Industry Updates

ESMA consults on progressive cash penalties for CSDR settlement fails

Penalties could increase with the duration of the settlement fail

Theo Andrew

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The European Securities and Markets Authority (ESMA) is considering introducing progressive penalty rates for settlement fails under the Central Securities Depositories Regime (CSDR).

In a freshly launched consultation, Europe’s financial regulator said it wanted to assess the “full potential” of cash penalties to address settlement fails, which includes new measures that will raise penalties in line with the duration of the failed settlement.

It comes as the controversial mandatory buy-in regime – which contractually requires authorised participants to source securities elsewhere in the event of a settlement fail – continues to loom over the industry.

The introduction of the regime has been described as a “last resort” by the regulator should settlement times not improve.

“The proposed amendments to the structure and severity of the mechanism should effectively discourage settlement fails, incentivise their rapid resolution and improve settlement efficiency,” ESMA said.

The consultation also takes aim at market makers failing on purpose to avoid the costs of creating a new basket.

“To be effective and efficient, the cash penalty should be unequivocally more expensive than remedial action, like borrowing the securities or funding the cash,” it added.

The financial watchdog will also assess other measures to improve settlement including “alternative parameters” when the official interest rate for overnight credit charged by the central bank issuing the settlement currency is not available.

It said it will also investigate the treatment of historical reference data for the calculation of late matching fail penalties.

Cash penalties were established under CSDR in February 2022 but its introduction was plagued with issues during the first few months.

Since then, settlement fails have gradually improved from roughly 10% at the end of Q2 2022 to around 5% in April, the most recently available figures.

However, experts warned in February that investors were facing higher costs when trading ETFs due to CSDR as authorised participants pass on the cost of settlement fails with wider bid-ask spreads.

ESMA said reducing settlement fails was now “essential” given the growing conversations around shortening the settlement cycle from T+2 to T+1 and eventually T+0 in Europe.

Settlement fails have been of particular importance to ETFs, which are prone to late settlement due to the connection between primary and secondary markets.

Respondents have until 29 February 2024 to respond to the consultation. ESMA said it will publish its final report to the European Commission by the end of September next year.

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