UK may not adopt CSDR buy-in regime post-Brexit

Industry experts believe the UK may decide not to adopt one of the most controversial aspects of the new settlement regulation post-Brexit.

The UK may decide not to adopt the buy-in regime under the Central Securities Depositories Regulation (CSDR) following it’s exit from the European Union, industry experts have said.

Considered to be one of the most controversial aspects of the Settlement Discipline Regime (SDR), the buy-in regime is aimed at improving settlement efficiency. However, multiple participants have warned it could have significant negative implications on both trading and liquidity across asset classes.

Buy-ins, which are currently used at discretion as they can create unpredictable costs, are used by 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. Across the industry, talk of the UK potentially not adopting this aspect of the regulation is gaining momentum.

“We should expect implemented and in-flight regulations to be grandfathered as is, beyond the oversight moving from ESMA and the European Commission moving to the Bank of England,” said Emma Johnson, director of securities services regulation and market reform at Deutsche Bank, at a recent industry event in Stockholm.

“But we should be mindful that there may be some changes to UK statutory instruments. This is where Brexit poses challenges to existing and proposed EU regulations: MiFID, MiFIR, EMIR and CSDR spring naturally to mind. The expectation is that CSDR will be grandfathered as is, but there is ongoing debate as to whether the UK will adopt the buy-in. UK can decide not to adopt the buy-in regime and just have settlement penalties.”

Other industry experts confirmed to The TRADE they believe this could be a real possibility following the end of Britain’s transition period on 1 January 2021. Before that point, the UK has committed to applying the rules during the transition.

Controversial regime

In a joint letter to the European Securities and Markets Authority (ESMA) published in January 2020, a collection of trade associations called for a phased-in approach to the settlement discipline regime (SDR), as well as a deferral of mandatory buy-ins.

Within the letter, the trade bodies 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.”

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.

“Elements of the CSDR settlement discipline regime have been controversial, particularly the mandatory buy-in rules for failed settlements,” said Nick Bayley, managing director within Duff & Phelps’ compliance and regulatory consulting practice. “While some of the CSDR has already come into effect, implementation of the settlement discipline rules has been delayed to next year and the UK could still theoretically decide to not to implement those particular rules.”

After intense lobbying across the industry, European regulators pushed back the implementation date of SDR to 1 February 2021, however many believe this extension will not solve many of the industry’s problems.

Trade bodies unite in protest

Industry associations are still calling for a deferral of the mandatory buy-in regime until the effects of penalties and other measures to promote settlement efficiency are implemented.

In the letter from January, the trade bodies 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.

“The UK has the most important OTC and quote-driven markets in Europe and many instruments, such as small-cap equities, do not trade on cleared order books in the UK but rely entirely on market makers to provide liquidity,” Bayley explained. “This makes the proposed settlement discipline regime a key issue for participants in those particular UK markets.

“The extent to which the UK will want to diverge from EU regulation over the coming years is still unclear but if the UK does adopt the CSDR’s settlement discipline regime, as I expect it will, it will hopefully do so cautiously.”

On 27 February 2020, the UK Government published its approach to the future relationship with the EU, which included its stance on financial services regulation.

“As many of us suspected, the government implies that it is looking to ease regulatory burden as the UK exits the EU. Being able to have more autonomy on regulatory affairs certainly looks like a “red line” for the UK government, as it looks to the UK’s future role on the global stage outside the EU,” said Mark Turner, managing director within Duff & Phelps’ compliance and regulatory consulting practice.