ESMA’s latest data on equities settlement fails paints a worrying picture with penalties now in play

Settlement failure rates in European equities have remained alarmingly high since March 2020 with market participants set to face a financial hit if the trend continues.

The rate of equities settlement failures continues to remain at a high level according to new data from European regulators, a concerning reality with penalties now being enforced across the continent.

Despite monthly fails never hitting the highs of March 2020 when percentages leapt to 14%, the one-year moving average still sat at around 8% towards the end of 2021, significantly higher than pre-pandemic levels. Three spikes in monthly fails figures also occurred between November 2020 and June 2021 where levels neared 12%.

“We’ve seen a fairly sustained high level of settlement failures within the European equities markets over the last two years, noticeably higher than the previous five years,” said Virginie O’Shea, founder of Firebrand Research.

“The volatility of the markets during the pandemic and the ongoing pressure on a smaller number of operational staff to cope with increased workload are partially to blame.”

The numbers are especially alarming given the introduction of the Settlement Discipline Regime (SDR) on 1 February, which enforces penalties for failed trades.

The levying of cash penalties is designed to improve settlement discipline by encouraging market participants to settle trades in a more timely fashion. The penalties – which range from 0.5 bps (basis points) to 1 bps depending on the nature of the financial instrument involved – will apply to securities which are either traded on an EEA exchange or cleared in an EEA central counterparty clearing house. Under the rules, central securities depositories (CSDs) are entrusted with imposing the cash penalties on the counterparty responsible for the failed trade. If the trade has failed because of an error further down the settlement chain, then the CSD participant is within their right to pass down the costs of such penalties to the at-fault entity(ies).

“These latest findings from ESMA reinforce why reducing settlement fails must be a primary goal for all market participants,” said Daniel Carpenter, head of regulation at Meritsoft (a Cognizant company).

“Huge strides have been made as banks prepared for the CSDR penalty regime introduced earlier this month, but this is only one part of the story. What’s needed is a better understanding of when, why and with which counterparties trades are failing to settle. All the relevant data from across the organisation needs to be centralised and accessible to enable any meaningful analysis of fails. Only then can banks take steps to address the operational inefficiencies and counterparty relationships that are impacting their profitability and, in so doing, reduce their overall fail rates.”

The European Securities and Markets Authority (ESMA) noted in its report on trends, risks and vulnerabilities that rising settlement fails remains a moderate risk in the markets. The regulator added that equity settlement fails remained more frequent than before the COVID-19 crisis and slightly above 2H20 levels across asset classes.

“These latest findings from ESMA show there is still room for improvement when it comes to driving settlement efficiency across the industry,” said Philip Slavin, CEO of Taskize. “However, there is evidence to suggest progress is being made with the more complex issue that require humans to come together to effect swift resolution. Our clients are currently reporting up to a 70% reduction in issue resolution time and a 90% reduction in operational emails.”

O’Shea noted that there was a lot of reticence to spend prior to the introduction of SDR due to the assumption that all of the requirements would be delayed. She added that the increase in failures across asset classes strengthens the case for investment in technology.

“We can expect settlement penalties to be the real driver over the next year or so to kick these projects into gear,” O’Shea explained.

“Financial institutions have spent years offshoring and downsizing their operations teams but there hasn’t been enough focus on modernising post-trade systems.

“No one likes to spend on the plumbing and the delays to CSDR have not helped firms to prepare for the changes that went into force this month.”