It’s a truism to say that since 2008 we’ve seen unprecedented levels of regulatory change in financial markets. Relentless initiatives to increase transparency, harmonise market standards and reduce risks to end clients have rolled in, despite numerous attestations from buy and sell-side that we’re fast reaching saturation in terms of both understanding and implementation. MIFID, EMIR, benchmarking and Brexit have drained banks’ change budgets and directed most BAs and project managers to focus their best energies on regulatory change.
Sadly, saturation doesn’t mean a slow down any time soon. Indeed by September 2020, in what could be the biggest shake-up ever in the optimisation of settlement fail and matching rates, ESMA are introducing the ‘Settlement Discipline Regime’ – part of CSDR (Central Securities Depository Regulation). The eye of the storm will be the introduction of mandatory buy-ins (S+5 – Equity & S+7 – FID) along with late settlement penalties and late matching penalties for equity and fixed income transactions that don’t settle on contractual settlement date. By introducing these penalties there’s little doubt that ESMA are serious about achieving their desired ambition of increasing settlement efficiency.
For most CSD participants this is a welcome and desired aspiration. But just how possible is it to achieve ESMA’s long-coveted 99.5% settlement efficiency rate? The truth is many institutions will struggle get close to this level without major investment in re-designing legacy booking models, front to back systems, data management and introducing automation.
Investment now could be money well spent in the long run. The direct trading P&L impact of this new regulation should not be underestimated by EU CSD participants. The upper limit (1 bp) late settlement charge may seem punitive when compared to market lending rates, but it’s worth considering that, even if you’re able to meet ESMA’s 99.5% settlement efficiency rate, the costs can still be prohibitive. For example:
- If a bank’s net $ value of sales totals $10,000,000,000 per day and they have an average fail rate of 0.5% with an average fail duration of just one day, the costs incurred as a result of the new 1bp fail fines will equate to $1,280,000 each year.
And the buy-side are not out of the firing line.
- The late matching penalty ensures it will also be in their interests to have robust confirmation and instruction interfaces with their custodians that ensure they do not accrue avoidable penalties. Coupled with the risk of buy-in exposure and related costs it will be in everyone’s interest to match and settle transactions within the agreed parameters.
We’re advising our clients to begin working on CSDR as soon as possible, particularly with several other regulations and market events that could result in a fresh 2020 regulatory deluge. SFTR may currently be scheduled for go-live in Q1 2020, but this date has already been adjusted and could be pushed back to come in-line with the go-live for CSDR Settlement Discipline. Added to that, if a transition deal for Brexit is agreed, the EU have advised that the transition should not extend beyond 31st December 2020, possibly also bringing this into scope for Q4 2020.
Next time we’ll focus on the possible liquidity risks, costs and administrative burdens of mandatory buy-ins. Contact us to find out more.
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Note: This opinion piece was first published by Catalyst prior to the Davies merger
