The implementation of Central Securities Depositories Regulation has invoked regulators to publish guidance on best practices to tackle the legislation for the bond and repo markets. Carmella Haswell summarises all you need to know
After much anticipation, the Central Securities Depositories Regulation (CSDR) went live across Europe on 1 February 2022. Regulators, including the International Securities Lending Association (ISLA) and the International Capital Market Association (ICMA), seek to support the bond and repo markets through the transition with guidance from its best practice recommendations.
ISLA had previously drafted a list of recommendations within its CSDR Penalties Best Practice Guidelines for the cash penalty regime, but have since updated the document to include changes that reflect member comments over the Christmas period and, where possible, aligned with other trade associations.
Claims issuance and settlement
ISLA suggests counterparties issue their CSDR claims within 30 calendar days from the CSD penalty issuance. It is noted that proposed deadlines for CSDR triggered claims may be amended as the process matures. Claims made should be sent electronically or via email, with signature, and preferably in PDF format. The recipient should acknowledge the receipt of the claim within 24 hours and must endeavour to pay the claim within 30 days, with a maximum of 60 days from the CSD penalty issuance.
The minimum claim is €500, or lower if bilaterally agreed prior to activity, and parties may agree consolidation of multiple failing transactions to pass the minimum threshold. Once the claim has been agreed by both trading parties, payment is to be made within five business days. The claim can only be formally closed when the claim issuer confirms receipt of payment.
The claim issuer should provide the following information:
• Claim initiator name and BIC
• Cash currency and value
• Trade date of failing instruction
• Claim reference
• Intended settlement date
• Claim calculation
• Actual settlement date
• Claim/penalty currency
• Security ID and description
• Claim/penalty amount
• Quantity
• Reason for claim
• Payment details
Netting of claims
In regards to a single failing event, ISLA recommends that claiming parties incorporate and consider relevant credits and debits that may apply for each failing instruction. Furthermore, a net settlement — a single cash flow to resolve multiple claims within the same penalty period — should be agreed for total claims between parties. CSDR penalises the failing party to the trade as a means to promote more efficient settlement across EU capital markets. The Directive specifies that claims should not unduly enrich either party.
Partialling
Automatic Partial Settlement is a facility to settle incremental quantities of a failing transaction. Auto-partial facilities should be applied by default for failing securities lending trades, where its use does not disadvantage either party. Parties may bilaterally agree to time or quantity limitations to provide sufficient opportunity to maintain collateral or other controls. The T2S settlement system provides Partial Hold Release functionality, which should be used as noted in the Securities Market Practice Group (SCPG) market practices.
Sale Notifications
Although best practice may recommend guide cut-off times, it is recognised that counterparts to a loan will want to retain a flexible approach. However, should notifications, instructions and settlement occur outside the recommended guide-times, parties should acknowledge that settlement will be on a best-effort basis. To avoid any backdating of activity, instructions should be processed on the date they are negotiated.
The recommended cut-off times for new loans should be no later than one hour prior to the relevant market cut-off. Collateralisation of new loans will occur at different times relative to the trade and settlement. In regards to returns, notification of a loan return should be processed electronically and, where possible, via an electronic platform, no later than one hour prior to the relevant market cut-off.
ICMA’s regulatory guidance
Through its CSDR Settlement Discipline Working Group, ICMA released its guiding practices on cash penalties to aid the bond and repo markets. The document first discusses best practice relating to Article 6 notification requirements. As a measure to prevent settlement failure, Article 6 of CSDR obliges an EU investment firm, executing a block trade with a professional client, to require that client to promptly communicate the information needed by the investment firm to instruct settlement. ICMA warns that not only is this instruction vulnerable to delay, but the regulatory obligation lies solely on the investment firm. The firm will need to contractually bind its professional client into the process to meet the obligation, whether or not that client is in the EU or in a third country.
The regulator adds that the processes of sending notices of allocations and confirmations of the terms of a block trade are independent and not sequential. The contractual arrangements between the investment firm and the professional client may take any form deemed effective by the parties, provided they are clear regarding the responsibilities of the two parties. The contractual arrangements should specify the close of business of the investment firm for the purposes of receiving and acting upon notices of allocations and confirmations. The contractual arrangements should also specify the necessary information, detailed in Article 2 (1) of the relevant Regulatory Technical Standards, that is required by the investment firm to facilitate settlement.
Other best practices surrounding the notification requirements include monitoring receipt of notices of allocations and confirmations of terms by investment firms, and the dispatch of acknowledgements of receipt to professional clients, against the deadlines set by the regulations or any earlier deadlines agreed by the parties and audited. Furthermore, as proof of regulatory compliance, a record must be kept of the timeliness of incoming notices and confirmations, outgoing acknowledgements, and the validity of incoming allocations.
The particular technology used to transmit notices of allocation, confirmations of terms and receipt of these notices is not prescribed by regulation and is entirely the choice of the investment firm, according to ICMA. However, the likely scale and urgency of the process of sending and receiving notices means that best practice in fulfilling these regulatory requirements is only likely to be achieved through automation of the process. The particular institutional arrangements used to transmit these notices and receipts is also not prescribed by regulation and is entirely the choice of the investment firm.
Bilateral restitution of penalty charges
Within its best practice document, ICMA discusses a scenario in which a party to a repo has offered partial delivery but the counterparty has refused, resulting in the first party suffering a CSDR cash penalty charge for the whole amount of the failed settlement. It gives rise to the question, is it best practice for the first party to be able to seek restitution for that part of the charge where partial delivery was refused?
The regulator concludes that claims for restitution, where partial delivery is refused, are not best practice. “Claims are likely to be contentious and lacking the support of an industry consensus, and while it is important to encourage partialling, it has to be recognised that there are good reasons why parties may not accept partial delivery and that the failing party has breached its contractual obligation to deliver the whole of an agreed amount of securities or cash,” explains ICMA. Parties are free to agree restitution where partial delivery is refused, but this should be agreed in advance of trading.
In terms of partial settlement — where parties to a failed settlement agree bilaterally to partial settlement after the original intended settlement date (ISD) — it is within ICMA’s best practice to agree the date on which the original settlement instructions are to be cancelled and reinstructions issued. Should one of the parties fail to cancel and reinstruct on the agreed date, that party would be liable for any Late Matching Fail Penalties (LMFP) for the delay from the ISD and would have no right to reclaim the LMFP for the period of the delay.
Invoice and billing CSDR cash penalties
Daily reports of CSDR cash penalties on individual failed instructions should be made as soon as possible by CSD participants and non-CSD participants, after receiving a daily report from the calculating CSD. The same guidance is applied to monthly reports of the aggregate CSDR cash penalties, which are to be charged per currency and, if necessary, per CSD. For the purpose of collection from and distribution to clients, custodians should aggregate CSDR cash penalties at the higher level of investment fund or custody account. It is also recommended that Treasury Market Practice Group (TMPG) and CSDR cash penalties be paid separately.
Reports to clients should be in the form of MT537 PENA SWIFT messages, but custodians are advised to consider offering alternatives, for example web reporting, for clients that have not developed the capability to receive MT537 PENA messages via SWIFT.
