With whispers of delays in multiple regulations, Tony Freeman, executive director, DTCC Industry Relations, highlights some of the issues around pushing back these deadlines.
Prior to the global financial crisis, market infrastructure was perceived as the necessary but boring plumbing which underpinned the far more glamorous front office functions of sales and trading. This perception started to change once policymakers and regulators agreed that bolstering market infrastructure was the most effective means of mitigating systemic risk. This is evidenced by the fact that the majority of regulation which has emanated since the financial crisis -- EMIR (European Market Infrastructure Regulation) and Dodd-Frank; and the forthcoming MiFID II (Markets in Financial Instruments Directive) and CSD-R (Central Securities Depositories Regulation) -- has large sections devoted to the reconfiguration of middle and back office processes.
Last week at the Bank of England Open Forum, Governor Carney reinforced the rise in the importance of market structure to the efficient functioning of the markets and went a step further by distinguishing between 'hard infrastructure, the plumbing of the markets that determines the mechanics of markets and soft infrastructure, like standards and codes that define how market participants should behave'. He went on to claim that 'robust market infrastructure is a public good.'
Despite this current consensus, recently it would seem that the practical reality of overhauling Europe's market structure is proving more challenging than was originally anticipated. Last week media reports circulated that the implementation of MiFID II would likely be delayed to 2018 due to issues around industry readiness for implementation. And CSD-R looks set to follow suit, again due to implementation issues around some of the more complex aspects of it. There is a common theme here that while regulators and policymakers have agreed the broad principles of change to market infrastructure with the industry, the practical reality of actually implementing the technical rules is much more complex than anyone had originally imagined.
Let's take CSD-R as an example; some of the prerequisites for its implementation have been achieved. The harmonisation of the European settlement cycle to T+2 is a significant move and has already taken effect. Ahead of the CSD-R implementation, a number of infrastructure providers - CSDs (central securities depositories), clearing houses and stock exchanges - across Europe agreed that starting 6 October 2014 transactions should be settled on a T+2 basis. The industry showed wide support for this initiative and it was implemented efficiently and effectively. There are however, some complex areas of CSD-R which will undoubtedly lead to a delay in its implementation.
The majority of issues are related to the implementation of the settlement discipline regime. In December 2014, it was stated that the settlement discipline regime would be applied 18 months after the publication of the final regulatory technical standards due to the extra time European CSDs and custodians needed to develop harmonised systems to cope with the new rules. This need is understandable given the scope of the changes which are required.
According to most market participants, the current settlement rate in Europe is 97-98%, whereas in CSD-R the settlement efficiency target has been set at 99.5% meaning that to avoid financial penalties, an improvement of approximately two percentage points needs to be achieved. For this target to be obtainable, CSDs based in Europe will need to come up with a common set of measures to prevent and address settlement failures; as well as to define what constitutes a failed trade and to build a mechanism to report failed trades to regulators.
Furthermore, the custodians, which internalise settlement processes, need to build mechanisms to report their settlement processes on a monthly basis. With this volume of work yet to be completed, It would be surprising if CSD-R is implemented within the current timeframe which has been set - January 2017.
There is no doubt that policymakers and regulators believe that bolstering market infrastructure is one of the most effective means of mitigating systemic risk in the financial markets. On the other hand, changing market infrastructure across Europe is by no means an easy task. In Europe, not only is there the challenge of changing middle and back offices processes which have been in place for many years; updating legacy technology and implementing new systems; but there is the added complication of harmonising post trade practices which differ from provider to provider and from country to country. With all this in mind it is not surprising that delays to regulatory implementation affecting financial market infrastructure will likely be a big theme now and into 2016.