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January 23, 2018

It Ain’t Over Till The Fat Lady Sings (Part 1) The Central Securities Depositories Regulation (CSDR)

The standard response I get to CSDR is the “yeah so what, we’re not a CSD”. Brilliant. That’s a bit like saying that you’re out of scope of EMIR because you’re not a CCP and so what is CSDR all about?

The standard response I get to CSDR is the “yeah so what, we’re not a CSD”. Brilliant. That’s a bit like saying that you’re out of scope of EMIR because you’re not a CCP and so what is CSDR all about?

Historically, CSDs – such as Crest – along with their ‘international’ (ICSD) cousins – such as Euroclear – used to be regulated in the EU at a Member State level and CSDR, quite simply, aims to harmonise that by creating a common authorisation, supervision and regulatory framework for CSDs, much like EMIR did for CCPs.

Granted, much of CSDR is about the authorisation of CSDs and the recognition of their third country equivalents but, just like with EMIR, there’s much more to this regulation that will impact your business and so the two requirements that I want to touch on are the Article 6 & 7 ‘settlement discipline’ measures and the Article 9 ‘settlement internaliser’ reporting obligation, both of which will affect all participants of a CSD and will require significant efforts to implement.

CSDR requires participants to settle their transactions on the intended settlement date and introduces a ‘two pronged’ approach to harmonising the timing and discipline of securities settlement in Europe. First up is the Article 6 ‘measures to prevent settlement fails’, that encourage and incentivise the timely settlement of transactions, followed by the Article 7 ‘measures to address settlement fails’, which deter settlement fails through mandatory cash penalties and a buy-in mechanism. This pretty much amounts to what it says on the tin – firms need to try harder to settle on time and when they don’t, they’re going to be whacked with a cash penalty, followed by a compulsory buy-in if that doesn’t work. Perennial failers take note!

We’re still waiting for the final technical standards but we do have a comprehensive 112 page Final Report that details the draft RTS and ITS for the settlement discipline regime and these are worth looking at now, even though the obligations won’t kick in for another 24 months following publication in the Official Journal.

In particular, the measures to prevent settlement fails will require CSDs and their participants to:

  • Make enhancements to the allocation and confirmation process, including the mandatory offering of electronic interaction with professional clients
  • Automate the processing of all settlement instructions in order to improve STP and limit manual intervention
  • Provide for mandatory matching of settlement instructions in order to support fully automated, continuous real-time matching throughout the day

Whilst the measures to address settlement fails will require:

  • CSDs to implement a comprehensive monitoring and reporting regime for settlement fails
  • CSDs to implement a cash penalty mechanism for settlement fails, redistributable to the receiving participants that suffered from the settlement fail and calculated on a daily basis for each business day that a transaction fails to be settled after its intended settlement date
  • Cash penalties not to be considered as a source of revenue for CSDs but CSDs allowed to apply fees to cover costs
  • CSDs to implement a mandatory buy-in process for any financial instrument which has not been delivered within a set period (4 business days for liquid markets, 7 business days for illiquid markets and extendable to 15 days for SME growth markets) of the intended settlement date

The second point on my list for CSDR is the Article 9 ‘settlement internaliser’ reporting obligation – regulators are aware that the practice of internalising settlement exists and so they want better visibility over it. CSDR defines a settlement internaliser as the following:

“any institution, including one authorised in accordance with Directive 2013/36/EU [CRD IV] or with Directive 2014/65/EU [MiFID 2], which executes transfer orders on behalf of clients or on its own account other than through a securities settlement system”

And you’ll be surprised as to just how often this actually takes place. Cross securities in an omnibus account? – settlement internaliser. Cross securities through a custodian? – settlement internaliser. I mean heck, even CSDs cross securities through their own CSD, which should technically make them a settlement internaliser, other than the fact that they actually are the “securities settlement system” and so that technically doesn’t count, but I guess ESMA didn’t think of that one. Doh!

Anyway, whilst the reporting requirement could be worse  – it’s a quarterly report, not a daily report – this one has got a fixed go-live date of 10 March 2019 and so you’ve only got a year or so to finish this. To be honest, your real challenge here is probably not the reporting requirement per see, although this is far from trivial, but will be trying to identify every single touch point in your business where you might be a settlement internaliser and then centralising the data accordingly in order to make your report. If you’re a big bank, with lots of businesses, doing lots of things, you will have a bucket load of entities that settle securities and my guess is that you’ll still be discovering some of them buried at the back of a cupboard by the time this requirement goes live!

Clock’s ticking.


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