ESMA rejects industry calls for changes to CSDR buy-in regime

Watchdog rejects appeal for an overhaul of key pillars of CSDR from over a dozen concerned trade bodies, including the Investment Association.

Europe’s securities watchdog has denied a formal request to defer or amend the mandatory buy-in regime and phase in new rules for failed settled trades and under the Central Securities Depositories Regulation (CSDR), The TRADE has learnt. 

Mandatory buy-ins have been a point of contention between the industry and regulators with many believing the regime will have a negative impact on market liquidity, operational processes, and ultimately, end investors if implemented in its current format.

These concerns among others were highlighted by in a letter sent by over a dozen trade associations in January who subsequently called for a deferral until the effects of penalties and other measures to promote settlement efficiency are implemented. They also asked for the practice to become discretionary, highlighting extreme concerns about the.

In response, the European Securities and Markets Authority (ESMA) has rejected calls for changes and delays to critical elements of rules – including the buy-in regime – despite the urgency from the consortium of trade bodies.

The reply also highlighted how the mandatory nature of the buy-in regime was a “clear policy choice by the co-legislators when adopting the CSDR” and is meant to protect the securities buyers.

Buy-ins, which are presently used at discretion as they can create unpredictable costs, are used for market participants to manage settlement risk in the case of failed trades, as the buyer goes to market to source the bonds from another party.

In a letter seen by The TRADE, ESMA denied a postponement or an alteration to make buy-ins discretionary. “It is premature to consider further action at this point in time, in the absence of concrete evidence following the implementation of the buy-in requirements,” said ESMA.

ESMA has already moved to postpone the implementation of the Settlement Discipline Regime (SDR) – the key pillar for market participants under CSDR – from September 2020 to 1 February 2021. The regulator has made it clear that it believes this is sufficient time for market participants to prepare.

The buy-in regime has been met with criticism from buy-side representatives, in particular related to the cash bond markets and subsequent liquidity impacts.

“Mandatory buy-ins are expected to lead to wider bid-offer spreads in the cash markets, reduce market efficiency and remove incentives to lend securities in the securities lending and repo markets, and may ultimately favour the settlement in non-EU CSDs of less liquid securities,” the associations said in their appeal in January.

In addition, The Investment Association (IA) and the International Capital Market Association’s (ICMA’s) Asset Management and Investors Council (AMIC) then followed up to ask regulatory authorities to exclude cash bond markets and phase-in the implementation of the CSDR buy-in regime.

Both trade groups urged the European Commission to undertake a ‘robust market impact’ assessment of the buy-in regime before it is rolled out across Europe in early 2021, and in the absence of such an assessment, they have requested cash bond markets be excluded from the buy-in regime, to allow for close evaluation of the rule’s impact on liquidity and market pricing.

“Our members feel that such a cautious approach to phasing-in the mandatory buy-in requirements, based on the careful assessment of market impacts, will ultimately be in the best interests of investor protection, market stability, and the goals of the capital markets union,” said the IA and ICMA AMIC’s letter to the European Commission.

Initiating a buy-in against a failing counterparty will become a legal obligation under CSDR with limited flexibility on timing to complete the process. The payment of the difference between the buy-in price or cash compensation must also be made by the failing trading entity.

A study from ICMA in November last year found the majority of asset managers and pension funds surveyed expect a negative impact on bond market efficiency and liquidity as a result of the rules, when they come into force later this year.

ESMA did add at the end of its letter that it is continuing to discuss some of the matters raised in the January letter, including the pass-on mechanism, the asymmetry of buy-in costs and the topic of cash compensation.