LCH wades into CSDR buy-in delay debate
27 January 2020 London
Image: Shutterstock
Global clearing house LCH is the latest market participant to acknowledge the likelihood of a delay to the Central Securities Depositories Regulation’s (CSDR) settlement regime, currently due to go live on 13 September.
CSDR aims to improve settlement discipline by the imposition of daily financial penalties for failed settlements and mandatory buy-in provisions.
In a recent whitepaper on the incoming regulation, LCH notes that full implementation of the settlement discipline regime is “widely expected to occur once modifications to the TARGET2-Securities settlement system run by the European Central Bank are tested and complete”.
The clearing house explains that these amendments are necessary to enable the financial penalties introduced by the settlement discipline regime to be processed.
According to LCH, a further extension, to early 2021, has been proposed, although the European Commission is yet to publicly comment on the matter.
For the securities finance market, the costs and challenges of CSDR will likely come indirectly, as short-dated (less than 30 days) transactions, such as repos, are excluded from buy-ins.
However, securities financing transactions without a fixed maturity date may not be exempt from the settlement discipline regime in the same way as repo transactions of less than 30 days in duration are.
In its whitepaper, LCH states that two consequences that may come from the settlement regime are that asset owners and their agent lenders may be less willing to lend securities, raising the cost of borrowing stock to cover short sales and settlements.
Additionally, the risks of short selling are increased by a lack of supply of securities available to borrow, greater recall risk and an increased possibility of being bought in.
LCH also notes that, on the flip side, the risk of being bought in might increase demand to borrow securities to avoid settlement fails.
The clearing house’s comments on focus largely on the technical requirements for a delay which
were highlighted last year by the International Capital Market Association (ICMA), among others.
Other market observers have raised several concerns around what has been described as fundamental flaws with the mandatory nature of the buy-in rules and lack of research around the impact of cash penalties.
The buy-in rules are expected to significantly increase the number of buy-ins instigated in the market, with an analysis by the European Central Securities Depositories Association using 2014 data from 11 European CSDs estimating as many as 1.8 million buy-ins a year, worth more than €2.5 trillion, could be seen.
Commenting on the research, LCH says that “while the actual outcome is unlikely to be as high as this, since market participants will adjust their behaviour, as is the intent of the settlement discipline regime, a significant increase from present levels of buy-ins is almost certain”.
LCH whitepaper came days before 14 trade bodies, including ICMA, sent a joint letter to the European Commission and the European Securities and Markets Authority calling for comprehensive reforms and a delay for CSDR’s settlement discipline.
“We [the associations] are extremely concerned that if the buy-in regime is implemented as it stands, there will be a significant negative impact on market liquidity, operational processes, and ultimately, end investors,” the letter reads.
The letter warns that the costs for in-scope market participants that will come directly or indirectly from the settlement regime’s have not been satisfactorily modelled by ESMA or the commission and not enough time has been taken to ensure the market is comfortable and ready for the framework to be implemented.
CSDR aims to improve settlement discipline by the imposition of daily financial penalties for failed settlements and mandatory buy-in provisions.
In a recent whitepaper on the incoming regulation, LCH notes that full implementation of the settlement discipline regime is “widely expected to occur once modifications to the TARGET2-Securities settlement system run by the European Central Bank are tested and complete”.
The clearing house explains that these amendments are necessary to enable the financial penalties introduced by the settlement discipline regime to be processed.
According to LCH, a further extension, to early 2021, has been proposed, although the European Commission is yet to publicly comment on the matter.
For the securities finance market, the costs and challenges of CSDR will likely come indirectly, as short-dated (less than 30 days) transactions, such as repos, are excluded from buy-ins.
However, securities financing transactions without a fixed maturity date may not be exempt from the settlement discipline regime in the same way as repo transactions of less than 30 days in duration are.
In its whitepaper, LCH states that two consequences that may come from the settlement regime are that asset owners and their agent lenders may be less willing to lend securities, raising the cost of borrowing stock to cover short sales and settlements.
Additionally, the risks of short selling are increased by a lack of supply of securities available to borrow, greater recall risk and an increased possibility of being bought in.
LCH also notes that, on the flip side, the risk of being bought in might increase demand to borrow securities to avoid settlement fails.
The clearing house’s comments on focus largely on the technical requirements for a delay which
were highlighted last year by the International Capital Market Association (ICMA), among others.
Other market observers have raised several concerns around what has been described as fundamental flaws with the mandatory nature of the buy-in rules and lack of research around the impact of cash penalties.
The buy-in rules are expected to significantly increase the number of buy-ins instigated in the market, with an analysis by the European Central Securities Depositories Association using 2014 data from 11 European CSDs estimating as many as 1.8 million buy-ins a year, worth more than €2.5 trillion, could be seen.
Commenting on the research, LCH says that “while the actual outcome is unlikely to be as high as this, since market participants will adjust their behaviour, as is the intent of the settlement discipline regime, a significant increase from present levels of buy-ins is almost certain”.
LCH whitepaper came days before 14 trade bodies, including ICMA, sent a joint letter to the European Commission and the European Securities and Markets Authority calling for comprehensive reforms and a delay for CSDR’s settlement discipline.
“We [the associations] are extremely concerned that if the buy-in regime is implemented as it stands, there will be a significant negative impact on market liquidity, operational processes, and ultimately, end investors,” the letter reads.
The letter warns that the costs for in-scope market participants that will come directly or indirectly from the settlement regime’s have not been satisfactorily modelled by ESMA or the commission and not enough time has been taken to ensure the market is comfortable and ready for the framework to be implemented.
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