CSDR is another opportunity to review existing efficiency

The efficiency of post-trade processing is often a hotly discussed topic amongst the European broker community, and the next wave of EU regulation, in the form of CSDR, adds yet another challenge to the mix. CSDR, and specifically, for the purposes of this blog, SDR, the Settlement Discipline Regime, is officially due to come into force in September 2020, although it is widely expected to be delayed until at least November. It is predicted to directly affect brokers’ performance and ability to make markets in certain sectors, according to concerns raised at a recent roundtable discussion, hosted by Torstone, to debate the challenges faced by the UK broker community.

SDR is a game changing component of CSDR. It endeavours to improve settlement efficiency and harmonise processes across Europe by applying rules to resolve settlement failures through late delivery penalties, mandatory buy-ins and ultimately, cash settled close-outs in place of non-delivery. However, whilst the end-game ambition of harmonisation across Europe is admirable, the reality today is that not all markets across Europe are created equal, and common regulation potentially runs the risk of disproportionately impacting certain sectors of the market.

Let’s consider the process to manage settlement failures; Under Article 7 of CSDR, the rules set out a model for a mandatory buy-in of securities when trades have not settled past a certain point – four days for liquid equities and seven days for all other assets, with cash penalties applying for trades that fail to settle. Brokers are concerned that this will significantly limit their ability to support market making in less liquid assets, because under the new rules, the cost of providing liquidity will have to factor in the additional potential penalties and mandatory buy-ins that they could be exposed to; making them uncompetitive. Furthermore, those penalties will be based, in part, on the classification of the instrument as either liquid or illiquid. This classification is reviewed and updated periodically, which my not be often enough. Markets are dynamic and fast moving; a stock can move from being available (liquid), to ‘hard to borrow’ in a matter of minutes, and vice verse.

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