by the delay is also an opportunity to find the path forward in areas such as electronic allocation, confirmations and affirmations. Here the industry must collectively drive a wider adoption of tools and platforms that solve legacy issues in these areas. These service providers must be encouraged to interoperate and lower the barriers to entry to the benefit of the entire market.
Furthermore, the industry should seek to reduce bilateral settlement and move towards full adoption of a central counterparty clearing (CCP) model. Following the more recent focus on this model due to the EMIR and Dodd-Frank regulations, there has been a wider adoption of CCP clearing in the OTC derivatives space – but the securities markets have not followed suit.
The following themes should be a key focus for the industry to address:
1. Reduce settlement activity
- TARGET2-Securities (T2S) – a holistic T2S and clearing strategy could see the consolidation of CSD and agent bank accounts and relationships.
- Internal booking models – post-Brexit and business reform programmes, firms should look at how booking models can be simplified or removed.
- CCP clearing – participants should work to widen the adoption of CCP clearing services (buy-side and broker to broker activity).
- Inventory management – firms should develop consolidated real-time single stock records and a more efficient approach to inventory/ collateral management.
2. Increase T+0 trade capture, allocation, confirmation & affirmation accuracy
- Trade capture automation/ timeliness and accuracy remain a key requirement.
- Widen the adoption of electronic allocation, confirmation, and affirmation processes.
3. Improve reference data quality
- Enhance instrument reference data, for instance via the adoption of a standardised product taxonomy and instrument classification used to confirm settlement location
- Client SSIs – enhancements can be achieved via intelligent automation using digital technology such robotic process automation, native language processing and machine learning
4. Rationalise/transform technology
- Retire or plan the decommission of legacy hosted technology and transition to cloud-based applications technology
- Consolidate duplicate/ legacy systems that perform similar processes or functions
5. Buy-in management
- Firms should collaborate with peers, market infrastructures and FinTech vendors to define and implement a common industry process for the end-to-end management of buy-ins.
- They should also establish the right internal processes to identify and manage buy-ins.