Late settlement penalties under the Central Securities Depository Regime (CSDR) have been “bigger than expected” following the introduction of the regulation last March, the Securities Lending Committee for the Bank of England (BoE) has said.
Discussing settlement fails in a meeting at the end of last year, the committee noted penalties were both bigger and “not washing through the system as easily as anticipated”.
CSDR was implemented in February 2022 in a bid to improve efficiency across the European market by fining firms that fail to settle equity, bonds and ETF trades on time.
However, the committee said the level of fails has remained high since its implementation.
“CSDR penalties are bigger than expected – and not washing through the system as easily as anticipated,” notes from the meeting read. “Levels of fails remain high, which means the level of penalties remains high, particularly in Europe.”
It added settlement rates had fallen across the equity and fixed income space but that “CSDR penalties have not made a large improvement thus far”.
According to the committee, reasons for the failures include technical issues, liquidity of the underlying security and “deliberate fails”.
Market makers have often chosen to purposely delay settlement after weighing up the penalty cost for failing and the cost to create a new product.
The BoE committee also noted an increase in securities lending fails following the UK government’s ‘mini budget’ in September, resulting in a huge gilt sell-off.
A potential solution being touted across Europe is increasing the levels of fines, but the securities lending committee said other avenues needed to be explored such as allowing partial settlements.
“Technological improvements are clearly the most important way to improve this issue, due to reliance on rigid archaic systems,” the group added.
“Better investment is therefore needed, and that the trend of managing books to zero balances may have to be reviewed so firms can carry cash buffers to account for fails.”
CSDR has been on a rocky road since its implementation with problems around the reporting and enforcement of penalties while concerns around the fines leading to wider bid-ask spreads for investors have been raised from the start.
The European Securities and Markets Authority (ESMA) launched a consultation on the cash penalty process in July, suggesting Central Securities Depositories could take responsibility for collecting and distributing all cash penalties in a bid to improve efficiencies.
ESMA said it would be publishing its annual settlement report at the end of 2023.