ECSDA responds to ESMA on settlement discipline

19 Feb 2015 – What will be the market impact of the CSDR rules on settlement discipline? The draft measures issued by ESMA for consultation in December 2014 in the context of the CSD Regulation (CSDR) would create a settlement discipline framework which has the potential to substantially affect the way securities transactions are cleared and settled today.

In its response to the consultation, ECSDA insists that the impact of the proposed measures should not be underestimated and highlights six problems that need to be addressed before the draft standards are finalised and become law:

1. There must be a solid impact assessment to accompany the standards. ECSDA is disappointed by the lack of impact assessment in the ESMA Consultation given the substantial market-wide effect the future settlement discipline framework is expected to have. For instance, according to estimates compiled by ECSDA, the total number of buy-ins per year could reach over 1.8 million, representing a total value of more than EUR 2.5 trillion. As for the gross amount of late settlement penalties to be collected by CSD, it could total EUR 2.2 billion.
2. CSDs should not play a central role in relation to buy-ins. Although CSDs, unlike CCPs, are not required to execute buy-ins, ESMA suggests giving CSDs an unprecedented role, requiring them to perform new tasks which are not entrusted to them today, such as collecting detailed information on buy-ins, appointing a buy-in agent, or performing “consistency tests” on the instructions they receive in order to prevent multiple buy-ins. Some of these tasks might not be practically possible for CSDs to perform and are likely to increase CSDs’ risk profile by creating new liabilities. An alternative approach is needed whereby buy-ins are handled at trading level, not at the settlement level.
3. Legislation should not impose specific technical functionalities in CSD systems. Some draft ESMA standards are too prescriptive, mandating for instance the compulsory matching fields, technical functionalities that CSDs should offer their clients, the number and duration of settlement batches etc. CSDs are convinced that a high level of settlement efficiency can better be achieved by allowing each CSD to decide on the most appropriate tools and technical solutions, based on the specific characteristics of the market in which it operates.
   
   Besides, ESMA seems to underestimate the importance of harmonising market practices prior to imposing the use of certain harmonised standards. Imposing mandatory matching fields by law might not only create obstacles to future adaptations, it could also increase the number of settlement fails and create systemic risk if market practices have not been harmonised beforehand.
4. ESMA should not mandate the use of codes which are not compatible with global standards. Some of the codes currently being proposed by ESMA in relation to CSD records and the identification of certain transactions and instruments for the purpose of the settlement discipline regime are not aligned with internationally recognised ISO standards, yet CSDs and their participants operate in global markets.
5. As regards penalties for late settlement, the system proposed by ESMA will only work if some conditions are met, including:
   
   (a) a central database of financial instruments allowing CSDs to determine which instruments are “in scope” and which are “out of scope” of penalties and buy-ins;
   
   (b) clear rules on the source of reference prices to be used by CSDs to calculate penalties;
   
   (c) consistent categories of instruments: the categories used in CSD fails reports should match the categories used to determine the level of the penalty rate.
6. Finally, ESMA is right to recommend a phase-in for the implementation of the settlement discipline rules, but 24 months would be more appropriate than 18 months given the parallel implementation of TARGET2-Securities by several EU CSDs.

Read the full ECSDA response to ESMA on settlement discipline (with cost estimates and market impact analysis in Annex)

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