January 2021

How is Covid-19 impacting the Central Securities Depository Regulation? flow editorial director Janet Du Chenne finds out from Emma Johnson, Securities Services regulatory expert at Deutsche Bank and John Siena, Associate General Counsel at Brown Brothers Harriman

“The thing that really struck was how the crisis effectively provided a live test of what would have happened in an environment where liquidity might be challenged”

Emma Johnson, Director in the Deutsche Bank Securities Services Market Advocacy team

The impact of Covid-19 on CSDR

Janet Du Chenne: How has the pandemic accelerated the focus on the regulation, and what post-trade issues has it exposed?

Emma Johnson: As the pandemic really took hold back in March (2020), it really did highlight the equation between volatility liquidity and performance. There was a surge in trading volumes and settlement instruction and settlement fails spiked in response. This had a direct impact on operational teams across investment firms and the infrastructure layer when they were adapting to working from home en masse. Basically overnight, we just flicked the switch and as an industry we started working from home. So the low liquidity environment was a challenge as well as the timely delivery of securities. And then, I think we saw the elaboration of a common problem that we are aware of in the settlement chain. We had cash trades and collateral movements like loan recalls and this was challenging across the industry. ESMA published a report of settlement fails, and they reported record volumes of settlement files and an increase of 14% for equities and 6% for bonds, the highest since the reports’ inception in 2014. On the surface it didn't seem too bad as it was around one to five days. But then when we flip that into an SDR (Settlement Discipline Regime) scenario and the intended settlement date application that will be five days of cash penalties to accumulate if the regime were live.

I dialled into a Bloomberg webinar the other day which was very interesting in that they studied the number of settlement fails across the month of November and applied SDR outcomes. And there are some shocking numbers there: around seven and a half buy-ins per day and 180 million worth of penalties in a month. This is alarming. So it drew out the volatility and performance equation for sure, which for some investment and trading houses are big volumes. It was the timing that was ironic because as we’re truly supposed to be ramping up to the full implementation, the crisis hits. And that wasn't just with regard to CSDR. It was across other pieces of very demanding legislation as well. But the thing that really struck was how the crisis effectively provided a live test of what would have happened in an environment where liquidity might be challenged. So as a result we saw what the impact would be. Then we could plug in what the impact of a mandatory buy in might be and think about the implications. ICMA has an excellent paper, which analysed the bond markets across Europe during the month of March, where there was a lot of volatility and liquidity could have been an issue. The point is that parties could let fails go for a while and could have allowed the market to work its way through, but you would have seen a very significant impact with SDR.

So all of this was clearly taken into account when deciding to favour and endorse the postponement of SDR to February 2022.

John Siena: So the work we've been doing on the penalty mechanism is becoming more and more important. I think if all of this plays out it will be much more focused on how well the penalty mechanism works and how well we in the industry actually interact with each other. Having said that the perceived issues around market liquidity as to what drove the postponement are key. There was recognition that there was just a general state of readiness issue across certain segments that the Commission acknowledged in its letter to ESMA. I think the pandemic clearly exacerbated the ability in certain segments to really get all necessary aspects in line and February 2021 (for SDR implementation) was looking increasingly unrealistic. So the crisis certainly had major impacts but I think those effects were a more prosaic in terms of interfering with operational readiness. But they did focus the mind on what could happen in a stressed trading environment.

Regulation an enabler of settlement efficiency

Janet Du Chenne: So with that said, is it fair that CSDR could be seen as a positive for the post trade value chain?

Emma Johnson: Yes and when you think about mandatory change there should always be an opportunity. From trade to post trade, it is a chance to review products and services, internal processes optimise and review operating models and look to identify and eliminate manual processing, which is a big hurdle for this industry. It’s a review of technology so I think it’s really important with that in mind. We’ve seen some vendors evolving their products and extending their service footprint such as the Deutsche Borse, Euroclear and their association with Taskize and new companies such as Access Fintech partnering with the industry to bring about innovative new workflow solutions. I think it's actually really exciting.

But it’s not just about the technology and innovation. I harken back to a bygone era of thinking about settlement efficiencies not just a requisite for CSDR compliance but also for safe, orderly and efficient markets, which is a foundation for attracting and retaining investors and loans to the Capital Markets Union. So it's at the heart of European growth. I think we shouldn't ever underestimate that we will pull in the same direction really for the same cause. And we don’t need a date to be more efficient.

John Siena: I agree with all that and I would just add that that an unexpected by product has been that, prior to CSDR legislation, many industry associations and industry segments tended to talk among themselves. What it has done is led forced different industry segments to really work with each other, to try to collaborate and understand what some of the priorities of those other segments might be. And that collaboration and coordination is really critical. It’s been really healthy with managing expectations all the way through the chain so that, ultimately, the interests of our clients are served in a way that's better. So we see those as very positive developments of late.

The technology requirements will come as part of this, but you can’t overemphasise the potential interoperability that hopefully will make the post trade infrastructure, much more efficient, more low cost and provide participants with much better access to the table.

Next steps for industry participants

Janet Du Chenne: So if we look to conclude, what steps should participants in securities value chain should take to prepare for CSDR?

Emma Johnson: I always say prevention has to be the priority. Obviously we need to be very cognizant of the regulatory requirements, what they're demanding and what we need to comply with. But we need to focus on prevention, ensuring that from a trade risk assessment lifecycle, from booking the allocation of confirmation, which I think is an understated and a critical element of the regulation, and on managing your positions and knowing they’re in the right place and making sure you're not sitting short. In many respects CSDR ties many different regulations together and wraps it up with a penalty framework that penalises institutions who don't do their homework and get their house in order. So, there's an absolute urge to be superefficient. And also remember that relationships are at stake here. It’s the penalty mechanism and they will make failure transparent. This is a relationship business and whether that be trading level, at an intermediate level, or at a CSD or CCP level those relationships are going to be at stake. So it’s about prevention and being as ready as you possibly can be. And using this extra year we've got to make it count.

Don't just sit on your hands and wait for any changes that may or may not materialise. We definitely need to think worst case scenario and really progress what we've already started.

John Siena: Yes, it’s about managing your clients’ expectations. If you think in terms of what their expectations are today, a lot of the work we've been doing has been with that in mind. We’re all talking to each other to ensure that it does affect the process of protocol, with each other, and with the end client in mind so that we can minimise the surprises. Because if you’re on the buyside, you should be thinking in terms of the middle office.

For the purpose of the firm, imagining what the environment’s going to do and whether or not practices and operations should change in order to avoid some of the less favourable consequences.

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