With a further delay to the EU’s Central Securities Depositories Regulation (CSDR) just announced, market participants and tech vendors face an uncertain future.
“There’s a level of uncertainty and to be able to plan for that is hard. Do you carry on, or do you wait? More time is great and broadly welcomed, but there’s a level of uncertainty now around what it is that needs to be delivered to, and that’s challenging,” says Simon Davies, business development manager at Pirum Systems.
According to Robert Frost, Pirum’s head of product development, tech firms who have prepared for CSDR will have to quickly readapt to developments.
“We had a roadmap finalised, we’ve run three CSDR user forums, we’ve spent a lot of time talking to our clients looking at enhancements, starting build, making changes. That’s not to say that would stop because clients are still very engaged, but it does lose some momentum,” says Frost.
“If we’ve now got another year; we’ve hired people – what do we do with those people? Do they stay on that [CSDR] project? Do we move them to other projects until we may need them?”
Originally announced in 2014 as one of the EU’s key financial crisis regulations, CSDR was intended to harmonise operational aspects of securities settlement. It applies to central securities depositories (CSDs) – institutions that hold financial instruments such as equities and bonds – and attempts to prevent settlement failures by improving matching rates. In the event of a settlement failure, the regulation puts in place cash penalties and mandatory buy-ins.
In February, the European Securities and Markets Authority (Esma) announced a delay to CSDR from September 13, 2020 to February 1, 2021 due to concerns over IT system changes. The regulator then expressed intent to further push the deadline to February 2022 in July, following complications caused by the pandemic.
The delay was officially announced by Esma on August 28.
“I can’t believe that we might just be a few weeks away from implementing [CSDR] if the original date remained … There needs to be a cohesion which I feel has been pretty underestimated,” says Emma Johnson, director, securities services market advocacy at Deutsche Bank, referencing the original go-live date.
Daniel Geddes, global head of product management at Torstone Technology is also wary of potential delays.
“Regulatory work for software vendors like ourselves requires a great deal of upfront analysis and planning, and so delays and uncertainty around implementation requirements create challenges when determining budget and schedule of work, an issue that is compounded by the ongoing Brexit negotiations,” he said in an email.
The delay has not been the only source of speculation; Esma has long faced pressure from industry groups to revise certain key elements of the rules. While a review had always been intended by the regulator, the International Capital Market Association (ICMA) and International Securities Lending Association (Isla) have lobbied to clarify the scope of security financing transactions (SFTs) and perhaps most fervently, the buy-in regime under article seven of the regulation. Esma is currently reviewing these elements through industry Q&As.
Market participants tend to welcome regulatory delays, but the uncertainty surrounding both deadlines and scope of CSDR leaves many frustrated.
“It’s disruptive for the market participants, it’s disruptive for vendors,” says Frost. “I think this is probably the right thing because of the way the rules are written, there’s still so much to be clarified. Whilst this delay is definitely welcomed – even probably from a vendor perspective – my point is more broadly with all of these regulations with such late announcements on these delays. I don’t think that helps anyone.”
“They should be reviewed earlier by the regulators once the market participants start pushing back. I don’t think [this delay] is coronavirus related, I think it’s because all the industry associations all got together and pressurised the regulators.”
While regulatory uncertainty provides roadblocks for vendors working on CSDR solutions, there is hope from the buy-side that a delay will offer the opportunity for the sell-side to solidify its offerings.
“I think [a delay] will actually give the tech firms an opportunity to fine-tune their platforms and also get some critical mass on them. If we’re looking at a workflow platform across trading parties, custodians, if you get the buy side and sell side together – you need to have an element of scale to be able to have that end to end workflow across practitioners,” says Johnson.
“Recognising that you won’t get everybody on one platform because everyone needs to have a choice and that’s one of the commercial aspects that we should welcome, these systems need to interoperate and I’m not quite sure how much interoperability there is between some of these new entrants.”
She says vendors need to adapt to a firm’s broader strategy, something which new CSDR entrants still grapple with.
According to Pirum’s Davies, CSDR has been an agent for change within financial firms, which can leverage regulatory spend to perform much needed improvements to their settlement processes that may not have been done otherwise.
“But there’s less impetus because there’s uncertainty now. The CSDR rules are challenging … Firms are waiting to see if there is a delay, what delay there will be and what tweaks there will be to the regulation.”
While tech firms worry, consultants do not think potential amendments to the rules are likely to require a huge amount of reconfiguration.
“If things change, unless it was something so drastically off in the original regulation, you won’t see something change so dramatically that would completely throw out everything firms have done,” says Tej Patel, regulatory specialist and partner, Capco.
“There has been so much lobbying on this point and through industry bodies and discussions with each other, firms are in the same place where it’s about making sure you’re set up operationally as best as possible to deal with this. It’s how you treat any regulation – you’ve got to keep on top of any changes that come in and understand what that means for you as a firm.”
The buy-in question
Article seven of CSDR has long been debated by the industry. Buy-ins refer to the process of allowing a buyer of securities the right to source those securities elsewhere in the event of a settlement fail. It cancels the original instruction and settles differences between the two original counterparties.
In order to prepare for the buy-in regime, market participants must establish internal processes to identify and manage buy-ins. Davies hopes Esma’s current review will lead to amendments.
“There’s been a lot of lobbying around changing [the buy-in rules]; they’ve been seen as too punitive. The fails costs and fines, how the CSDs are going to deal with the challenge of managing those needs to be looked at as well.”
“I think there will probably be some changes there for the better; I’m sure they can’t make it worse. This is what a lot of our clients have been looking at, seeing the positives and trying to drive change and better processes for fails managements and for more efficient settlements. That has frustrated me for many years and it’s frustrated a lot of our clients as well – that people don’t always use the tools that are there now to prevent some of these issues and sometimes that’s because the investment is not a priority and certainly these regulations help get that focus and that IT budget if required,” he says.
One of the questions pending Esma’s review involves the definition of a buy-in agent.
“The regulation mandates the use of a buy-in agent, but it doesn’t define what a buy-in agent should be,” says Johnson.
“One weakness we have with CSDR is there’s only one buy-in agent that’s out there, and no matter how good their platform might be, one solution is nowhere near enough. It might be a good opportunity for a tech firm to work with a trading member or an exchange to develop a system.”
Agnieszka Pokorska, senior consultant at Capco, agrees.
“There’s only one buy-in agent on the market at the moment and that was also a source of concern; there’s not really anyone coming out to say that they’re going to be a buy-in agent,” she says.
“The preparations that firms would have done are probably around the workflow and sales management, which is fine, and I think the next step was still pending resolution.”
According to Pokoroska, firms are tepid about announcing buy-in solutions due to industry backlash against the buy-in regime.
“There is probably a bit of a commercial consideration and also a reputational one, whether you actually want to be a buy-in agent given that so much of the industry was against buy-ins or seeing them as a big problem,” she says
“They will probably come slowly and probably not advertise them as a buy-in agent solution, but just as a kind of broker solutions executing under the CSDR buy-in rules.”
It is unlikely that buy-ins will disappear completely, but points about not making them mandatory or allowing for longer extension periods are being considered, she says.
While Esma debates the buy-in questions, the UK has decided to drop buy-ins altogether with their decision to abandon CSDR post Brexit. In June, chancellor Rishi Sunak announced that the UK would opt out of the regulation and instead apply the existing industry-led framework.
“I was actually expecting buy-ins not to make the cut, but I was quite surprised that the broader regime is being dropped in its entirety,” says Johnson.
“In terms of the development work done, the UK and Ireland have done a brilliant job. They’ve really matured their development [in preparing for CSDR]. But surprises aside, the UK is an incredibly efficient market, it has a very high settlement rate, it has its own separate efficiency regime, so it’d be quite interesting to see what develops in due course. I think there’s risk of divergent regimes between the UK and EU, but I think that’s bigger than CSDR actually.”
Along with CSDR, the chancellor announced plans to not incorporate the EU’s Securities Financing Transactions Regulation (SFTR), indicating a desire for the UK to forge its own path in capital markets regulations after Brexit.
“There’s this question around divergence. There will always be elements of it as a result, it’s just a question of how closely will they try to align? I don’t see there being significant divergence initially, but who knows in the future where that may be. Some of this will be politically-driven posturing,” says Capco’s Patel.
While much remains to be seen for UK firms and all firms with UK exposures, operating across jurisdictions will not be an issue, he says.
“It’s not overly complicated. It can be painful and messy because you’ve got to keep up to date with another set of regulatory bodies pushing out requirements for you to operate in that market, but it shouldn’t be that much harder for firms that are used to operating in multi-jurisdictions.”
While the pandemic is being cited as justification for a delay, there is indication that much of the industry was far from ready for the February 2021 live date.
“A significant proportion of the organisations have not really mobilised their implementation programs in any significant way and have only done some initial analysis,” says Mikhael Behzad, manager, capital markets at Baringa Partners.
A Baringa study from July found that only 40 percent of firms had completed a CSDR profit and loss (P&L) impact assessment. The study was done when firms were still preparing for the September 2020 deadline, making the lack of preparation “alarming,” says Behzad.
“You’d hope that you’d know the business impact of a regulation, but not many people have done it,” says Chris Dominy, partner, capital markets at Baringa.
“I think it was a bit of a wake up moment in terms of you’re going to have to address this CSDR aside, and it’s an opportunity to do that because if you’re getting budget for CSDR, why don’t you get a bit more budget and look at this end-to-end?”
However, many tech vendors are still not up to scratch on the rules, says Pokoroska.
“Trying to go with solutions in a few months that are still in their demo stage and not even tested, and relying on them might have been a bit of a concern. The additional time might actually give people more confidence to look at more strategic solutions,” she says.
Deutsche’s Johnson thinks firms have underestimated the amount of work needed to be ready for the new rules.
“Sometimes the deeper you get into the regulation the more complex it becomes, the more aware you become of dependencies across the broader ecosystem,” she says.
“We haven’t got full clarity and certainty of the scope, completed technology builds, end-to-end testing across the industry, legal documentation. When you factor these existing readiness challenges into the current context of a global pandemic… it’s really altered the market and will leave lasting change.”