The next few months are set to be a fascinating time for the European ETF industry as participants grapple with the challenges of the Central Securities Depositary Regime (CSDR).
After two delays, CSDR finally came into effect on 1 February. The wide-ranging regime is designed to harmonise settlement standards and improve settlement efficiency across the European market while providing a common set of requirements for central securities depositories (CSDs) operating across Europe.
In particular, it places an emphasis on entities settling equity, bond and ETF trades on time with fines for any firm that fails to do so.
Preparations for CSDR have taken place over the past few years, however, the next few months will provide more clarity into whether there will be any unintended consequences for the ETF market.
One key area of focus is around the settlement fines. Failures can happen for a number of reasons including operational issues or a lack of liquidity in the market. There are concerns the fines will lead to wider bid-ask spreads for ETF investors as market makers price in the risk of having to settle on time.
Market makers often do not own the full basket of securities when pricing ETFs meaning there is always a risk they will not be able to deliver on time and subsequently incur a fine.
As Simon Barriball, ETP and portfolio trading, Europe, at Virtu Financial, told ETF Stream: “All market participants would like to see a higher percentage of trades settle on their due value date. The question is what price are they willing to pay in terms of the impact on trading spreads.
“If market makers have to cover the inventory more promptly and via potentially more costly routes such as going direct to the primary market, then there will be a price to pay in terms of spreads.”
Furthermore, it is still unclear who must pay the fines if a settlement is missed. Market makers and liquidity providers can pass on a penalty to another firm within the settlement chain including brokers or ETF issuers when they are not at fault.
In a note, Irish law firm Dillon Eustace said: “While the regime is structured so that cash penalties will be imposed by the CSD on the relevant “participant” in the CSD responsible for the settlement fail in the first instance, in cases where a trade has failed due to the fault of a party in the settlement chain other than the participant in the CSD, that participant may seek to pass on such penalties to other entities in the settlement chain.”
While the ETF market has had plenty of time to prepare for CSDR, it is only after a few months of the directive being in force will the industry understand the true impact on costs for the end investor.