The UK’s exclusion of the Central Securities Depositories Regulation’s (CSDR) settlement discipline regime as part of its adoption of EU regulations post Brexit
, will “undoubtedly create new challenges for firms in the UK”, according to Neil Vernon, CTO at Gresham Technologies.
On 23 June, the chancellor of the exchequer Rishi Sunak confirmed several major updates to the UK’s Brexit plans for adopting EU rules frameworks in a written statement that will radically impact the country’s securities services market participants.
Firms impacted by CSDR are likely to be settling in both EU and UK regulatory regimes and “any divergence will add a degree of complexity to the settlement process and so from a business process perspective”, Vernon explained.
Also weighing in, Daniel Carpenter, head of regulation at Meritsoft, said: “As the majority of capital markets firms operate globally, having footholds or transactions flowing through the EU, UK, US and Asia Pacific regions, and will, therefore, be pulled into CSDR.”
He added: “Specifically, there will be many UK-based investment managers who will be settling transactions across the EU and will need to make sure that they are compliant with this regulation."
Carpenter explained that the regulation highlights that reducing the number of trade fails is best practice and commercially beneficial and as a result, he suggested “improving processes will no doubt be looked at favourably by UK firms, even following [the] statement”.
CSDR aims to improve settlement rates by imposing cash penalties for fails along with a mandatory buy-in requirement.
The settlement discipline regime was originally due to come into effect in September but “technical impossibilities” around the implementation of IT solutions of industry stakeholders, and the fact that an essential ISO update due from SWIFT would not be in place until its annual November update, scuppered this timeline.
Explaining his position, Sunak noted: “The UK played a pivotal role in the design of EU financial services regulation. The government remains committed to maintaining prudential soundness and other important regulatory outcomes such as consumer protection and proportionality.”
However, Vernon suggested that CSDR was “a poorly drafted regulation and is in need of re-thinking”.
He said: “The cost of a failing-trade under CSDR is significantly higher than the cost of a failing-trade under a non-CSDR regime.”
“Businesses will need to ensure that appropriate resources are allocated to these higher cost breaks than lower cost breaks. Indeed, the unintended consequences of this change, given that organisations are unlikely to allocate more resources, is that the UK failing trades are likely to fail more frequently than they currently do leading to potential increased market inefficiencies in the UK.”
Paul Baybutt, senior product manager at HSBC Securities Services, stated that it was “not surprising given the uncertainty that currently exists with how the settlement discipline regime should be implemented”.
Baybutt said the settlement process should not be affected too much by the UK’s decision.
He explained: “The idea of a split model will introduce a small but not insignificant challenge; however, buy-ins and penalties already exist in other markets so we have the experience to manage these different requirements.”
Although he noted that how the relationship between the UK CSD and those CSDs in Europe pans out has yet to be seen.
“On the one hand, if for example there ends up being no mandatory buy-ins in the UK, that could attract liquidity. On the other hand, the removal of barriers to competition will no longer be available to the UK”, he added.
Although Sunak’s statement will create challenges for some firms, Baybutt noted that it will only be securities settled in CREST which are affected by this announcement.
Baybutt highlighted: “It does not fundamentally change the fact that UK firms must still be compliant with the European settlement discipline regime.”
However, he suggested that opportunities could arise for firms to move European assets into CREST under the investor CSD model.
“If that happens, it will be interesting to see how both the EU and HM Treasury respond, and how the EU CSDs and the European Central Securities Depositories Association (ECSDA) will approach it. ECSDA has already asked for a postponement to the implementation of Settlement Discipline Regime and Settlement penalties in particular,” he explained.
Also discussing the opportunities, Vernon said that the mandatory buy-in aspect of CSDR is predicted to reduce market liquidity and consequently increase cost.
However, he noted: “This also potentially creates an opportunity for more aggressive pricing of instruments settled in the UK versus equivalent EU settled instruments”.
“Consequently, a net inflow of trading activity into the UK could follow from this announcement and this could create an opportunity for UK centric houses,” Vernon added.
Looking ahead, the UK Government said it remains “committed to regulation that supports and enhances the functioning of UK capital markets”. The settlement discipline regime was designed to ensure protection for investors from settlement risk.
Baybutt explained: “HM Treasury and the Financial Conduct Authority, together with the industry, and in particular, the trade associations such as Association for Financial Markets in Europe, International Capital Market Association and IA, are likely to determine how settlement discipline measures can be implemented. Solving the liquidity issue is key, as is still retaining the need for efficient financial markets, yet reducing settlement risk.”
In his statement, Sunak commented: “The UK played a pivotal role in the design of EU financial services regulation. The government remains committed to maintaining prudential soundness and other important regulatory outcomes such as consumer protection and proportionality.”
“However, rules designed as a compromise for 28 countries cannot be expected in every respect to be the right approach for a large and complex international financial sector such as the UK.”
“Now that the UK has left the EU, the EU is naturally already making decisions on amending its current rules without regard for the UK’s interests. We will therefore also tailor our approach to implementation to ensure that it better suits the UK market outside the EU.”
