Reg Wars: A new hope
13 October 2020
The European Commission’s newly-outlined action plan for the coming years of regulatory initiatives has given securities finance market participants fresh optimism that some of today’s most stubborn regulatory headaches may soon be soothed
Image: sdecoret/stock.adobe.com
The European Commission (EC) has offered securities finance market participants a glimmer of hope that some of their biggest regulatory bug-bears may soon be addressed as part of its action plan for developing the Capital Markets Union (CMU).
The CMU is arguably one of the EU’s most ambitious projects and aims to unify member states through standardising financial markets from top to bottom.
The EC adopted the first CMU action plan in 2015 and the latest iteration, published in late September, argues that “significant progress” has been made “on putting the building blocks in place”. However, the report notes that “a lot still remains to be done and it is now time to step up the level of ambition”.
To that end, the commission has now detailed its next set of key priorities and legislative initiatives on capital markets to be completed by 2023.
The scope of the CMU is vast, but the latest action plan touches upon some very specific sore points for securities finance markets, namely the Central Securities Depositories Regulation (CSDR) and the Shareholders Rights Directive (SRD), which was updated to its second form on 3 September.
CSDR
Since the 2007/8 financial crisis, regulatory oversight has developed such that a constellation of new acronyms — each representing a plethora of new rules — now hangs over the securities financing landscape.
The one in accession directly over our market is the Securities Financing Transactions Regulation, which went live in July and required market players to construct comprehensive new technology frameworks to submit an offering of transaction data hitherto inaccessible for market overseers. What they will do with this hoard of information is yet to be seen.
But, the four letters keeping market participants up at night the most is CSDR. In brief, this regulation aims to create a common set of prudential, organisational, and business standards for EU CSDs.
A key aspect of CSDR is the settlement discipline regime, which is designed to support the Target2-Securities initiative by introducing mandatory buy-ins and cash penalties to encourage participants to improve settlement rates.
The regime has been plagued with issues — including a persistent lobbying effort by industry bodies flagging the potentially catastrophic consequences of its introduction — which have culminated in a second 12-month delay meaning it will now not see the light of day before February 2022, if at all.
As part of the EU’s action plan, the commission is committed to a review of the regulation aimed at improving cross-border settlement services. However, the investigation, which will not be completed before Q4 2021, will only focus on the CSD passport (its licence to offer services across the EU) and conditions for CSDs and credit institutions to provide bank-like ancillary activities. The settlement discipline regime, however, will not be examined.
Part of the reason behind this is that the review is not a direct reaction to stakeholder concerns but is required as standard for all EU regulation five years after implementation. Market observers described being disappointed, but not surprised.
That said, all is not lost. Before this review can take place, the commission must conduct a consultation with industry stakeholders and the European Securities and Markets Authority (ESMA). The scope of this consultation was recently expanded to include a discussion on all aspects of CSDR, including the regime.
This opens the door to the most outspoken reform advocates, such as the International Capital Market Association (ICMA) and the Association for Financial Markets in Europe, to repeat their concerns once again and, they hope, begin a dialogue for meaningful change that pleases all parties.
The outreach effort was meant to take place last year but was bumped due to the hectic regulatory schedule. It is now expected to take place before the end of the year.
The commission will be under no illusion as to the feedback it will receive. In its letter to ESMA recommending the delay to 2022, it stated: “Other stakeholders have also noted that market developments during this crisis would have been significantly worse in terms of available market liquidity (especially in the non-cleared bond and repo markets) if the mandatory buy-in regime was in place. We note that certain stakeholders have been precise in their communications to us, asking that the entry into force of the regulatory technical standards on settlement discipline be postponed for an additional year.”
This is a direct reference to one of the central concerns raised in ICMA’s latest of several letters sent to EU rulemakers on the subject of CSDR’s flaws. To address market issues with the mandatory buy-ins would require the commission to re-open the level one text and rebuild from the ground up. It has so far preferred to kick the can down the road but sources close to the matter are quietly confident that regulators now accept the rules are potentially damaging to market stability and are willing to give ground. Whether that means the buy-in rules are scrapped, which is the preference of many in the market, or just amended is yet to be seen.
SRD II
SRD II will require asset managers to disclose their policy on securities lending to institutional investors and how it is applied to fulfil its engagement activities, particularly ahead of the general meeting of the investee company. Among SRD II’s primary aims is to crack down on the misuse of voting rights, which were previously abused in several ways including via the borrowing of shares ahead of key corporate action dates to influence the result of company votes.
Similar to CSDR, those in-scope for SRD II were ringing loud alarm bells on its several defects long before it came into effect in September. Chief among these shortcomings is the fact it’s a directive and not a regulation, meaning it must be interpreted by each of the 27 EU member states. This is particularly pertinent to the defining of key terms, such as ‘shareholder’.
Unsurprisingly, in the immediate aftermath of go-live, market commentators highlighted that 27 slightly different definitions of a stakeholder now existed across the bloc.
To address this directly, the CMU action plan references the “possibility of introducing an EU-wide definition of shareholder”. The catch is that this was originally earmarked for completion by June 2022 but thanks to the pandemic disruption a legislative proposal to this effect may not appear until Q3 2023.
In addition, the EU also wishes to clarify rules on the corporate actions process, and the analysis of potential national regulatory barriers to the use of technology to facilitate communication between issuers and shareholders that will be taken forward by Q4 2021.
Market sources described the plan as “promising” but were unwilling to celebrate until proof of the EU’s commitment to the task was clear.
Despite the tepid wording, the EC’s acknowledgement of the specific issue of defining a shareholder is a step forward from earlier this year, when 11 trade bodies including the International Securities Lending Association, the European Banking Federation, ICMA, and AFME unsuccessfully pushed for a one-year delay to SRD II implementation. In its response to the joint letter in June, the commission made no reference to the shareholder problem while also dismissing the group’s claims that the pandemic had scuppered their implementation timelines.
In the days before implementation, the same group reiterated their concerns in a new letter and requested confirmation that, given the several areas of ambiguity in the rules framework, no fines for non-compliance would be issued until September 2021. They are yet to receive a response.
The CMU is arguably one of the EU’s most ambitious projects and aims to unify member states through standardising financial markets from top to bottom.
The EC adopted the first CMU action plan in 2015 and the latest iteration, published in late September, argues that “significant progress” has been made “on putting the building blocks in place”. However, the report notes that “a lot still remains to be done and it is now time to step up the level of ambition”.
To that end, the commission has now detailed its next set of key priorities and legislative initiatives on capital markets to be completed by 2023.
The scope of the CMU is vast, but the latest action plan touches upon some very specific sore points for securities finance markets, namely the Central Securities Depositories Regulation (CSDR) and the Shareholders Rights Directive (SRD), which was updated to its second form on 3 September.
CSDR
Since the 2007/8 financial crisis, regulatory oversight has developed such that a constellation of new acronyms — each representing a plethora of new rules — now hangs over the securities financing landscape.
The one in accession directly over our market is the Securities Financing Transactions Regulation, which went live in July and required market players to construct comprehensive new technology frameworks to submit an offering of transaction data hitherto inaccessible for market overseers. What they will do with this hoard of information is yet to be seen.
But, the four letters keeping market participants up at night the most is CSDR. In brief, this regulation aims to create a common set of prudential, organisational, and business standards for EU CSDs.
A key aspect of CSDR is the settlement discipline regime, which is designed to support the Target2-Securities initiative by introducing mandatory buy-ins and cash penalties to encourage participants to improve settlement rates.
The regime has been plagued with issues — including a persistent lobbying effort by industry bodies flagging the potentially catastrophic consequences of its introduction — which have culminated in a second 12-month delay meaning it will now not see the light of day before February 2022, if at all.
As part of the EU’s action plan, the commission is committed to a review of the regulation aimed at improving cross-border settlement services. However, the investigation, which will not be completed before Q4 2021, will only focus on the CSD passport (its licence to offer services across the EU) and conditions for CSDs and credit institutions to provide bank-like ancillary activities. The settlement discipline regime, however, will not be examined.
Part of the reason behind this is that the review is not a direct reaction to stakeholder concerns but is required as standard for all EU regulation five years after implementation. Market observers described being disappointed, but not surprised.
That said, all is not lost. Before this review can take place, the commission must conduct a consultation with industry stakeholders and the European Securities and Markets Authority (ESMA). The scope of this consultation was recently expanded to include a discussion on all aspects of CSDR, including the regime.
This opens the door to the most outspoken reform advocates, such as the International Capital Market Association (ICMA) and the Association for Financial Markets in Europe, to repeat their concerns once again and, they hope, begin a dialogue for meaningful change that pleases all parties.
The outreach effort was meant to take place last year but was bumped due to the hectic regulatory schedule. It is now expected to take place before the end of the year.
The commission will be under no illusion as to the feedback it will receive. In its letter to ESMA recommending the delay to 2022, it stated: “Other stakeholders have also noted that market developments during this crisis would have been significantly worse in terms of available market liquidity (especially in the non-cleared bond and repo markets) if the mandatory buy-in regime was in place. We note that certain stakeholders have been precise in their communications to us, asking that the entry into force of the regulatory technical standards on settlement discipline be postponed for an additional year.”
This is a direct reference to one of the central concerns raised in ICMA’s latest of several letters sent to EU rulemakers on the subject of CSDR’s flaws. To address market issues with the mandatory buy-ins would require the commission to re-open the level one text and rebuild from the ground up. It has so far preferred to kick the can down the road but sources close to the matter are quietly confident that regulators now accept the rules are potentially damaging to market stability and are willing to give ground. Whether that means the buy-in rules are scrapped, which is the preference of many in the market, or just amended is yet to be seen.
SRD II
SRD II will require asset managers to disclose their policy on securities lending to institutional investors and how it is applied to fulfil its engagement activities, particularly ahead of the general meeting of the investee company. Among SRD II’s primary aims is to crack down on the misuse of voting rights, which were previously abused in several ways including via the borrowing of shares ahead of key corporate action dates to influence the result of company votes.
Similar to CSDR, those in-scope for SRD II were ringing loud alarm bells on its several defects long before it came into effect in September. Chief among these shortcomings is the fact it’s a directive and not a regulation, meaning it must be interpreted by each of the 27 EU member states. This is particularly pertinent to the defining of key terms, such as ‘shareholder’.
Unsurprisingly, in the immediate aftermath of go-live, market commentators highlighted that 27 slightly different definitions of a stakeholder now existed across the bloc.
To address this directly, the CMU action plan references the “possibility of introducing an EU-wide definition of shareholder”. The catch is that this was originally earmarked for completion by June 2022 but thanks to the pandemic disruption a legislative proposal to this effect may not appear until Q3 2023.
In addition, the EU also wishes to clarify rules on the corporate actions process, and the analysis of potential national regulatory barriers to the use of technology to facilitate communication between issuers and shareholders that will be taken forward by Q4 2021.
Market sources described the plan as “promising” but were unwilling to celebrate until proof of the EU’s commitment to the task was clear.
Despite the tepid wording, the EC’s acknowledgement of the specific issue of defining a shareholder is a step forward from earlier this year, when 11 trade bodies including the International Securities Lending Association, the European Banking Federation, ICMA, and AFME unsuccessfully pushed for a one-year delay to SRD II implementation. In its response to the joint letter in June, the commission made no reference to the shareholder problem while also dismissing the group’s claims that the pandemic had scuppered their implementation timelines.
In the days before implementation, the same group reiterated their concerns in a new letter and requested confirmation that, given the several areas of ambiguity in the rules framework, no fines for non-compliance would be issued until September 2021. They are yet to receive a response.
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