Europe’s largest trading and banking associations have urged regulators to soften new rules laying out penalties for failed settled trades and to delay the mandatory buy-in regime.
In a joint letter to the European Securities and Markets Authority (ESMA), the collection of industry bodies called for a phased-in approach to the settlement discipline regime (SDR), as well as a deferral of mandatory buy-ins.
Buy-ins, which are typically 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 securities from another party.
Initiating a buy-in against a failing counterparty will become a legal obligation under the Central Securities Depository Regulation (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.
The industry’s letter was co-authored by industry groups consisting of the Association for Financial Markets in Europe (AFME), the Investment Association (IA), the International Capital Market Association (ICMA), the Alternative Investment Management Association (AIMA), and the International Securities Lending Association (ISLA), among others.
While the letter supports the rules to drive greater settlement efficiency, the consensus among both buy- and sell-side firms is that the mandatory buy-in regime will have significant negative implications on both trading and liquidity across asset classes.
“It [buy-ins] will negatively impact the efficiency of European capital markets, leading to greater costs and barriers to investing in European securities,” the letter said. “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.”
To help ease the impact of the rules on market participants, the groups are urging ESMA to only introduce cash penalties on failed settled trades once market infrastructures, banks and their clients have built and test the required new messaging and technology.
They also called for a “deferral of the mandatory buy-in regime until the effects of penalties and other measures (e.g. prompt allocation/confirmation processes) to promote settlement efficiency are implemented”.
The letter added that the European Commission should undertake an in-depth impact analysis on the buy-in regime during this period, and also proposed a replacement of the mandatory nature of the buy-in with an optional right of the receiving party to allow a buy-in of a non-delivering counterparty.
“We support the imposition of a penalty regime under CSDR as an important step towards improving settlement efficiency in European capital markets. However, we continue to be concerned that the impact of a mandatory buy-in regime will have negative consequences that are damaging to market liquidity and efficiency and restrict the growth of capital markets in Europe,” the groups explained. “We respectfully request the authorities to consider a cautious, phased-in approach to ensure the successful implementation of the cash penalty regime and reconsider the mandatory nature of the buy-in.”
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.