On 4 February, ESMA published its final report (the “ESMA’s Report”) with new draft regulatory technical standards on the postponement of the date of entry into force of Commission Delegated Regulation on settlement discipline (the “Settlement Discipline RTS”)[1].

The Settlement Discipline RTS sets out the measures that central securities depositories (“CSDs”), trade venues and investment firms need to have implemented by 13 September 2020 in order to comply with the new settlement discipline regime introduced by the Central Securities Depositories Regulation (“CSDR”)[2] (see our article from December 2019 for further detail on CSDR).

ESMA has now recommended to delay the entry into force of the Settlement Discipline RTS (and the full implementation of the relevant settlement discipline measures) to 1 February 2021.

The settlement discipline regime

Broadly, the CSDR settlement discipline regime consists of three key features:

  1. Rules for the trade allocation and confirmation process of executed trades;
  2. Cash penalties on failed transactions which CSDs will be required to enforce to incentivise timely settlement; and
  3. A mandatory buy-in process under which a buy-in will be effected to provide the receiving counterparty with the securities that the defaulting counterparty failed to deliver.

The Joint Trade Association letter

In light of the concerns raised by many market participants over the implementation difficulties of the Settlement Discipline RTS, fourteen trade associations issued a joint letter to the European Commission and ESMA on 22 January 2020 calling for a phased-in approach to the cash penalty mechanism and a deferral of the mandatory buy-in process.

While the trade associations express their support for the cash penalty regime generally, they explain that the consensus among both buy-side and sell-side firms is that the mandatory buy-in regime would have significant negative implications on both trading and liquidity across asset classes, ultimately affecting the end investor. The letter also notes that there would be a risk of greater costs and barriers to investing in European securities which would directly conflict with wider Capital Markets Unions objectives of developing EU capital markets. 

The joint trade associations recommend that the settlement discipline regime should only be implemented once the infrastructure to facilitate the regime has been properly tested.

ESMA’s Report

ESMA’s Report follows publication of the joint letter and states that the proposed delay of the Settlement Discipline RTS comes as a result of stakeholders’ requests to give the market and settlement participants more time to deal with the complexities of implementing the necessary infrastructure and relevant settlement discipline measures, in particular with regards to:

 

  • the establishment and testing of a cash penalty framework by CSDs with a common settlement infrastructure (the T2S penalty mechanism is currently scheduled to go live during the weekend of 21/22 November 2020);
  • IT system updates and changes, including with regards to ISO messages;
  • adapting existing market practices and contractual arrangements to facilitate the mandatory buy-in regime; and
  • market testing.

ESMA did not consult on the proposed postponement of the entry into force of the Settlement Discipline RTS given its targeted nature and the resulting benefits for affected stakeholders. It is expected that ESMA’s proposal will be endorsed by the European Commission in form of a Commission Delegated Regulation and enter into force shortly after following non-objection by the European Parliament and the Council. 

The market will then have just under an extra five months until 1 February 2021 to implement and get ready for the operation of the settlement discipline regime under CSDR.

Our view

ESMA’s proposal clearly provides welcome relief to CSDs and market participants alike in their implementation work in relation to the introduction of the settlement discipline regime. Whilst the postponement of the effective date offers some breathing space, it does not address stakeholders’ deeper concerns regarding the mandatory nature of the buy-in regime and the negative impact on settlement efficiency and liquidity associated with it. 

It also remains to be seen how the market will deal with the practical complexities of effecting buy-ins along settlement chains involving multiple market participants and interlinked transactions. As stakeholders continue to grapple with these aspects, it is unclear at this point whether we will see further relief in form of a phased-in approach or a change to the mandatory character of buy-ins being agreed before the new effective date.

Co-authored by Janice Pang.