Section 1: General Updates and Industry News
With planning and development continuing for readiness for CSDR, this document will provide updates on the key questions and details which are under discussion in the industry. As firms prepare for operational readiness, regulatory bodies and industry groups have ongoing discussions on the scope of regulation, the priority and focus areas, and how these will impact on trading parties settling securities transactions in European CSDs.
| The implementation of the Settlement Discipline Regime (SDR) has been delayed once more until February 2022. Will this be the final timeline for the go-live of the SDR? | In July 2020, ESMA confirmed the European Commission approval to delay the Settlement Discipline Regime go-live once more. It has been originally expected to proceed as of September 2020 and was first pushed back to February 2021. Events such as the global pandemic impacts in 2020, large market trading volatility in March and April 2020, as well industry feedback on readiness for topics such as mandatory buy-ins appear to have supported the decision to delay again. It is not possible to be completely certain that the Settlement Discipline will enter into force on February 1, 2022 as it is currently written. While the industry is broadly supportive of the implementation of the penalty regime in 2022, there is still intense lobbying of the EU Commission to either delay the implementation of the buy-in regime or amend the practical operation of buy-in mechanism. Based on the recently concluded consultation, the EU Commission is due to publish an interim report in the second quarter of 2021 which should give further indication if the timeline will remain unchanged. |
| The European Commission has also been doing a regulatory review of CSDR early in 2021. Will the feedback to that review mean likely changes in scope or timing of the regulation? | Firstly, it is worth referencing that the European Commission performs a cyclical review of such major regulations, usually each 5 years. With parts of CSDR having been initially implemented in 2014 / 2015, the review began in Q4 2020, and industry feedback was gathered until early February 2021. The review allows the possibility to assess how the legislation fares against market conditions and looks to gather comments from industry participants to provide operational-level comments on the regulation. In this instance, it also allowed the industry to provide feedback on aspects of CSDR, the Settlement Discipline Regime (SDR), that had not entered into force at the time. For this CSDR review, there was wide industry engagement, which resulted in large amount of responses received. Industry associations such as AFME, ECSDA, ISLA, the AGC, the IA – as well as local industry bodies in different European markets – all provided their comments and feedback. The European Commission is reviewing all submissions and expects to give initial feedback in Q2 2021, with full detailed feedback to be provided in Q4 2021. An initial assessment of the feedback on the proposed SDR focused on buy-in mechanism, looking at the requirements for buy-ins to be mandatory, as well as the capability of buy-ins agents to support the volumes and asset classes. Other impacts such as the need for a buy-in pass-on mechanism to avoid multiple buy- in for related trades. It remains to be seen if the EU Commission will propose regulatory updates or changes in scope based on this consultation and the resulting industry feedback. At this point, an interim report is expected from the EU Commission during the second quarter of 2021. |
| How do the industry updates impact on BBH’s readiness for SDR go-live? | As the outcome of the consultation is still to be understood, we will continue with our currently planned development and testing to support the more preventative measures, such as partial settlement, hold and release. We are planning to be ready for the cash penalty and buy-in elements of the Settlement Discipline Regime with the February 2022 go-live date in mind. Consideration is also being given to where we may engage in industry wide testing and dry running of the cash penalty regime – expected in the second half of 2021. |
Section 2: Trade Settlements and Preventative Measures Impacts for Trading Parties
Custodians will be in a key position in supporting their clients CSDR readiness, both through supporting preventative measures to achieve the best rates of settlement success, supporting the new messaging activity needed for clients to manage their cash penalties and buy-ins activity.
| What preventative measures can BBH expect to provide to help avoid penalties and buy-ins? |
Managing SSIs (Standing Settlement Instructions) will be a key activity ahead of go-live of the regulation. BBH works closely with providers such as DTCC and their GC Direct tool which allows for automatic updates of their SSIs across their network when any changes have been applied. With a focus on efficient instruction matching to avoid cash penalties, a clean-up of SSIs before CSDR go-live, and then ongoing maintenance of them over time will become more important. Partial Settlement is another key area to support preventative measures. The legislation directly referencing the use of partial settlement to reduce the impacts of cash penalties and buy-ins and this shows how the use of partial settlement will likely become more of a standard to be used when settling in European markets. This will allow for settlement of as much of the available position as possible on the Intended Settlement Date (ISD). BBH continues to work on further developing capabilities to support preventative measures, such as partial tags, partial release, cancellations and hold & release functionality. |
| How will BBH provide visibility of settlement statuses with CSDR impacts in mind? | Real-time reporting of data related to trade instructions and trade settlements will be key to being in the best position to take any preventative action to avoid trade fails. BBH provides real-time updates to the settlement status of trades via SWIFT MT548 status messages and are also available in the custody reporting tools on the BBH Infuse portal. Should a trade not have settled at the CSD, BBH provides various options for clients to understand the status. The transaction will have a failed (‘FD’) status applied, which will be visible on the BBH Infuse portal and can also be seen via the MT537 Statement of Pending Transactions. The MT536 Statement of Transactions or the BBH portal is also available for clients to understand what has settled during the previous business day. |
Section 3: Settlement Discipline Regime Impacts for firms
While the regulation aims to improve the settlement success rates, and preventative measures can help avoid trade fails – we expect that cash penalties and buy-ins will still occur from trades failing to settle on the Intended Settlement Date. In our custodian role, BBH will support the communication of the daily penalties and the collection and distribution of the monthly net amounts, while also ensuring that requirements around the buy-in processes will be supported.
| How do the preparations for penalty handling look from a custodian perspective? | Daily and monthly reporting will be provided by the CSDs to their direct participants, and on through the chain of custody to the custodians and their clients. Current understanding says that daily penalties (for the previous business days activities) will be reported by the CSDs by 12PM CET each day. Once received BBH will look to match the penalty to a valid failed trade record on our platform and confirm that BBH did not negatively impact the processing of the original settlement instructions. BBH will not validate the penalty calculation itself, as not all the reference data will be present on the inbound messaging. Should there be no daily penalty reports provided for a certain day, BBH will not send a Swift MT537 message. Clients that generate reports via the BBH Infuse online portal will have no records returned for a date that BBH has not received any penalties for the client’s account. Monthly penalty reports will be provided by the CSDs to their participants on the 15th business day of the next month (after the trade fails occurred) and they will be a summary of the daily penalty reports previously provided. BBH will provide clients with their final monthly report as soon as possible after the 15th business day after receiving and reconciling the monthly report versus the daily penalties we received. CSDs will process penalty payments on the 17th business day by doing net debits and credits between their participants. BBH will process penalty debits and credits to our clients as soon as possible after the 17th business day and provide clients with a 2-day pre-notification of the upcoming debits or credits to their accounts. Clients will have the option of electing to have an FX Standing Instruction to fund or repatriate all penalties to a single base currency. BBH will only support direct debiting of CSDR penalties though clients may elect to have all penalties directed to or debited from a specific account. |
| Will custodians be managing the appeals on behalf of their clients? | Appeals to the CSD against a penalty record will be allowed only in limited circumstances – for example when a security is no longer tradeable, or when the CSD may have incorrectly reported a penalty based on a technological error. CSDs will allow appeals from their direct participants, and in the case that firms wish to appeal a penalty formally, BBH will support that communication chain, using our network of sub-custodians to connect with the CSDs to input the appeal and receive the response. |
| How will bi-lateral claims be considered for CSDR penalties? | With the limited nature of the appeal process, a bi-lateral claim process will be required to allow counterparties to request repayment of a penalty that they do not believe is their responsibility. Industry proposals for a best practice are being drafted to apply similar claims principles as there already are in place for processes such as interest claims. BBH will not be directly engaged in the bi-lateral claims process. |
| How will custodians be involved in the buy-in process? | As a custodian, BBH does not expect to be engaged directly in the execution of a buy-in, as that is seen as another standard trading scenario. BBH will support the custody messaging activity that the buy-in requires. An example of that messaging is forwarding the client’s instruction to place the original settlement instruction on hold to our sub-custody network, where MT530 instructions will be provided to first hold and later release the original trade instructions, when the buy-in has been successfully completed. Cancellation instructions would be provided by an MT54X Cancel Swift message. |
| There is only one confirmed buy-in agent in place. Will it be possible that trading parties can act as their own buy-in agents to settle a buy-in trade? | For now, a third party buy-in agent must be appointed to execute the buy-in and provide the settlement messaging for the buy-ins. As the industry gets more feedback from the Regulator, this situation may develop further. Whether there will be other buy-in agents available to be appointed by Feb 2022 is a further consideration for the Regulator. |
Section 4: Developments for other functional areas
| What impacts will there be to Securities Lending transactions from CSDR? |
Securities Lending trades are expected to be subject to penalties and potential buy-ins, although some regulatory clarity is still being sought there. Where penalties will be calculated for Securities Lending trades, they will follow the same flows as the overall custody models. Differences may occur where there can be third party lending agents involved in the flow, and if they can have penalty ownership then identifying them and passing penalty messaging to them to be settled will require additional effort specific to Securities Lending flows. |
| Are ETFs considered as being in scope of the regulation? How will they be affected here? | While primary market ETFs creations and redemptions are not expected to be in scope of the regulation, the underlying basket security trades will be in scope. Thus, parties involved in ETFs (ETF Issuers, brokers and AP’s) will need to also monitor the underlying security trades settlements in case of potential impact from the Settlement Discipline Regime. Penalty flows are expected to be handled in the same manner as other custody flows here. |
| How will CSDR penalties and buy-ins be accounted for with Fund Accounting in mind? | Discussions in the industry continue regarding how fund accounting will accrue for the penalties and consider the downstream flow to financial reporting and other needs. Current consensus is that the monthly cash penalty movements will flow from Custody to Accounting via the existing cash connectivity, for inclusion in the NAV on a cash receipt/payments basis. If a buy-in occurs and is processed on Custody, this will also flow to Accounting via the existing trade connectivity for inclusion in the NAV in line with standard trade processing protocols. |
Section 5: Other
| Should firms be preparing for contractual re-papering ahead of the Settlement Discipline Regime? |
There are two perspectives to look at regarding contractual arrangements. From a regulatory perspective, there is an article (Art.25) in the legislation which indicates that all entities in the chain of settlement need to ensure that the agreements with their counterparties contain sufficient language to support compliance with the requirements of the buy-in regime that can be enforced in all jurisdictions. Should the buy-in regime enter into force in Feb 2022, and Art.25 not be amended to relate purely to the Trading parties, then the agreements between the Custodians and their clients would require updating with additional language relevant to the buy-in process. The second aspect regarding contractual arrangements is around the appointment of a buy-in agent, which will require an agreement, or a series of agreements with your chosen provider. A full client onboarding exercise will need to be undertaken before the agent will be able to execute a buy-in on behalf of the client. Operationally, it is likely that Service Level Agreements (SLAs) with custodians and other providers would need to be reviewed to assess any procedural changes required based on CSDR needs. |
| How will testing of new CSDR requirements or changes proceed? |
Industry discussions are ongoing on the topic of testing, with consideration for a T2S ’dry run’ of penalty messaging flows to be tested in Q3 of 2021. Otherwise, timing of testing will vary based on different development schedules and cycles of the various intermediaries. Please connect with your Relationship Manager for more details on how this can apply specifically for you. |
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