The Settlement Disciple Regime
The Settlement Discipline Regime (“SDR”) is part of the third phase of the implementation of the Central Securities Depositories Regulation (“CSDR”). Following some delays, it is currently scheduled to come into force on 1 February 2022.
The SDR is designed to improve the safety and efficiency of securities settlement, particularly for cross-border transactions, by ensuring that buyers and sellers receive their securities and money on time and without risk. The SDR provides a set of measures to prevent and address failures in the settlement of securities transactions (‘settlement fails’), including cash penalties, mandatory buy-ins and monitoring and reporting measures to be taken by the CSDs.
According to CSDR and the final Regulatory Technical Standards (RTS) from ESMA, the following principles must be applied by all EU central securities depositories (“CSDs”):
- A CSD shall provide for a cash penalty mechanism for participants who cause settlement fails.
- Cash penalties are to be calculated on a daily basis for each business day that a matched payment settlement instruction fails to settle on or after its intended settlement date (“ISD”), including those instructions that are “on hold” or failing due to a lack of cash.
- Penalties shall also apply to instructions that matched in the securities settlement system after their ISD.
- Cash penalties are calculated from the ISD until the actual settlement or (bilateral) cancellation date of the instruction.
- For settlement fails involving multiple CSDs, SDR penalties, if applicable, shall be calculated only by the CSD where settlement is actually taking place based on the “actual place of settlement” concept. This means that an investor CSD participating in another CSD shall comply with the terms and conditions of the latter.
- Daily reports shall be provided to the CSD participants in order to allow them to reconcile and calculate the recharge of the penalty to their underlying clients where applicable.
- The full amount collected as a penalty shall be redistributed to the participant who suffered from the fail at least on a monthly basis.
- A CSD must a) calculate and report penalties for participants that are central clearing parties (“CCPs”), but not actually collect or distribute any penalties and b) ensure that CCPs collect and redistribute penalties to the relevant clearing members and provide a monthly report to the CSDs.
Delay of mandatory buy-in element of SDR
On 23 September 2021, the European Securities Markets Authority (“ESMA”) sent a letter to Mairead McGuinness, Commissioner for Financial Services, requesting that consideration be given to modifying the implementation schedule for the SDR.
ESMA stated that market participants are largely ready to implement two of the key components of the settlement discipline regime (settlement fails reporting and cash penalties) on the scheduled date, but market participants have serious difficulties regarding the implementation of the mandatory buy-in regime, in particular:
- the absence of clarity regarding some open questions necessary for the implementation of the buy-in requirements.
- uncertainty as to whether the European Commission’s legislative proposal will include amendments to the mandatory buy-in rules and the extent of any potential amendments.
ESMA therefore said in its letter that it supports a delay of the buy-in regime to give time for a thorough consideration of the mandatory buy-in framework as part of settlement discipline.
Commissioner McGuinness indicated on 24 November 2021 that the European Parliament and the EU Council had agreed to delay implementation of the mandatory buy-in regime. It is not yet clear how long such delay will be.
The International Capital Markets Association (ICMA) welcomed the delay saying:
“ICMA has long taken the position that this regulatory initiative contained a number of critical design flaws as well as ambiguity around scope and process, not only from an implementation perspective, but also with respect to the potential implications for EU bond market liquidity and stability. ICMA looks forward to engaging further with the European Commission and ESMA as they review the role of regulatory buy-ins in the European bond markets, and how this sits with the objectives of CMU.”.