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The introduction of the Central Securities Depositories Regulation (CSDR) mandatory buy-in element of the settlement discipline regime (SDR) presents a “significant risk to Europe’s recovery from the COVID-19 crisis and will likely disproportionately impact on small and medium-sized enterprises and less liquid securities”, according to AFME.
The comments were made in a position paper by the Association for Financial Markets in Europe (AFME) highlighting the risk of mandatory buy-ins to Europe’s economic recovery from the pandemic and calling for the measure to be removed from the upcoming CSDR.
AFME explains that although it supports the SDR measures, it is against a mandatory buy-in requirement.
Rules requiring central securities depositories (CSDs) to facilitate partial settlement and ‘hold and release’, new requirements for trade confirmation and allocation, and a penalty mechanism applied to failed trades, will all contribute towards improving market settlement efficiency, AFME says.
However, it argues that mandatory buy-ins for non-centrally cleared transactions will lead to higher issuance costs and reduced access of issuers to primary markets, and to increased costs, reduced liquidity and reduced investment returns for investors.
“The periods of high volatility and low liquidity observed during COVID-19 crisis would have been further exacerbated by the existence of a mandatory buy-in regime,” the association explains.
AFME describes the mandatory buy-in regime as a “disproportionate measure to address settlement fails”.
The association says: “The purpose of the mandatory buy-in is to ensure remediation of the small percentage of trades that continue to fail for multiple business days. The impact of the mandatory buy-in regime will be wider spreads and less liquidity, meaning more expensive and less efficient capital markets for Europe’s issuers and investors.”
It highlights that the negative effect is “clearly disproportionate to the problem the mandatory buy-in is trying to fix”, especially during Europe’s economic recovery from the ongoing pandemic.
Instead, AFME suggests the buy-in should be a discretionary right of the receiving party, not a mandatory obligation.
“This provides sufficient protection to the buyer without enforcing an action that may be against its economic or commercial interests. A discretionary buy-in regime will mean the buy-in is only used in cases where it is necessary and effective and will avoid significantly damaging market liquidity,” it explains.
In the European Commission’s CSDR review consultation, which closed on 2 February, AFME proposed a number of amendments to the legislative.
Some of AFME’s recommended changes included adjusting mandatory obligation to buy-in to a discretionary right for transactions that do not involve a central counterparty clearing house (CCP); to refine and clarify the scope of the buy-in regime; remove the regulatory requirement to appoint a buy-in agent; and the inclusion of new Level 1 provisions to explicitly allow for a functioning pass-on mechanism.
It also suggested redrafting Level 1 to mandate symmetric payments of price differences in order to restore parties to the same economic position and amending Article 25 of Level 2 to clarify that a CSD participant is not required to amend its contracts to ensure the enforceability of settlement discipline on its clients.
AFME also asked for the removal of the requirement of Article 25 to fully contractually incorporate the provisions of the CSDR buy-in regime and to replace it with a requirement for CCPs, clearing members, trading venue members and trading parties to establish contractual arrangements that incorporate an appropriate mechanism for the resolution of settlement failures.
“It is important that the SDR is workable in practice and effective in achieving its goals at the moment it goes live,” AFME notes.
In the position paper, AFME also outlines the need for “urgent clarification” on the implementation timeline of a reviewed SDR.
It explains that significant amendments to the legislation are necessary, but the current implementation date of February 2022 “doesn’t allow sufficient time for these changes to be passed into law and incorporated into industry participants’ development projects”.
AFME says it supports a phased approach, with penalties and other measures introduced in February 2022 and revised buy-in rules deferred to a later date.
Also calling for the mandatory buy-in element of SDR to be scrapped, is the International Capital Markets Association (ICMA).
In its response to the commission’s consultation, ICMA said that mandating buy-ins will have adverse impacts on European bond market efficiency and liquidity, noting that a significant body of evidence suggests it will ultimately lead to increased costs for market participants and particularly end investors.
The consultation was scheduled as part of the usual bedding in of EU regulation but scope being reviewed was expanded to include the SDR following claims by ICMA and others that the existence of mandatory buy-ins during the market volatility seen in March and April last year would have compounded the troubles.
