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CSDR: Settlement discipline on the horizon

Regulation will put pressure on market participants to settle securities transactions on time

Introduced five years ago, the Central Securities Depository Regulation (CSDR) left a lasting legacy on the post-trade ecosystem. In 2020, the regulation will make itself felt on the asset management industry.

CSDR created a framework for European Union (EU) markets to gradually reduce trade settlement cycles to no more than two days after trade date (T+2), as a prelude to their adoption of TARGET2-Securities (T2S), a European Central Bank (ECB) backed securities settlement platform, which has facilitated cost savings along with enhanced liquidity and cash optimization for end users. With further provisions taking effect in 2020, CSDR is a regulation that the buy-side should also be firmly aware of, and actively preparing for.

“Many of the recent standardization reforms, such as the European Market Infrastructure Regulation (EMIR) and T2S have had a lasting impact on post-trade providers such as market infrastructures, global custodians, and agent banks. However, buy-side firms such as asset management companies are not exempt from CSDR and will also have to make changes to their business practices," said Wendy Phillis, Managing Director, Regulatory Solutions at RBC Investor & Treasury Services.

Two decades of post-trade harmonization

Key insights

  • CSDR will become a growing priority for asset managers in 2019, with the impending introduction of cash penalties and buy-ins for settlement fails set to take effect in September 2020
  • Asset managers will have to take measures to address mandatory buy-ins, which may include additional operational oversight, while simultaneously adding to operational risk

Deepening integration across Europe's post-trade industry has taken precedence among regulators ever since the Giovannini Group–which comprised experts entrusted with finding ways to harmonize the EU's capital markets–first published its findings 18 years ago. The Group identified a number of barriers impeding the development and growth of the continent's securities' markets. The document's contents have long been a critical resource for those pushing for greater harmonization of the EU's clearing and settlement processes, something industry experts believe will enable widespread efficiencies to be realized in the post-trade model.1

Progress has been made in meeting at least some of the objectives identified in the Giovannini Group's report,2 most notably the shift to T+2. However, CSDR will also apply settlement discipline measures, including the imposition of mandatory buy-ins and cash penalties on market participants for settlement fails,3 a provision expected to come into force in September 2020.4 “These requirements will oblige asset managers to make operational changes to ensure they instruct their intermediaries to deliver in good time in order to offset the risk of fines for failed settlements," said Phillis. “It will also require firms to ensure that pre-settlement data is valid, and accurate," she added.

Asset managers bracing for CSDR

A number of complex regulations have been imposed on asset managers over the last few years including the Alternative Investment Fund Managers Directive (AIFMD) and the Markets in Financial Instruments Directive II (MiFID II), notwithstanding the acceleration of Brexit contingency planning, all of which may have distracted some firms from focusing on CSDR requirements. Phillis noted that it was also important for asset managers to be aware of CSDR's geographical reach. “CSDR is an extraterritorial piece of legislation that extends well beyond the EU's border as it applies to any security settled in an EU Central Securities Depository or International Central Securities Depository," she said.

Buy-side firms such
as asset management
companies are not
exempt from CSDR

The limited buy-side preparation for CSDR can also be partly attributed to the widely held notion at investment firms that their brokers and custodians are solely responsible for ensuring that trades settle on time.5 CSDR changes that dynamic. In the event of a trade not settling on the contractual settlement date, the rules demand that Central Securities Depositories (CSDs) levy a fine on the at-fault counterparty, with the penalty proceeds going to the institution on the other side of the transaction.6

“Until now, if a broker decided to charge a fund manager client interest for continually failing to deliver securities on time, then the client would go elsewhere. Yet under CSDR, interest charges will be mandatory. It is a bit like dealing with a credit card, if you do not pay your bill on time you get charged 4% APR. With a 3.65% charge penalty whacked onto late settlement, CSDR is not dissimilar. Therefore, unless asset managers start delivering securities in a timelier fashion, they could face some hefty fines," writes Daniel Carpenter, Head of Regulation at Meritsoft, a regulatory technology company.

Buy-in rules, whereby the purchasing counterparty must buy-in in the event of a failed settlement within a prescribed time period (four days for liquid securities and seven days for all other securities such as bonds), may create a number of added risks for asset managers.8

These requirements will oblige asset managers to make operational changes to ensure they instruct their intermediaries to deliver in good time in order to offset the risk of fines for failed settlements

With the CSDR settlement discipline 2020 deadline moving ever closer, impacted buy-side firms should consider the requirements and look to make the necessary preparations.

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