We have created this document as a follow up to the white paper we published in 2019. In it we summarize key discussion areas and address frequently asked questions which may arise as part of your preparations.
|What is CSDR?
The EU 909/2014 Central Securities Depository Regulation (‘CSDR’) is focused on improving securities settlement discipline and the activities of CSDs within the EU.
|What are the aims of the regulation?
The main objectives of CSDR look to make cross-border settlement processing and safekeeping more efficient and secure through:
|Which countries are in scope of CSDR?
31 countries will implement the regulation – the EU 27 plus Iceland, Liechtenstein, Norway and the UK.
|What will the impact of regulatory non-compliance be?||In the shorter term, the Settlement Discipline Regime applying cash penalties and mandatory buy-ins will be the main non- compliance punishment. Longer term and persistent infractions can lead to assessment of trend behaviors with potential for suspension from settling in the markets in scope as a result.|
|What elements make CSDR global in its nature and impacts?||It applies to CSDs based in the Europe and their participants, including EU-based ICSDs such as Clearstream and Euroclear. With clients having a global footprint, it is expected that this regulation will be impactful and will need investment for readiness accordingly.|
|What are the key investor impacts expected from the regulation?||The Settlement Discipline Regime (SDR) will be of most impact, as a result of applying cash penalties for trades failing past Intended Settlement Date (ISD) and buy-ins becoming mandatory for liquid securities failing past ISD+4. Preventative measures to allow
for avoidance of penalties and buy-ins are also for consideration, allowing for better trade matching and settlement.
|Which implementation timeframes need to be met for the regulation?||
|How is Securities Lending impacted under CSDR?||Under Article 2 the Regulatory Technical Standards of CSDR Settlement Discipline, securities lending is specifically included as a transaction type within CSDR. In practice, this includes security movements for new loan and loan return transactions. BBH is actively engaged with ISLA (International Securities
Lending Association) and our trading counterparties (borrowers) to implement operational changes to minimize settlement failure.
Separately, BBH is reviewing the potential impacts of CSDR with our clients in order to minimize any impact the portfolio
management process. Specifically, we are engaged with clients on the need to receive sale instructions on trade date before the close of the local market in order to recall securities as necessary.
|Will ETFs be considered to be in scope of the regulation?||Primary market ETF transactions would not be in scope of the regulation, but the underlying securities being traded on the secondary markets would be in scope, meaning that ETFs will need to be monitored for potential Settlement Discipline Regime impact in case the underlying trade fails to settle on time.|
|What other ETF impacts can there be?||
Differences in how US and European ETFs are created and redeemed may lead to situations where asset managers may choose not to settle ETFs in European locations due to potential CSDR impacts. Depending on the cash rate versus securities rate of settlement, there may be a move for more cash settlement in future to avoid the securities settlement incurring penalties.
The impact to secondary market trades can also have knock-on effects if the primary market trades fails and is subject to CSDR penalties and buy-ins.
Other ETF impacts are being assessed in industry forums.
|What other downstream impacts will the regulation be expected to have?||
How penalties will be calculated and buy-ins are settled can result in them being assessed against the fund account, and as a result may have NAV impact, in case of price changes.
Other impacts can include how cash availability is projected and understood for treasury calculations.
Preventative Measures; where all efforts will be made to ensure successful trade settlement before or on the Intended Settlement Date.
|The Regulation Proposes:||Investors Impact:|
|Matching and population of settlement instructions||That CSDs shall provide to participants a functionality that supports fully automated, continuous real-time matching of settlement instructions throughout each business day.||BBH will continue to enrich trade notifications when CSDR is implemented and we assess updating our systems to allow for STP in some scenarios.|
|Cancellation facility||That CSDs shall set up a bilateral cancellation facility that enables participants to bilaterally cancel matched settlement instructions that form part of the same transaction.||BBH is assessing how apply bilateral cancellations considering omnibus and segregated account structures, in order to allow for bilateral cancellation where it can be applied.|
|Hold and Release Mechanism||
That CSDs shall set up a hold and release mechanism that consists of both of the following:
|BBH plan to accept instructions to put a transaction on hold, or later release the hold, when an MT530 message has been received. This will be used in particular to support the mandatory buy-in process.|
|Partial Settlements||That CSDs shall allow for the partial settlement of settlement instructions.||BBH continues to work with CSDs to understand how partial settlement and partial release functionality will be applied and will develop solutions accordingly.
Challenges with allowing for partial settlement when using omnibus account structures are being discussed with CSDs. BBH will continue to support the partial settlement instructions, and work to learn where auto-partialling can be correctly applied.
|Tolerance of Matching Levels||That for the purpose of matching, CSDs shall set tolerance levels for settlement amounts. The tolerance level shall represent the maximum difference between the settlement amounts in two corresponding settlement instructions that would still allow matching.||BBH will endeavor to apply the regulation level of tolerance matching: For settlement instructions in EUR, the tolerance level per settlement instruction shall be EUR 2 for settlement amounts of up to EUR 100000 and EUR 25 for settlement amounts of more than EUR 100000.|
|Further Key questions on preventative measures:
|Are there any CSDs which will not be able to support infrastructure enhancements, such as Hold and Release, or auto-partialling?
The regulation advises that CSDs should be able to support all, and we work with them to be advised of the changes they are applying for readiness. Clients can currently instruct partial settlement indicator on transaction level and custodians will act on those instructions.
|Will recycling of settlement instructions continue?
||CSDs indicate that they will continue to recycle settlement instructions that have resulted in a settlement fail until the trades have been settled or partially cancelled.
|Will Crest expect to need the Place of Trade MIC and Trade Date to be mandatory to correctly match instructions?
It is important to note that the Trading System of Origin (TSO) remains (per the current market practice) matching criteria for settlement if the two parties involved in a transaction instruct with a MIC code that is linked to a TSO code. The Off-Exchange (XOFF) MIC code does not have a corresponding TSO code.
|Who will send appropriate Settlement Transaction Indicator (SETR) codes to CSDs within settlement instructions?
||The trading parties can instruct their custodians or other providers to pass on the SETR instruction codes as needed.
|Will adjustments to market cut-off times (including time-zones) need to be applied?
||It applies to CSDs based in the Europe and their participants, including EU-based ICSDs such as Clearstream and Euroclear. With clients having a global footprint, it is expected that this regulation will be impactful and will need investment for readiness accordingly.|
|Are there any tools and devices which can support preventative measures avoiding failures?
||Industry options such as GC Direct (provided by DTCC) can allow for automated SSI updates, improving on the matching of settlement instructions.|
|When will there be sample messaging available to test for Hold and Release, Cancellation and Partial Settlement functionality?
It’s expected that it will be possible to view and test sample messaging later in 2020 for these new functionalities when the development for such capability has been handled.
Cash penalties; where a basis point penalty will be applied against the price of the traded security for each day of failing to settle. Penalties can be classified as Late Matching Fail Penalties (LMFP) or Settlement Failure Penalty (SEFP). The party at fault for late matching or settlement failure will be debited the penalty and it will be paid to their counter-party for that transaction.
|CSDs will:||Investor Impact:|
||Provide daily penalty reports to their participants for penalties calculated for trades failing on the previous business day.
||BBH aim to pass on penalty information by the end of the day (US East Coast timing) on ISD+1 – that being the day after when the trade fail had occurred.
||Provide information in machine readable formats to the CSD participants in order that it can be taken in. This would allow CSD participants to either pass on, or aggregate messaging. MT537 messages are the preferred option for most CSDs.
||BBH will provide MT537 reports for daily and monthly penalty messaging. BBH proprietary reporting in our client portal – Infuse – would also be available, in order to view penalty information.
|Penalty Amount Reconciliation
||Use external vendors for trade price references and will not consider adjustments or disputes on price and information provided by brokers or exchanges.||Custodians will also not be able to consider price differential information, as they will not have access to the external vendor data.
|Penalty Responsibility Determination
||Only determine responsibility based on the party who last updated the trade and this will not always be the party responsible for the failure.
||BBH will review penalties for potential BBH responsibility and will not pass on those penalties to clients. Other responsibility determination will not be done.
||Auto-debit and credit participant accounts on the 17th business day of the month following the penalty calculation.
||BBH expects to auto-debit and credit client accounts for the penalty amounts on or around the 17th business day of the month. The exact timing when this will occur is TBD however based on timing of communication from the CSDs and local markets. We will provide a 2 day debit/credit notice to clients which they will be able to see through their normal cash projection reporting.
|Appeal of Penalties to the CSD||
Consider appeals only in situations such as the below:
|BBH will support clients for how appeals need to be communicated to the CSDs and later in communicating the outcome of the appeals.|
|Dispute Handling||Not engage in any disputes between counter-parties.||Investors would need to engage their counter-party direct in the case of a dispute. Industry associations such as AFME prepare market practice guidelines for such bi-lateral claim processes.|
|Instruments in Scope||Plan to report on penalties for instruments determined in scope of CSDR, listed on the FIRDS database.||Custodians expect to follow the CSD and ESMA guidance from the scope perspective on the FIRDS database.|
|Further Key questions on cash penalties:|
|What will be the cut-off time to be provided the daily penalty reports?
||To be finalized, as there is no one agreed timing framework between CSDs yet.
|What are the basis point penalty calculations applied?
|Will penalty reporting be provided at the transactional level, or rather the account level (factoring for omnibus/segregated setups)?
||Penalty reports are expected at the transactional level.
|Will FX rate calculations be applied to settle the penalties in the correct currency expected?
||Penalties will be received in the currency of the trade which incurred the penalty. BBH will offer an FX standing instruction product to convert penalties to USD or other currency as needed.
|What would penalties look like on the blotter/projections?
||A two day prenotification of the final monthly penalties will be provided prior to passing penalties to client accounts. The projections and posting will include the net monthly penalty amount per fund and clearly indicate it is the CSDR fees for the prior month.
|Will there be separate reports for ‘new’ penalties and ‘adjusted’ penalties from previous reporting?||Awaiting CSD guidance as there is not yet a harmonized view for the formats of reporting.|
|If no penalties occurred for the previous day’s activities, how will this be reported?||An empty penalty message will be passed on to indicate that there was no penalty activity for the previous day.|
|What level of validation on penalties will be expected?||BBH will validate that we did not make an error but not look to determine if our clients or their brokers were responsible.|
|How will payment pre-advice for penalty settlement be given?||Final monthly reports with all adjustments accounted for will be provided by the 15th business day of the month following penalty occurrence, and this will be passed on as payment pre-advice before payments are settled after the 17th business day.|
Mandatory Buy-ins; where a buy-in for liquid securities is expected to be triggered after 4 business days of the trade failing.
|CSDs Understand:||Investor Impact:|
|Triggering a buy-in
||That the receiving party (awaiting the trade to settle) will engage the buy-in agent to start the process.
||Investors will gather trades eligible for buy-in. Liquid trades will trigger buy-ins after failing for more than 4 business days, while illiquid
securities buy-ins will occur after trades failing for 7 days. Investors should send a trade instruction to put the original trades on hold (using MT530 messaging) after the buy-in is triggered.
||That third party buy-in agents will manage the buy-in process
||Investors will need to contract with a buy-in agent in advance of triggering the mandatory buy-in.
||That auction scenarios will be held each day for buy-ins eligible to be bought, where interested parties can sign up to engage.||Investors should receive information from the buy-in agent regarding successful buy-in using the auction and then settlement of the buy-in transaction.
||That a pass-on mechanism can be used to ‘jump’ to the point where there are available securities to settle the buy-in, rather than triggering a buy-in in each step of a chain of transactions.
||The International Capital Markets Association have a proposal to allow for a pass-on mechanism to be used and industry participants await the outcome there.|
||That where a buy-in has not been possible, a cash compensation can be offered at the end of the buy-in period.
||Buy-in agents work to understand this flow and will advise how cash compensation can impact on buy-in settlement and other impacts.
|Buy-in reporting & monitoring
||That they will not be monitoring the outcomes of the buy-ins as there is no regulatory requirement for them to do so.||Custodians expect to monitor the buy-in outcome to ensure the custody book of records is accurately reflected.
|Further Key questions on buy-ins:
|Will there be more buy-in agents available to choose from before the regulation goes live?
There will likely be more buy-in agents available before CSDR implementation, beyond the one organization currently confirmed as an agent – Eurex.
|What preventative measures can allow for prevention of buy-ins?
||Partial Settlements, Hold and Release and Cancellations can be used to avoid some or all of the position to be bought in after 4 days of a liquid security failing.
Additionally, trade status reporting in BBH’s Infuse platform will use a tile specific to CSDR impacts, showing a graph of trade volumes approaching buy-in, which can then be drilled down into in order to see detail on which trades are of most impact.
|What happens with the original failing trade, after the buy-in has been triggered, and later settled?
The failing party should instruct for the original trade to be put on hold (using an MT530 message), and when the buy-in is settled, another MT530 instruction should be sent to cancel the original trade.
|How will fund accounting and cash availability projections be impacted by having a trade on hold while awaiting the buy-in settlement?
||Because the security can change in price from the original intended settlement date until the time when the buy-in is settled, this will cause breaks in fund accounting records, cash projections and treasury records. The original trade will also continue to accrue cash penalties, depending on how it has been put on hold during the buy-in.
Where there can be a large price difference, this has potential to result in claims being raised for the difference between the original trade value and final buy-in settled value. There can also be corporate actions impacts based on changes to record date and other asset servicing elements.
These elements are being discussed for final operational design in industry forums, in order to be ready for the CSDR implementation date.
|What will happen when there is a price differential from the original trade to the buy-in being settled?
||Industry associations such as the International Capital Markets Association (ICMA) understand that price differentials can occur and work on a proposal to allow for asymmetric price differences to be addressed.
|Will both the original trade and buy-in need to be funded by the failing party, and what will this mean for liquidity?
||It seems likely that both the original trade and buy-in trade will need to be funded.|
|What part can partial settlements play in supporting buy-ins?
Partial settlements can be attempted to allow to minimize the impact of a buy-in in advance of it being triggered. When the buy-in process has started, it is seen as a separate process and would be settled separately, likely without partial settlement.
|Will buy-in agents support various financial instruments to be bought in
– equities, fixed incomes and more?
|To be confirmed with buy-in agents before the Settlement Discipline Regime implementation date.|
|Can an investor act as their own buy-in agent, in the case where they are unable to contract with and engage a third-party buy-in agent?||The regulation states that “A buy-in agent shall not have any conflict of interest in the execution of a buy-in” – meaning that the buy-in agent must be an independent party.|
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