The International Capital Market Association (ICMA) has released a report strongly criticising the mandatory buy-in provision in the Central Securities Depository Regulation (CSDR).
Buy-ins act as additional security for the buyer of securities in a trade. If the counterparty fails to deliver the securities agreed, the buyer has the right to appoint an agent to purchase the securities at market value for guaranteed delivery.
The buyer will still purchase the securities for the agreed price, and the seller must make up the difference.
This is currently primarily conducted on a discretionary basis, and occurs fairly infrequently, however, under new CSDR rules buy-ins will become mandatory if instruments are not delivered within a specified time frame.
The responsibility for managing the buy-in could also lie with the central securities depository (CSD), trading venue, or even the central counterparty.
According to the ICMA report, the impact of Basel III on the cost of a bank’s balance sheet has led to market-makers retaining low levels of inventory, and therefore in many cases they will be offering securities that they do not have.
Market-makers could be forced to add a premium to their offers. The repo market could also be affected, with more reliance on short-data repo funding, or ‘exempt’ repo.
Liquidity across secondary European bond and financing markets could reduce, as bid offer spreads widen dramatically. More stable, fixed-term markets may see a dramatic widening of spreads for more liquid securities including some sovereign and public bonds, and most corporate bonds.
The report estimated that the cost of mandatory buy-in regime for bonds markets would amount to about €1.4 billion per €1 trillion of annual volume.
For the repo market, the estimated annual cost to the market is about €3.14 billion.
There is a concern that this is a cost that will directly affect investors as well as issuers, who will have to pay a ‘liquidity premium’ for their primary debt issuance. Changes are likely to have cost implications for both public and private borrowers.
The report’s author, Andy Hill, pointed out that these estimates do not take in to account the probable market contraction that would follow the introduction of a mandatory buy-in regime, which could be considered a greater cost in itself.
Either way, he maintained that its ability to improve settlement efficiency remains unproven.
The report follows a similar study from the European Central Securities Depositories Association, which found that a mandatory buy-in regime would result in more than 1.8 million buy-ins per year, with a total transaction value of €2.5 trillion.
Hill’s report concluded: “While initiatives to improve the efficiency and safety of Europe’s settlement systems should be supported, every indication suggests that mandatory buy-ins is an ill-conceived and poorly constructed piece of financial markets regulation with no obvious benefits or likely positive outcomes.”
