CSDR’s buy-in rules will hinder, not help the market, survey shows
28 November 2019 London
Image: Shutterstock
The majority of the market participants expect the incoming EU buy-in provisions, aimed at improving settlement discipline, to negatively impact market efficiency and liquidity, according to new market research.
The results of a survey by the International Capital Market Association (ICMA), released yesterday, have prompted calls by industry stakeholders for EU regulators to go back to the drawing board to fix fundamental errors that have caused the buy-in rules to now not be fit-for-purpose.
ICMA’s survey revealed that 84 percent of respondents believed the buy-in regime would be detrimental to the market, with 56.25 percent suggesting it would ‘worsen’ market liquidity and efficiency and a further 23.13 percent saying it would ‘significantly worsen’ the trading environment.
Only 9.38 percent said it would improve the market.
The survey garnered 44 respondents including 12 securities lending and repo desks, 16 buy-side firms and 16 sell-side firms.
The CSDR buy-in rules are currently officially slated to come into force in September 2020 but ESMA has acknowledged a delay is likely as there are fundamental technical issues with its implementation that won’t be addressed until SWIFT’s annual November update.
Once in place, the rules create a mandatory obligation for trading parties to execute buy-ins against counterparties who fail to settle their trades within a required period.
The requirements will apply to trades that are intended to settle on EU international central securities depositories (ICSD) and CSDs.
ICMA’s report has warned that the buy-in rules will cause several unintended consequences and change securities lending participants’ behaviour as new risks will be introduced and overall market liquidity will likely be reduced.
More than half of survey respondent firms have plans to adapt their operational processes and approaches to trading and risk management, with repo and securities lending businesses leading the field, according to ICMA.
Commenting on the association’s report, ICMA's senior director in market practice and regulatory policy team, Andrew Hill, said he was not surprised by the results, adding that “taking something [the buy-in process] that is currently a contractual remedy and a risk management tool and altering it so radically is questionable."
“This was always going to fail and it was never going to help market liquidity,” he added.
Unlimited potential fails costs
Hill explained that the reality of the scale of the problem that transaction fails in the bond market posed was unclear and that there are “so many better tools to use” to address it.
In ICMA’s report, the association predicted that bid-ask spreads of all bond sub-classes will “more than double”, with covered bonds and illiquid investment-grade credit seeing the biggest impact.
In absolute price terms, ICMA noted, the impact is most notable at the lower end of the credit spectrum, with significant increases for emerging markets, high yield, and illiquid investment-grade corporate bonds.
“There is a flaw in the regulation which means the cost to the failing party could potentially be significantly higher than with the current buy-in method,” Hill said. “It’s very dangerous for lending securities as well because if you lend a security but don’t get it back you may be able to pass on the buy-in costs but if there’s a loss due to asymmetry in the buy-in rules dynamic then that’s a consequential loss and cannot be passed on.”
Hill explained that EU regulators have been clear that maintaining securities lending market liquidity is important but by introducing these new risks, that’s is only going to disincentivise new or existing market participants and create a “liquidity death spiral”.
Possible solutions
With the extent of the potentially damaging effects of the buy-in rules laid bare, Hill is now calling on the European Commission to take heed of ICMA’s report and take steps to rectify the market’s concerns.
“I would like the commission to really consider the possible impacts and go back to the way they focused on liquidity when drafting the Markets in Financial Instruments Directive transparency framework.”
“We currently have an effective framework for over-the-counter buy-ins in the form of the ICMA buy-in rules, which are a contractual mechanism that’s existed for decades.”
Hill added that in order for the buy-in rules to work they shouldn’t be overly prescriptive in terms of timing, and should include exemptions, or at least a staggered implementation timeline, for illiquid bonds that would be most likely to cause losses during the buy-in process.
Elsewhere in the report, further concerns were raised about a general lack of understanding of the terms of CSDR and its buy-in rules.
In answering whether the wider market was cognisant of the requirements and likely impacts of the regulation, the vast majority of all three demographics of respondents (buy-side, sell-side and securities lending and repo desks) reported a 'limited awareness' or 'very little awareness' of the requirements and likely impacts of the regulation.
The results of a survey by the International Capital Market Association (ICMA), released yesterday, have prompted calls by industry stakeholders for EU regulators to go back to the drawing board to fix fundamental errors that have caused the buy-in rules to now not be fit-for-purpose.
ICMA’s survey revealed that 84 percent of respondents believed the buy-in regime would be detrimental to the market, with 56.25 percent suggesting it would ‘worsen’ market liquidity and efficiency and a further 23.13 percent saying it would ‘significantly worsen’ the trading environment.
Only 9.38 percent said it would improve the market.
The survey garnered 44 respondents including 12 securities lending and repo desks, 16 buy-side firms and 16 sell-side firms.
The CSDR buy-in rules are currently officially slated to come into force in September 2020 but ESMA has acknowledged a delay is likely as there are fundamental technical issues with its implementation that won’t be addressed until SWIFT’s annual November update.
Once in place, the rules create a mandatory obligation for trading parties to execute buy-ins against counterparties who fail to settle their trades within a required period.
The requirements will apply to trades that are intended to settle on EU international central securities depositories (ICSD) and CSDs.
ICMA’s report has warned that the buy-in rules will cause several unintended consequences and change securities lending participants’ behaviour as new risks will be introduced and overall market liquidity will likely be reduced.
More than half of survey respondent firms have plans to adapt their operational processes and approaches to trading and risk management, with repo and securities lending businesses leading the field, according to ICMA.
Commenting on the association’s report, ICMA's senior director in market practice and regulatory policy team, Andrew Hill, said he was not surprised by the results, adding that “taking something [the buy-in process] that is currently a contractual remedy and a risk management tool and altering it so radically is questionable."
“This was always going to fail and it was never going to help market liquidity,” he added.
Unlimited potential fails costs
Hill explained that the reality of the scale of the problem that transaction fails in the bond market posed was unclear and that there are “so many better tools to use” to address it.
In ICMA’s report, the association predicted that bid-ask spreads of all bond sub-classes will “more than double”, with covered bonds and illiquid investment-grade credit seeing the biggest impact.
In absolute price terms, ICMA noted, the impact is most notable at the lower end of the credit spectrum, with significant increases for emerging markets, high yield, and illiquid investment-grade corporate bonds.
“There is a flaw in the regulation which means the cost to the failing party could potentially be significantly higher than with the current buy-in method,” Hill said. “It’s very dangerous for lending securities as well because if you lend a security but don’t get it back you may be able to pass on the buy-in costs but if there’s a loss due to asymmetry in the buy-in rules dynamic then that’s a consequential loss and cannot be passed on.”
Hill explained that EU regulators have been clear that maintaining securities lending market liquidity is important but by introducing these new risks, that’s is only going to disincentivise new or existing market participants and create a “liquidity death spiral”.
Possible solutions
With the extent of the potentially damaging effects of the buy-in rules laid bare, Hill is now calling on the European Commission to take heed of ICMA’s report and take steps to rectify the market’s concerns.
“I would like the commission to really consider the possible impacts and go back to the way they focused on liquidity when drafting the Markets in Financial Instruments Directive transparency framework.”
“We currently have an effective framework for over-the-counter buy-ins in the form of the ICMA buy-in rules, which are a contractual mechanism that’s existed for decades.”
Hill added that in order for the buy-in rules to work they shouldn’t be overly prescriptive in terms of timing, and should include exemptions, or at least a staggered implementation timeline, for illiquid bonds that would be most likely to cause losses during the buy-in process.
Elsewhere in the report, further concerns were raised about a general lack of understanding of the terms of CSDR and its buy-in rules.
In answering whether the wider market was cognisant of the requirements and likely impacts of the regulation, the vast majority of all three demographics of respondents (buy-side, sell-side and securities lending and repo desks) reported a 'limited awareness' or 'very little awareness' of the requirements and likely impacts of the regulation.
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