Meritsoft
Daniel Carpenter
12 May 2020
Daniel Carpenter, head of regulation at Meritsoft, a Cognizant company, discusses the challenges of CSDR and ESMA鈥檚 stance on the buy-in regime
Image: Daniel Carpenter
In a joint letter sent to the ESMA in January, a collection of trade associations asked for a phased-in approach to CSDR as well as a deferral of mandatory buy-ins. Following the most recent announcements, what will different houses have to prepare for ahead of the February 2021 deadline?
Institutions have been aware of the Central Securities Depositories Regulation (CSDR) for many years. A lot of houses were initially resistant to the penalties but accepted them later down the line, agreeing that perhaps penalties were acceptable and that there was a reason for having a settlement discipline that enabled transparency. This would introduce a process that discourages people from not settling their securities transactions on time.
This means that projects that had been put on hold have had their delivery schedule revised for the February 2021 deadline. Market participants must now deliver their own penalty processing projects. As this stand, there is an acceptance that market participants are moving forward with this.
Houses also now have to deal with the buy-in aspect of this legislation. Buy-ins involve a more complicated process than penalties. There is potentially more risk associated with Buy-ins which require more external processing and communication.
Further definition of the requirements and associated clarity in certain areas of this element of the legislation is still needed. As things stand, there is only one company that has declared itself as a buy-in agent. This begs the question of whether other players will enter the market as alternative buy-in agents for the industry.
With more projects to run and more regulatory delivery requirements, houses need a system that bridges those penalty processing and communication needs through to buy-in completion. In addition, they also need a fail-safe management system. Most houses, amid the current crisis, have to be ready for CSDR by December this year. We are now in May, so if houses have not defined their requirements yet, and started their projects, they do not have long to meet this target deadline.
With concerns expressed over the impact CSDR will have on liquidity and market prices, what can the various houses do to potentially mitigate any such impact?
With houses both buying and selling, they have two goals: they have a commitment to deliver cash or deliver both stocks and cash, and therefore, also have a binding transaction to complete.
Houses should take a holistic view at both their receivables and their payables especially those that are going to fall within the CSDR regime (the European process side). In this situation it is likely that, if houses feed all transactions into a single fails system, they should be able to predict and communicate the outcomes for tomorrow to minimise failed trades and associated costs.
CSDR specifically defines different rules for how to treat illiquid and liquid securities. Typically, market participants are less worried about the liquid securities. After all, the more liquid the security, the easier it is to transact. However, illiquid securities are the real concern. There may only be one or two houses that source securities that trade infrequently. As a result, sourcing a buy-in will be limited and consequently risk falling foul of Best Execution rules.
The CSDR buy-in provisions are due to come into force from 1 February 2021. Do you think the pandemic will have any impact on this?
It does not look likely the date will change with regards to buy-ins as the European Securities and Markets Authority (ESMA) made its announcement during the pandemic.
ESMA knew what was happening when it made the announcement a couple of weeks ago, but still confirmed the deadline. Based upon our current engagements and projects we are delivering; market participants are anticipating no change in dates and must plan towards the deadline of 1 February.
The chair of ESMA recently stated that, despite industry concerns, no amendments will be made to the settlement discipline regime until after the go live date. What does this mean for market participants?
In my experience, regulations change both during initial phases and post introduction. Regardless, at the outset, houses will be looking at buying or building a solution or process that can handle the regulation as it stands today. They will also be looking to ensure that the external or internal partner they are working with has the flexibility to change their system or solution, as necessary.
Houses will be looking for some form of contractual commitment from their vendor that demonstrates an understanding that houses are delivering a solution for which requirements may change. By going with a vendor, houses get certainty that they are obtaining one solution for the whole of the market.
Crucially, the solution will be future-proofed and will be supported and developed by leveraging multiple business input and rule interpretations, as well as the vendor鈥檚 own expertise. This will provide houses with the certainty that they are partnering with vendors who will provide them with security.
Will the new CSDR take away incentives to lend securities in securities lending and repo markets?
From a technical perspective, having transparency over what houses do and do not have will enable them to make decisions about what to do next.
Each house will evaluate its own lending position and approach based on its business practices, as well as its own liquidity needs. I do not envisage that securities lending or repo activities are going to stop as, for many houses, this is a core part of their business practice.
They will need better technology and processes to not only help minimise risk, but to identify persistently failing counterparties. Stronger technology and processes can also prevent houses from having to borrow stock to cover their own fails.
Given the concerns that have been raised around CSDR, do you foresee the UK making any amendments that brings it into UK law when Brexit is complete?
CSDR is an EU regulation. If you are trading in the UK, or in any country in the world, and it is going through and settling in a European security, you must comply with the regulations of that jurisdiction. CSDR is just one of many extraterritorial rules being introduced globally.
If the UK goes ahead, I do not envisage it is going to request any changes to CSDR, as it is an introduction of a practice improvement to protect parties and deter malpractice. The UK is a key player in the global capital markets and has been part of the designing of this legislation.
It is, therefore, unlikely the UK stance will change. As recently seen in response to another EU rule SFTR, the Treasury will allow trade repositories to register in the UK at the conclusion of the transition period. The UK may take a similar stance when it comes to CSDR.
Why won鈥檛 ESMA change CSDR after the industry has requested it?
CSDR has been introduced because of best practice. ESMA is encouraging best practice so that market participants are prepared carry out their work on time. The authority is trying to level the playing field and balance the books for all market participants.
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