Responding to demand
12 November 2019
CSDR represents the first example of legally mandated loan settlements with the added twist of cash penalties for fails. Deutsche Boerse has responded to this threat with the formation of a new buy-in service
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For the securities lending industry, 2020 will be a year of firsts. In April the Securities Financing Transactions Regulation will require a granular level of transaction reporting hitherto unknown in the industry. Beyond that, the Central Securities Depositories Regulation (CSDR) will seek to improve settlement discipline with the introduction of mandatory buy-in rules and even cash penalties for fails, both also industry firsts.
The cash penalties and buy-in requirements for failing transactions kick in at varying dates from the intended settlement date (ISD) depending on the liquidity of the instrument in question鈥搒pecifically, on ISD+4 for 鈥榣iquid鈥� securities and ISD+7 for those deemed illiquid.
In its report on the CSDR鈥檚 impact on the market (published in February) the International Securities Lending Association (ISLA) did not mince its words when it described the regulation鈥檚 features as likely to bring additional costs and greater risks and complexities to the market.
The CSDR buy-in provision is slated to come into force on 14 September 2020 and will apply to trading entities domiciled not just in the EU but also the European Economic Area and even beyond.
To put the scope of the potential challenges mandatory buy-ins in context, settlement rates for securities lending transactions in 2018 were estimated to be between 80 percent and 90 percent, with the majority of failed settlements occurring on the return leg of loan transactions, according to ISLA鈥檚 Q1 2018 report.
However, the good news for the market is that all securities financing transactions with a term of fewer than 30 days will be exempt鈥揳 fact which brought an industry-wide sigh of relief when it was first announced.
In theory, this exception grants market participants a fair amount of wiggle room to manage their open transactions accordingly so as to avoid falling foul of buy-ins and penalty rules, but the true impact of CSDR on the market will remain unknown until it is upon us next year.
Given the period of uncertainty within which the market now operates, it will no doubt be a comfort to many that Deutsche Boerse has become the first to throw its hat into the ring to offer a service that directly mitigates the thorny issue of mandated buy-ins. Under the stewardship of Marcel Naas, formally of Eurex Repo, and Marcus Addison, who shifts over from Eurex Clearing, the German exchange has founded a new company that will act as a neutral buy-in agent for the market. The service is on track to launch in September 2020, in time for day one of CSDR鈥檚 implementation.
To discuss the finer points of what the buy-in agent service can offer the market, SLT sits down with the company鈥檚 new managing directors.
This is a new venture for you both after many years in other areas of Deutsche Boerse. What can the industry expect?
Marcel Naas: The regulatory framework of CSDR allows for a neutral buy-in agent and we at Deutsche Boerse saw this as a natural progression of our existing services. We already have a lot of experience in settlement and post trade, as well as offering some buy-in services out of our central counterparty (CCP).
As a result, we founded a new company in July called Eurex Securities Transaction Services, which will host the new buy-in service as a subsidiary of Eurex Frankfurt. The service will be launched in September 2020 in time for the new harmonised standards for settlement discipline that come as part of the EU鈥檚 CSDR.
The service aims to offer Deutsche Boerse customers with a high level of standardisation and automation to resolve the challenges posed by the mandatory buy-in requirements imposed by CSDR. We will require a banking licence for this service and we are currently applying for that with the German Federal Financial Supervisory Authority.
Marcus Addison and I will run the company and we are currently building up a team that will assist us in that aim.
Deutsche Boerse is the first, and only, market participant to embrace this opportunity to become a buy-in agent so far. Why is that?
Marcus Addison: The CSDR rules are quite strict in outlining that a buy-in agent must be neutral in the market. This plays to our strengths as Deutsche Boerse Group does not hold a position on any security.
Naas: This requirement will have limited the number of entities that can take on this mantle of a buy-in agent. More people may come forward as time goes on but at the moment it is only us.
What impact do you expect CSDR to have on the securities finance industry?
Naas: It will have more of an impact on the underlying markets because transactions with terms less than 30 days are excluded. The question is whether that remains the case or if things change over time - nobody knows. At the same time, it may be the case that more people turn to securities lending and repo as a way to avoid settlement fails.
How are buy-ins currently executed and how will that change under CSDR?
Addison: Buy-ins are usually done via a CCP and its safe to assume some buy-ins occur bilaterally as well, although the number of these is hard to quantify. Once CSDR comes into effect buy-ins will be mandated after the trade is deemed to have 鈥榝ailed鈥� and so that will naturally increase the overall number of buy-ins that are initiated.
Through Eurex Securities, we will run a series of daily over-the-counter auctions to attempt a buy-in for the required securities. We are not a marketplace and we only facilitate an auction for the security to be bought, so that will not always be successful. If it isn鈥檛 successful then that will be reported to the instructing party and, in those instances, the original transaction will have to be cash-settled as mandated under CSDR.
How many transactions can we expect to run into the buy-in rule?
Addison: Precise data on settlement fails in the securities finance market is hard to come by. Some estimates say that up to 20,000 trades a day fail to settle in Europe, which represents between 2.5 percent and 3 percent of all transactions that take place daily. The question is, how many of those will remain open once the time allowed by CSDR to settle has elapsed, which could be either four, seven or even 15 days depending on the liquidity and type of instrument. At the same time, we expect the industry to engage in efforts to improve its settlement deficiencies so the number of fails will go down.
In terms of buy-in success rates, that will depend on the liquidity of the instrument. That said, CCPs already do buy-ins and I鈥檓 sometimes surprised at the types of instruments that go into buy-ins and their success rates, which is relatively high, although that鈥檚 partly to do with the highly-liquid basket of instruments with which the CCP is active.
By codifying buy-ins in law, do you foresee CSDR providing greater standardisation and best practice in this feature of transactions?
Addison: Today there are some issues in the market because there are disputes around which side of the trade will ultimately pay if a buy-in is instigated. In the future, this will be clear under CSDR as the buyer must instigate the buy-in and the seller must cover all the costs. Even if trade reverts to a cash settlement then CSDR includes a formula for that as well.
The cash penalties and buy-in requirements for failing transactions kick in at varying dates from the intended settlement date (ISD) depending on the liquidity of the instrument in question鈥搒pecifically, on ISD+4 for 鈥榣iquid鈥� securities and ISD+7 for those deemed illiquid.
In its report on the CSDR鈥檚 impact on the market (published in February) the International Securities Lending Association (ISLA) did not mince its words when it described the regulation鈥檚 features as likely to bring additional costs and greater risks and complexities to the market.
The CSDR buy-in provision is slated to come into force on 14 September 2020 and will apply to trading entities domiciled not just in the EU but also the European Economic Area and even beyond.
To put the scope of the potential challenges mandatory buy-ins in context, settlement rates for securities lending transactions in 2018 were estimated to be between 80 percent and 90 percent, with the majority of failed settlements occurring on the return leg of loan transactions, according to ISLA鈥檚 Q1 2018 report.
However, the good news for the market is that all securities financing transactions with a term of fewer than 30 days will be exempt鈥揳 fact which brought an industry-wide sigh of relief when it was first announced.
In theory, this exception grants market participants a fair amount of wiggle room to manage their open transactions accordingly so as to avoid falling foul of buy-ins and penalty rules, but the true impact of CSDR on the market will remain unknown until it is upon us next year.
Given the period of uncertainty within which the market now operates, it will no doubt be a comfort to many that Deutsche Boerse has become the first to throw its hat into the ring to offer a service that directly mitigates the thorny issue of mandated buy-ins. Under the stewardship of Marcel Naas, formally of Eurex Repo, and Marcus Addison, who shifts over from Eurex Clearing, the German exchange has founded a new company that will act as a neutral buy-in agent for the market. The service is on track to launch in September 2020, in time for day one of CSDR鈥檚 implementation.
To discuss the finer points of what the buy-in agent service can offer the market, SLT sits down with the company鈥檚 new managing directors.
This is a new venture for you both after many years in other areas of Deutsche Boerse. What can the industry expect?
Marcel Naas: The regulatory framework of CSDR allows for a neutral buy-in agent and we at Deutsche Boerse saw this as a natural progression of our existing services. We already have a lot of experience in settlement and post trade, as well as offering some buy-in services out of our central counterparty (CCP).
As a result, we founded a new company in July called Eurex Securities Transaction Services, which will host the new buy-in service as a subsidiary of Eurex Frankfurt. The service will be launched in September 2020 in time for the new harmonised standards for settlement discipline that come as part of the EU鈥檚 CSDR.
The service aims to offer Deutsche Boerse customers with a high level of standardisation and automation to resolve the challenges posed by the mandatory buy-in requirements imposed by CSDR. We will require a banking licence for this service and we are currently applying for that with the German Federal Financial Supervisory Authority.
Marcus Addison and I will run the company and we are currently building up a team that will assist us in that aim.
Deutsche Boerse is the first, and only, market participant to embrace this opportunity to become a buy-in agent so far. Why is that?
Marcus Addison: The CSDR rules are quite strict in outlining that a buy-in agent must be neutral in the market. This plays to our strengths as Deutsche Boerse Group does not hold a position on any security.
Naas: This requirement will have limited the number of entities that can take on this mantle of a buy-in agent. More people may come forward as time goes on but at the moment it is only us.
What impact do you expect CSDR to have on the securities finance industry?
Naas: It will have more of an impact on the underlying markets because transactions with terms less than 30 days are excluded. The question is whether that remains the case or if things change over time - nobody knows. At the same time, it may be the case that more people turn to securities lending and repo as a way to avoid settlement fails.
How are buy-ins currently executed and how will that change under CSDR?
Addison: Buy-ins are usually done via a CCP and its safe to assume some buy-ins occur bilaterally as well, although the number of these is hard to quantify. Once CSDR comes into effect buy-ins will be mandated after the trade is deemed to have 鈥榝ailed鈥� and so that will naturally increase the overall number of buy-ins that are initiated.
Through Eurex Securities, we will run a series of daily over-the-counter auctions to attempt a buy-in for the required securities. We are not a marketplace and we only facilitate an auction for the security to be bought, so that will not always be successful. If it isn鈥檛 successful then that will be reported to the instructing party and, in those instances, the original transaction will have to be cash-settled as mandated under CSDR.
How many transactions can we expect to run into the buy-in rule?
Addison: Precise data on settlement fails in the securities finance market is hard to come by. Some estimates say that up to 20,000 trades a day fail to settle in Europe, which represents between 2.5 percent and 3 percent of all transactions that take place daily. The question is, how many of those will remain open once the time allowed by CSDR to settle has elapsed, which could be either four, seven or even 15 days depending on the liquidity and type of instrument. At the same time, we expect the industry to engage in efforts to improve its settlement deficiencies so the number of fails will go down.
In terms of buy-in success rates, that will depend on the liquidity of the instrument. That said, CCPs already do buy-ins and I鈥檓 sometimes surprised at the types of instruments that go into buy-ins and their success rates, which is relatively high, although that鈥檚 partly to do with the highly-liquid basket of instruments with which the CCP is active.
By codifying buy-ins in law, do you foresee CSDR providing greater standardisation and best practice in this feature of transactions?
Addison: Today there are some issues in the market because there are disputes around which side of the trade will ultimately pay if a buy-in is instigated. In the future, this will be clear under CSDR as the buyer must instigate the buy-in and the seller must cover all the costs. Even if trade reverts to a cash settlement then CSDR includes a formula for that as well.
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