The European Securities and Markets Authority (ESMA) has published a consultation paper on the CSDR penalty regime seeking input on amendments which may include cash penalties that increase with the length of the settlement fail.
The paper follows requests from the European Commission for technical advice on the regulation, with the consultation running to 29 February 2024.
Despite consulting on three parts, the progressive penalties appear to be the most impactful and could also be a last line of defence against the introduction of the controversial mandatory buy-in regime, which has been referred to as a “last resort” if fail rates don’t improve.
“The aim of the consultation is to collect evidence and data from stakeholders on the effectiveness of the current penalty mechanism in discouraging settlement fails and incentivising their rapid resolution,” ESMA said in a statement.
Outside of the alternative methods for calculating cash penalties, the watchdog is also seeking input on alternative parameters, when the official interest rate for overnight credit charged by the central bank issuing the settlement currency, is not available and the treatment of historical reference data for the calculation of late matching fail penalties.
Cash penalties for settlement fails were introduced in February 2022, however rates were not immediately impacted and continue to be a concern for regulators.
According to data from ESMA, fails peaked at around 12% of total settlement instructions in May/June 2021, and again spiked following the introduction of CSDR’s Settlement Discipline Regime in February 2022, which introduced penalties for late or failed trades.
The number of fails saw a steady increase until the end of Q2 2022, accounting for around 10% of total trade values. However, since then, efficiency in the market has steadily improved, with the latest figures (April 2023) placing the share of failed instructions at around the 5% mark.
With mandatory buy-ins still looming over the industry – they were not removed entirely in the CSDR refit proposal – ESMA has reiterated that the aim should be to build a cash penalty mechanism that reduces the need for more drastic measures, rather than turn to the contentious buy-in regime.
The regulator’s latest consultation appears to be looking at removing the economic incentives to letting the trade fail but adding in the progressive fines. ESMA said the penalties need to be “unequivocally more expensive than remedial action, like borrowing the securities or funding the cash” and “certain in terms of calculation and forecasting, to facilitate cost/benefit calculations in terms of remedial investments”.
Another reason the fines may not be as impactful is due to the sell-side absorbing the costs rather than passing them onto the buy-side.
“The proposed amendments to the structure and severity of the mechanism should effectively discourage settlement fails, incentivise their rapid resolution and improve settlement efficiency,” the report said.
The feedback ESMA receives will feed into its technical advice, which is expected to be sent to the European Commission by the end of September 2024.