CSDR- The Peaceful Road to Glory or Just Additional Noise?
Harmonisation has been a key theme on regulators minds over the past decade and has created significant transformation within the Securities Finance ecosystem. Overall, with the exception of SFTR, the new regulations have not specifically been targeted at the Securities Finance industry although their implementations have had significant knock on effects. The upcoming CSDR (Central Securities Depositories Regulation) will have similar repercussions indirectly throughout the industry.
With the next phase of CSDR due to be implemented in February 2022, a phase of initiatives in Europe relating to core post-trade cash and securities infrastructure will be completed. Objectively a harmonised and efficient post trade life cycle should be perceived as a step forward for Securities Finance. Nevertheless, as always, the devil is in the detail, and with CSDR there are a lot of details. Especially as CSDR applies to all trading level entities, regardless of their domicile, that enter into transactions that settle on an EU CSD. With the European Football (Soccer as our American counterparts may know it) Championship just behind us, I felt it appropriate to invite you to join me in a game of Securities Finance Operations (Ops).
The Name of the Game: A Day in the Life of ‘Getting Stuff Settled
On any given day the Securities Finance Ops team are doing everything in their power to get ‘stuff settled’. Repetitively following the daily rhythm of settlement cycles and cut-offs. It can be an exciting world with each day bringing new demands around time sensitive and deadline driven tasks. In most companies the Securities Finance teams are highly specialised having a detailed understanding of the post trade securities settlements flows – ranging in experience from desk head to settlement clerk. In this daily cadence the MT-548 is the drumbeat. Any settlement clerk will know MT-548 swift message types by heart. It is the clear explanation as to why a settlement did not or will not happen. The classic reasons being the trades are ‘unmatched’ or there are insufficient securities and/or cash available to fund the settlement. Getting ‘stuff settled’ is the name of the game. Game on!
First Half - The Perfect Match
Let’s kick off! It would be ideal if all trades simply followed an uninterrupted post trade life cycle, however in reality, this is not the case. There are so many trade details to be captured and so many opportunities for mistakes to be entered. These could, for example, be the wrong SSI (Standing Settlement Instruction), the wrong trade/settlement dates or the wrong security quantities. Recent data from various firms found that some traders scored less than 35% ‘correct first time data entry’ when they reviewed the trade input across their teams, thus leaving a challenge for the Ops team to make quick decisions on identifying what is right and what is wrong. Lower levels of automation and error prone processes do not make life any easier and increase settlement risks and costs.
Ops teams across the globe follow the same daily cycle of franticly remediating any ‘unmatched’ instructions. For Securities Finance this is a fast-paced game as many securities movements are same day trades and need to settle ahead of cut-offs, further funding deadlines and general dependencies.
Without increasing (trade) automation and STP (Straight Through Processing) levels combined with robust pre-matching and intraday reconciliation, getting trades matched can become a cumbersome and costly exercise with a back and forth of data exchange and discussions taking up valuable time.
Second Half – The Right Place at the Right Time
Having that part of the ‘match’ out of the way, take a quick rest and let’s get into the second half - ensuring the securities are at the right place at the right time. The aim of this phase of the game is to avoid having the securities movements unsourced or unfunded. Two questions in every settlement clerks head are ‘what are the deadlines?’ and ‘where are the stocks?’.
The Securities Finance rapid rhythm is combined with complicated analytics behind every trade and movement decision. Most securities transferred do not stand on their own as a funding action but are undertaken to ‘resolve’ another challenge. Often, it is part of a wider strategy, including covering shorts, settlement fails near to buy-in, funding of collateral with a CCP, meeting regulatory ratios or financing a client relationship.
As secondary transactions have their own deadlines and places of settlement, Ops are required to understand and analyse the ‘bigger picture’, ensuring the prioritised funding of movements intra-day to help solve the ‘bigger picture’ puzzle. The end game requires understanding and actioning the right order sequence of events, to ensure all goals and deadlines are met. Timing and knowledge are key. Anticipation of the knock on effects for each decision and a full understanding of the incentives relating to various trades help order the sequence of settlements in an efficient manner. Lack of accurate and comprehensive information, miscommunication and misunderstanding are all challenges for the team, making it a demanding task to take the correct course of action.
The complex (European) custody and settlements infrastructure, demands an in-depth understanding of local business practices, mechanics and timelines to ensure successful settlement of chains of transactions, although Traget2Securities (the European platform to centralise delivery versus payment and accordingly harmonise the fragmented securities settlements infrastructure) should remediate this challenge to a certain extent.
Extra Time - CSDR: A New Set of Offside Rules, The Solution is the Problem
Oh no, we need to go into extra time… The CSDR settlement discipline regime introduces a whole new set of rules to an already complicated rulebook and the sport of matching and funding are taken to the next level. This includes:
- Penalising late matching/settlement,
- Promoting the use of partial settlement
- Introducing (mandatory) buy-in
First, the erroneous behaviour resulting in late matching or late/failed settlements has further reaching (financial) consequences. Late matching and/or failing to timely settle securities transfers will be penalised and leaves little room for error. In Securities Finance the often rapid (same day) trade and settlements cycle can be an easy source of mismatches and late settlement. Accordingly, holding back settlement instructions (common practice in the Securities Finance domain) will become a costly solution as this can be the root cause of late matching and settlement fails. Have you taken into consideration the operational and financial consequences of these impacts?
Second, the operational complexity further increases with (voluntary) partial settlement being introduced in full force, which consequently complicates the daily ‘fund and settle’ puzzle. Pre-CSDR settlements fail or settle; partial settlement (promoted as part of the CSDR remediation for settlement fails) introduces a third option which can create significant challenges for Securities Finance participants. ‘Partial settlement’ doesn’t always equal ‘partial success’. It could still result in fully failing the participants objective, with additional knock on effects. Can your existing Securities Finance solution process partial settlements front to back (considering the spill over effects on inventory management, collateral management, PnL calculations, billing, etc)?
Third, the final step for settlement fails under CSDR, is the buy-in (triggered 4-7 days after intended settlement date). The regulation mandates buy-in regardless of the source of the transaction. Ironically enough, where securities lending is frequently used as a remediation to avoid buy-in’s for (cleared) securities settlements, the Securities Finance settlements themselves become subject to buy-in based on the ‘as-is’ state of CSDR.
Therefore, Ops need to be vigilant to anticipate failing Securities Finance trades ahead of the buy-in being triggered, giving little time to leverage existing market practices to resolve late settlement movements. CSDR is introducing yet another deadline and complication to the daily combat of having the right security at the right place at the right time. Inevitably this will come at a price that will make remediating general funding challenges via the means of Securities Finance less attractive. Have you analysed how your business would need to adapt to avoid the consequences of a significant increase in buy-in’s?
Time for a Penalty Shootout… Again?
Reviewing CSDR’s impacts in the light of Securities Finance, resembles those exciting Euro Final evenings that never live up to expectations.
The Securities Finance product itself is a way to oil the general liquidity and settlements machine and amend interim inventory challenges. Be it to fund a basket of HQLA to meet ratios or just the mundane scenario of avoiding a buy-in. Pre-CSDR Securities Finance has been a ‘go to’ strategy tool for general liquidity issues and settlement fails. The need for this tool to meet regulatory requirements has become very apparent.
Settlement fails on Securities Finance movements (especially securities lending recalls) can be expected given the incentives to trade and the same day settlement cycles. Often movements are ‘best effort’ and bilateral ‘what ifs’ are agreed. Putting these movements in a different ballpark from the general ‘buy and sell’ of securities scenarios which are clearly the forefront of the CSDR regulation.
Managing securities lending settlement flows involve a complex system of prediction and detailed understanding of the mechanics of the markets. Having this knowledge and process within your Ops team holds value and to a certain extent is the foundation of a successful Securities Finance desk. However, the introduction of the CSDR settlement regime brings the need to reconsider the cost vs benefit ratio and avoid nasty surprises. These surprises could be a direct hit on PnL (e.g. penalties, fines, buy-ins), the general operations burden, or, possibly most importantly, the reputational risk of damaging relationships with clients, counterparties and the supervisory bodies.
Consequently, the sources providing liquidity to the market via the means of Securities Finance, will be incentivised to take a more cautious and conservative approach, draining potential liquidity, and removing ‘grease’ out of the post trade flow. The CSDR goal is to increase the safety and efficiency of securities settlement. The regulation can easily have a significant, unintended an unexpected liquidity impact.
In a report on CSDR, the European Commission does acknowledge industry feedback and considers amendments (in particular related to mandatory buy-ins). Considering we are so close to go-live and the time required to make legislative changes to the rules could this be too little too late though for the industry to prepare?
The Final Whistle - To Fail to Prepare is Preparing to Fail
Johan Cruyff - playing football is very simple, but playing simple football is the hardest thing there is.
The regulatory trends over the last decade have proven that the industry can adapt to change and resolve unintended consequences unforeseen by the regulator. The question is - are you ready to adapt to the unforeseen consequences of CSDR?
In the case of CSDR, Securities Finance will move into a ‘perfect storm’ where SFTR reporting and CSDR settlement discipline will meet and take away the flexibility that participants have been used to for so long. There will be nowhere to hide. Remediating CSDR issues could have a knock-on effect for SFTR both directly and indirectly. Not being prepared could create immeasurable risk and impact commercial relationships.
CSDR demands participants to find solutions for front-to-back flows which will require a well-orchestrated game plan and accordingly high levels of automation and STP. With an increasingly complex daily operational cycle, more stringent deadlines, and higher costs there is little room for user error. Ahead of the CSDR settlement discipline going into force it’s time to further reduce operational risk and review with your ops team how the daily flows are currently operating.
Once your current operational flows and risks are clarified you can frontload ‘standard’ remediation solutions with one’s trading counterparts/peers which in the long run will hopefully result in a new set of best market practices. Getting prepared will position your Securities Finance business to be resilient and attractive once the CSDR settlement regime comes into force.
As an area of focus at Broadridge SFCM we have been adapting our front to back solution for Securities Finance to ensure we are ready for CSDR. Our solution has been enhanced to support the full CSDR settlement life cycle including fines/penalties management, partial settlement processing and buy-in. To help you navigate through CSDR Broadridge has created a dashboard to measure how sound your operational flows are, understand pain points and propose remediation.