22 September 2014

ICMA-ERC Briefing Note: CSDR Mandatory Buy-ins and the treatment of SFTs

This briefing note covers existing remedies for failing SFTs; SFTs and secondary market liquidity; collateral fluidity; CSDR mandatory buy-ins and SFTs; and the ICMA ERC position on mandatory buy-ins and SFTs.

The regulation on central securities depositories and securities settlement establishes a framework designed to enhance settlement discipline, including the provision for penalties for settlement fails and a mechanism for executing mandatory buy-ins against failing transactions in financial securities. The text provides that buy-ins should be initiated in the event of a transaction failing for 4 business days, with the scope for this to be increased up to 7 business days ‘where a shorter extension period would affect the smooth and orderly functioning of the financial markets concerned’.

Mandatory buy-ins are likely to be counterproductive to the objective of settlement efficiency and will have negative impacts for secondary market liquidity and spreads, which will be a cost ultimately borne by issuers and investors.

In as much as mandatory buy-ins impact SFTs, this will have further negative implications for both secondary market liquidity and collateral fluidity. Partial exemption will compound these issues, creating a bifurcated SFT market with different demand and supply skews, as well as adding additional complexities to risk management. The least damaging interpretation of Article 7(4)(b) would be to exempt the start-legs of most SFTs, and to consider term-SFTs, at least out to 6 months, as ‘sufficiently short’.

In the meantime, there is a lot that can be done to improve settlement efficiency before introducing mandatory buy-ins. Initiatives such as Target-2-Securities, and improvements in the ICSD ‘bridge’, should be successful in reducing the incidence of failed trades. Improving and standardising procedures for trade confirmation and affirmation will support settlement efficiency. An efficient and well calibrated mechanism for cash penalties and compensation for fails should also encourage the timely settlement of trades.

 

Full Briefing Note

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