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CSDR settlement discipline
March 2016 ICMA publishes a paper illustrating the problems arising from an asymmetry in the proposed CSDR mandatory buy-in process that only allows for the settlement of the buy-in or cash compensation price differential to be paid in one direction. Conventional buy-in processes, such as under ICMA Rules, allow for the payment of the buy-in differential to be paid in either direction between the buyer and seller, depending on whether the buy-in price is higher or lower than the original trade price. This ensures an equitable remedy, with neither the buyer or seller incurring an undue profit or loss as a result of the buy-in. The CSDR buy-in process, however, only allows for the payment to be made by the seller to the buyer in the event that the buy-in price (or cash compensation reference price) is higher than the original trade price. From a risk perspective, this asymmetry is the equivalent of any seller of securities also writing a free at-the-money put option which will become active in the event of a buy-in. Conversely, any purchaser of securities will be long this free option.
ICMA is hopeful that ESMA and the European Commission will address this highly technical, but fundamental, anomaly before attempting implementation of the mandatory buy-in regime, currently projected for early 2019.
CSDR Mandatory Buy-ins: An illustration of the problems arising from the asymmetric treatment of the payment of the buy-in or cash compensation differential
Since the publication of the Level 1 draft text of CSDR Regulation, ICMA has been highly engaged in cross-industry advocacy related to the Regulation’s provisions for settlement discipline, in particular mandatory buy-ins, which is broadly recognised as having a potentially detrimental impact on European bond and repo market liquidity and efficiency.
1 February 2016 ESMA published the long-awaited draft RTS for mandatory buy-ins. Given the restrictions of the Level 1 text, and the concerns raised by earlier draft RTS, the final draft RTS attempt to strike a balance between consistency with the intent of the Regulation and minimizing the potential for unintended adverse impacts to European capital markets.
Accordingly, EMSA has proposed what is essentially a trading level buy-in process, and so limiting (though not fully negating) risks to CSD participants (essentially custodian and agent banks). Furthermore, within the restrictions of the Regulation, ESMA proposes the longest possible extension period (i.e. the duration of the fail before a buy-in is initiated) of seven business days for all fixed income securities. With respect to securities financing transactions, which, are also brought in scope of the Regulation, ESMA proposes an exemption for any SFTs with a term of less than 30 business days. This exemption appears to apply to both start- and end-legs.
There remains an issue relating to an asymmetric treatment of the payment of the differential between the buy-in or cash compensation reference price and the original trade price, which ICMA will continue to discuss with the authorities.
The Final Report and draft RTS can be found here.
Click here for an overview of the draft RTS.
6 August 2015 ICMA has submitted its response to the ESMA Consultation Paper for Regulatory Technical Standards on the CSD Regulation related to the Operation of the Buy-in Process. ICMA has consistently advocated against a mandatory buy-in regime, which is broadly recognized as being detrimental to European bond and repo market stability, efficiency, and liquidity, as well as creating significant risks and costs for investors, trading counterparties, settlement agents, and settlement systems themselves.
The purpose of this ESMA Consultation Paper is to seek stakeholder input on the technical standards (the ‘Level 2’) for the process of the buy-in under the mandatory regime. In its response, ICMA has gone to great lengths to argue that any buy-in process, if implemented, should only be at the trading counterparty level, and not at the CSD participant level. This is wholly in line with the market-wide consensus. However, even with a trading level process, ICMA carefully outlines the challenges, risks, and inconsistencies, many of which are the direct result of the widely recognized flaws in the Level 1 Regulation. Furthermore, ICMA uses this response as another opportunity to recommend a practical delay in the implementation of the regime, ideally until post T2S (2018).
To view the response, click here.
Buy-ins, how they work, and the challenge of CSDR
An ICMA briefing note
July 2015 As ICMA prepared its response to the ESMA Consultation Paper on the CSDR regulatory technical standards related to the operation of buy-in, it published a Briefing Note on the buy-in process. The paper illustrates how buy-ins work currently, and how they are proposed to work under CSDR. While CSDR does not define what a buy-in is, or what it is intended to do, it does provide for who should be responsible for, and be affected by, a buy-in, as well as the related cash-flows.
To view the briefing note, click here.
ICMA publishes CSDR Mandatory Buy-in Impact Study
24 February 2015 The inclusion of a mandatory buy-in regime in CSD Regulation has been highly contentious, and many market participants question whether it can improve settlement efficiency. The ICMA study illustrates that if, or when, mandatory buy-in regulation is implemented (scheduled for early 2016), liquidity across secondary European bond and financing markets will reduce significantly, while bid-offer spreads will widen dramatically. The results suggest that even the most liquid sovereign bonds will see bid-offer spreads double, while secondary markets in less liquid corporate bonds may effectively close. The survey further suggests that for many less liquid bonds, including sovereign and public issues, market-makers will retrench from providing liquidity altogether.
The study also highlights the potential costs of these impacts, that will be borne by investors and issuers (public and private), and so constitute a cost to the real economy.
To view the study, click here.
19 February 2015 ICMA has submitted its formal response to the ESMA Consultation Papers on Technical Standards and Technical Advice under the CSD Regulation. ICMA’s response focuses primarily on Settlement Discipline, which will have the most direct impact on the functioning and efficiency of the European capital markets. Of particular concern to ICMA’s members is the provision for Mandatory Buy-ins. In responding to the various questions, ICMA provides a number of recommendations to support the successful implementation of Settlement Discipline measures, as well as suggested enhancements to the draft technical standards.
To view the response, click here.
26 November 2014 The ICMA ERC* and SMPC co-sign with AFME a letter to ESMA outlining potential models for a settlement discipline regime (‘cash penalties for fails’) under CSDR.
To view the letter, click here.
*On 4 December 2015, the name of the European Repo Council (ERC) was changed to the European Repo and Collateral Council (ERCC).
CSD Regulation: Migration to T+2
Senior Director, Market Practice and Regulatory Policy; secretary to the ICMA Secondary Market Practices Committee.
Direct line: +44 20 7213 0335
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