ISLA: CSDR buy-ins may deter asset owners from lending
03 February 2021 UK
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The introduction of mandatory buy-ins for settlement fails as part of the Central Securities Depositories Regulation’s (CSDR) settlement discipline regime (SDR) in February 2022 may put asset owners off from lending and drain the global liquidity pool, warns the International Securities Lending Association (ISLA).
The trade body submitted a pragmatic response to the European Commission’s CSDR consultation, which closed yesterday and drew widespread concern
over the requirements of the SRD, with many industry stakeholders offering various suggestions on how it could be amended without losing the spirit of the regulation’s aims.
Along with the mandatory buy-ins, the regime would also bring cash penalties for failing to settle trades.
In ISLA’s letter to the European Commission, Adrian Dale, head of regulation and market practice, writes: “Our members consider the introduction of a penalty mechanism to be an effective tool in reducing settlement failures across our industry, and strongly believe that this mechanism alone will help to achieve that objective.
“However, there is unanimous industry concern relating to the introduction of a mandatory buy-in," he adds.
Dale outlines that the one-size-fits-all buy-in proposal “could be severely damaging to market liquidity”, if applied to securities financing transactions, adding that securities lending, in particular, contributes to reducing settlement fails by offering an alternative avenue for accessing securities when traditional routes breakdown.
“Members are also concerned that by introducing an additional risk for parties to securities lending transactions, asset owners that engage in securities lending as a low-risk discretionary activity may be deterred from lending their assets,” Dale continues. “This would reduce the pool of securities available to borrow, leading to less liquidity and increased settlement failure.”
As such, ISLA would "strongly recommend” the introduction of the SDR be decoupled into two phases.
Phase one would see the cash penalties go-live as planned in February 2022 without the buy-ins. Phase two introduces the buy-in requirement after policymakers conduct an “in-depth assessment of the penalty mechanism to understand if it alone can achieve ‘target’ efficiency rates and grant the European Securities and Markets Authority to recalibrate penalty rates where no significant improvement is shown”.
Additionally, Dale suggests, the authority should clarify the scope of instrument types captured by the buy-in regime to ensure its effectiveness and, after further consultation with the industry, resolve any ambiguity in the current regulation.
ISLA also uses the consultation response to highlight the significant legal repapering exercise that baking the buy-in requirement into contracts would entail.
“Implementing Article 25 of the regulatory technical standards will require firms to expend significant legal and operational resources, in order to establish contractual arrangements with clients and counterparts,” Dale writes. “This represents a significant undertaking whilst providing little practical benefit, considering the securities financing master agreements contain contractual remedies addressing settlement failures."
Dale suggests that these remedies “have been an effective means of governance for many years and members believe they match the objectives of the buy-in requirements under CSDR. Any amendments to the current documentation will result in a global repapering exercise, which will take considerable time.”
ISLA, like the International Capital Market Association, concludes by emphasising that, given regulators are not expected to respond until Q4, this timetable risks leaving those in-scope of the SDR very little time to pivot their legal and infrastructure frameworks to comply with the rules in time with February 2022.
The trade body submitted a pragmatic response to the European Commission’s CSDR consultation, which closed yesterday and drew widespread concern
over the requirements of the SRD, with many industry stakeholders offering various suggestions on how it could be amended without losing the spirit of the regulation’s aims.
Along with the mandatory buy-ins, the regime would also bring cash penalties for failing to settle trades.
In ISLA’s letter to the European Commission, Adrian Dale, head of regulation and market practice, writes: “Our members consider the introduction of a penalty mechanism to be an effective tool in reducing settlement failures across our industry, and strongly believe that this mechanism alone will help to achieve that objective.
“However, there is unanimous industry concern relating to the introduction of a mandatory buy-in," he adds.
Dale outlines that the one-size-fits-all buy-in proposal “could be severely damaging to market liquidity”, if applied to securities financing transactions, adding that securities lending, in particular, contributes to reducing settlement fails by offering an alternative avenue for accessing securities when traditional routes breakdown.
“Members are also concerned that by introducing an additional risk for parties to securities lending transactions, asset owners that engage in securities lending as a low-risk discretionary activity may be deterred from lending their assets,” Dale continues. “This would reduce the pool of securities available to borrow, leading to less liquidity and increased settlement failure.”
As such, ISLA would "strongly recommend” the introduction of the SDR be decoupled into two phases.
Phase one would see the cash penalties go-live as planned in February 2022 without the buy-ins. Phase two introduces the buy-in requirement after policymakers conduct an “in-depth assessment of the penalty mechanism to understand if it alone can achieve ‘target’ efficiency rates and grant the European Securities and Markets Authority to recalibrate penalty rates where no significant improvement is shown”.
Additionally, Dale suggests, the authority should clarify the scope of instrument types captured by the buy-in regime to ensure its effectiveness and, after further consultation with the industry, resolve any ambiguity in the current regulation.
ISLA also uses the consultation response to highlight the significant legal repapering exercise that baking the buy-in requirement into contracts would entail.
“Implementing Article 25 of the regulatory technical standards will require firms to expend significant legal and operational resources, in order to establish contractual arrangements with clients and counterparts,” Dale writes. “This represents a significant undertaking whilst providing little practical benefit, considering the securities financing master agreements contain contractual remedies addressing settlement failures."
Dale suggests that these remedies “have been an effective means of governance for many years and members believe they match the objectives of the buy-in requirements under CSDR. Any amendments to the current documentation will result in a global repapering exercise, which will take considerable time.”
ISLA, like the International Capital Market Association, concludes by emphasising that, given regulators are not expected to respond until Q4, this timetable risks leaving those in-scope of the SDR very little time to pivot their legal and infrastructure frameworks to comply with the rules in time with February 2022.
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