Data published by the European Securities and Markets Authority (ESMA) in August revealed a notable decline in settlement failures between July 2022 and April 2023, however fails remain around the 5-6% mark.
“Settlement fails stand in the way of efficiency by generating undue costs, creating further frictions for the connected transactions and ultimately being a driver of systemic risk,” ECSDA said in a statement. “If a participant is expecting to receive securities or cash on the intended settlement date but is not receiving them, there is a risk that the affected participant is also unable to meet its obligations with other counterparties. That might result in a potential domino effect and be a cause of systemic risk.”
Looking at the reasons for fails within the market, ECSDA pointed to three key factors: a lack of securities, ‘on hold’ instructions, and late/lack of matching.
At the top of the list, a lack of securities constitutes the predominant reason for settlement fails, the report found, due to the “awaited delivery of corresponding securities through a related transaction or a realignment in another market”. Additionally, participants reported that securities lending was not possible on several occasions “as no lending service was offered”.
ECSDA also pointed to structural issues or national market practices that may be impacting settlement efficiency within Europe. Examples of this include the specific nature of the shares registration process, divergent asset protection laws, and differing cancellation timeframes for matched transactions – particularly for CSDs outside of T2S.
In addition, the report noted that time zone differences could also cause settlement issues for participants. An example of this would be clients who realign a position from the US market can only use the securities for same day settlement in the EU markets when the US delivered before the EU market close.
To increase the efficiency of settlements within the EU, ECSDA recommends that participants work more closely with the CSDs and make use of the tools that are available to them – with a particular nod to increased use of partial settlement solutions. CSDs, on the other hand, should work more proactively with market stakeholders to analyse efficiency data and explore potential solutions.
“Higher levels of efficiency would be most optimally achieved by the simultaneous and intensive use of all existing tools,” the report stated. “In our view, the best result will be achieved through a transparent collaboration among all the operators involved in the settlement process, to continuously identify pain points, solutions or mitigating actions.”
A copy of the full report can be found here.