The UK’s rejection of CSDR is not an opportunity for firms to down tools

Linda Gibson, head of regulatory change at BNY Mellon’s Pershing, looks at the implications of the UK walking away from CSDR’s buy-in rules upon exit from the EU. Gibson assesses what this means for the buy-side and whether this is a catalyst for post-Brexit regulatory fragmentation between the UK and the EU

And, breathe. Since CSDR was announced eight years ago, the proposed legislation has caused headaches across the EU. Yes, the original aim of the settlement discipline regime (SDR) – to reduce settlement fails and late settlement – was widely recognised and supported.

However, the mechanics behind the buy-in regime have remained a cause for concern, creating confusion and frustration among market participants. Through the early course of the coronavirus pandemic’s volatility, many firms were trading at up to three times their typical volumes in March.

If the buy-in regime and specifically mandatory buy-ins had been in force, the settlement fails stemming from the uptick in trading volumes would have potentially turned a market catastrophe into a crisis. Buy-ins have the ability to cause price distortions as the parties in the settlement chain are all currently required to buy-in the same security. 

Nevertheless, the need to facilitate the settlement of market transactions in a timely manner while sustaining market liquidity and efficiency is still firmly on the agenda of the UK government and its regulators.

This should not be overlooked by buy-side operators.

The UK may have provided a lifeline with its latest move, but CSDR – and its aim of improving the functioning and stability of the financial markets – isn’t going anywhere anytime soon.

Wishful thinking

Many firms assumed the UK would not implement CSDR post-Brexit. For most firms, this is wishful thinking. Within the UK, firms are already required to meet the first two parts of CSDR – offering individual and segregated accounts and providing internalised settlement reporting. These requirements will remain in place whether the UK is within or outside the EU.

Although the most controversial, the SDR was one part of the legislation.

What’s more, given the breadth of markets served by most buy-side firms, the decision not to adopt the SDR will only affect a limited number of UK firms that only settle trades with Euroclear UK and Ireland (EUI). It is only settlement at CREST that will not be in scope, although they are still making the place of trade mandatory and are still to clarify how EUI will interpret the announcement.

For the majority of firms who trade across the EU markets, CSDR implementation programmes must now factor in the different regimes for the EU and UK market.

Firms must also recognise that this is not the end of the saga. For multinational firms and cross-border transactions, it all depends on what LCH – the British clearing house serving major international exchanges – and EuroCCP decide for the UK post-Brexit. These unknowns must be included in contingency plans alongside the possibility that CREST may adopt settlement fines through their own rules.

CSDR’s future is still plagued with uncertainty.

Your move, EU

The flaws in the current EU implementation of CSDR were already apparent. However, the latest move from the UK may just give the EU the required push to adopt some of the suggested changes to the regime.

It has been recommended that implementation of settlement penalties and buy-ins be decoupled. Recent speculation suggests penalty and buy-in regimes might have a split implementation date of February 2021 and 2022, respectively. We may also witness the EU introducing the settlement penalties in a trial and error process, to see if this has the desired impact to make the concept of a buy-in regime redundant.

A further delay to SDR’s EU-wide implementation to February 2022 might help but will ultimately kick the can down the road for a market which will have by that time been waiting for clarity for a decade.

What’s next for the UK?

The Chancellor has made it clear that any future legislative changes will be developed through a dialogue with the financial services industry. The UK government is aware of the lobbying by UK market participants and will be keen to ensure that the regime they introduce is mindful of these viewpoints.   

However, the Chancellor has gone one step further to prove his word: aside from CSDR, the UK government will develop tailor-made approaches to SFTR, EMIR REFIT and the LIBOR transition. Collectively, these provide a clear example of the UK flexing its muscles in divorce proceedings and marks the beginning of an impending regulatory fragmentation.

What this means for the future of regulatory oversight in the UK post-Brexit is already high on the buy-side’s boardroom agenda. The UK has a real opportunity here to deliver a point of differentiation from the EU by providing realistic but effective regulations that achieve their purpose without causing confusion.

But that can also be a double-edged sword.

Different versions of fundamentally the same rulebook risks doing more harm than good and CSDR is just the first test of many.