SETTLEMENT DISCIPLINE REGIMES AND T2S

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T2S PROGRAMME OFFICE 8 March 2010 09.04.01/2010/001895 ITEM 7.

1 T2S PROGRAMME OFFICE 8 March /2010/ ITEM 7.4 SETTLEMENT DISCIPLINE REGIMES AND T2S Table of Contents 1 Introduction 2 2 Definition 2 3 ECSDA report scope 3 4 Settlement discipline topics Early matching Efficient matching processes Early settlement Continuous settlement Promotion of early settlement Prevention of settlement fails Monitoring fails Securities Lending Facilities Buy-in on ISD Settlement of fails after ISD Penalties after ISD Buy-in after ISD Recycling period Suspension sanctions 8 5 Summary Table 9

2 1 Introduction Upon invitation from the T2S Advisory Group (AG), ECSDA presented in the September 2009 AG meeting a paper 1 on market discipline regimes in Europe. The paper provides an overview of existing settlement discipline regimes in Europe based on a survey conducted by Working Group 3 of ECSDA. It also includes some ideas on possible ways forward in the context of T2S. In some markets, the term settlement (instead of market) discipline is used in order to better reflect the operation of a discipline regime focused on matching, settlement and fails management activities which is centrally monitored by the CSD. Trade confirmation would typically be excluded from such scheme. The term market discipline could be interpreted more widely and goes beyond the realm of T2S and the scope of this note. The ECSDA raises a number of very relevant questions: How should the national discipline regimes in Europe be adapted for ensuring timely settlement in a cross-csd environment? The analysis should assess the risks associated with the existent and non-harmonised national discipline regimes in an increasingly integrated settlement environment as the one of anticipated for T2S. Another important question, which the AG may decide to consider, is the so called regulatory arbitrage. Would market participants re-direct settlement volumes between CSDs due to softer discipline and penalty regimes on fails? Finally, should AG, CESAME2, CESR (or elsewhere?) coordinate any further actions or is the simple identification of relevant actors required per topic satisfactory? The present note prepared by the ECB T2S Team builds on the ECSDA paper conclusions. It provides the AG with a topic by topic analysis in order to decide on the possible follow up actions required. This note does not take into account the plans of the ESSF to coordinate its constituents in formulating harmonisation proposals for a European market discipline regime. Leaving outside the wider scope of this initiative, ESSF had not initiated its work when T2S Team drafted this note. Any follow up action from the T2S Team in this area would need to take into account the ESSF work. 2 Definition What should be understood as discipline regime in a securities settlement environment? The industry documentation seems to broadly agree that such a regime, typically run by a CSD, would include agreed market standards (or practices) with the aim of achieving timely matching and settlement of securities transactions. In addition, a framework of sanctions imposed on CSD participants is always 1 Market Discipline Regimes in Europe, v.1.0, ECSDA WG 3, September 2009 Page 2 of 9

3 attached to the breach of these standards and practices. Imposing sanctions requires CSDs to monitor the performance of their participants during the lifecycle of a transaction. 3 ECSDA report scope The ECSDA report provides an excellent stock taking account of the relevant areas (or goals) of a settlement disciple regime analysis: 1. Early matching of settlement instructions 2. Early settlement on intended settlement date (ISD) 3. Prevention of fails management 4. Settlement of fails after ISD The ECSDA report includes some measures required in order to achieve each goal. A stock taking exercise among the ECSDA members provides information of how current local discipline regimes address these measures. Finally, ECSDA provides some proposals for further action as per measure, including possible actors. The following sections of this note will follow the initial ECSDA classification, enriched where relevant for T2S. The note provides the AG with the ECB T2S Team proposals for further actions and relevant actors. References to existing standards (or announced plans for standards) will be made where applicable. 4 Settlement discipline topics 4.1 Early matching Efficient matching processes The question is more relevant in the present European financial environment on the OTC trades since instructions sent to CSDs from organised markets are centrally generated as matched pairs (no matching is required at CSD level). The ESSF/ECSDA matching standards provide the basis for harmonisation and promotion in efficient and early matching rules. T2S URD is in line with the ESSF/ECSDA standards. CSDs intending to operate in T2S should ensure that they comply with these standards prior to T2S testing and launch dates. CESAME2 is already monitoring the CSDs compliance with the matching standards regarding the wider European harmonisation initiatives. 2 The important topic of efficient trade confirmation is not part of the scope of this settlement discipline regime which is focused only on rules and procedures managed by a CSD. Page 3 of 9

4 In addition, and without the intention to duplicate efforts, there may be a need for the T2S Team to keep the AG informed on the readiness of CSDs to comply with the standards prior to T2S testing and launch dates. Monitoring of CSDs compliance with ESSF/ECSDA standards. CESAME2 and AG (regarding CSDs compliance for T2S testing and operations) 4.2 Early settlement In principle, all markets and participants recognise the benefits for the settlement of transactions as early as possible and through out the settlement day Continuous settlement CESAME2 subgroups have been monitoring market practices on continuous settlement during the settlement day. This is relevant only for the period until the launch of T2S. Today, CSDs still differ in their opening times and settlement models (real-time, number of batches, etc). Considerable progress has been made in recent years owing to the introduction of ECSDA standards, the ESCB/CESR standards and the required compliance with the TARGET2 calendar and schedule. T2S will have a material impact in harmonising these aspects of the CSDs operational environment through a single T2S schedule and a single settlement model for all connected CSDs (including the introduction of harmonised night-time settlement cycle for all connected markets). (de facto introduced via connection to T2S) Promotion of early settlement ECSDA and ESCB/CESR recommend the promotion of early settlement via incentives for early settlement and/or penalties for late settlement on ISD (including the night-time settlement period). However, current standards do not make a concrete harmonised proposal leaving the realisation of such requirement with the local CSD/market. Today, only a few CSDs have a penalty regime on this topic. The nature and value of these incentives vary considerably. ECSDA welcomes a single harmonised standard for all T2S CSDs. In particular, some T2S stakeholders are interested in seeing a discipline regime on the night-time settlement performance of CSDs and their participants. It is of importance that there are no free riders during the night time settlement, i.e. that some Page 4 of 9

5 market participants are benefiting from the early liquidity provided by some while they do not provide any liquidity themselves. 3 Neither the T2S platform nor the T2S Team has a regulatory role to play in defining such rules though. However, the AG may decide to invite regulators (CESR) and CESAME2 in order to raise awareness on this topic. Harmonisation proposal on clear and quantified promotion measures for early settlement (including during the night-time settlement period) AG to invite CESR and CESAME2 to consider harmonised measures for early settlement. ESSF future work may cover this topic too. 4.3 Prevention of settlement fails Assuming that timely submission and matching of instructions has taken place, transactions may still fail to settle on ISD depending on the availability of securities or cash. Settlement discipline regimes cover only the securities side of the fail, assuming that all CSD direct participants have access to intraday funds liquidity. AG should take note that although fails are not encouraged by any market stakeholder, the ECSDA paper does not make a single proposal in the direction of enforced or guaranteed settlement (i.e. a centrally managed procedure in the form of securities lending or buying-in with the purpose of imposing a 100% settlement ratio on ISD). Instead, there are proposals for harmonising settlement of fails during the recycling period after the ISD Monitoring fails ESCB/CESR standards recommend monitoring of fails. The recommendation does not explicitly assign this role to the CSDs. In practice, this monitoring is managed by the CSDs which are in the best position to do so. It is understood that CSDs will continue to perform this function once connected to T2S. CSDs will perform this role based on the information/reports received by T2S platform. The information flow between T2S platform and CSDs will be de facto harmonised. CSDs will receive information on the fails affecting only their books (as it is the case today). CSDs will be responsible for communicating relevant reports to their participants or national authorities according to their rules. 3 However, the liquidity requirements during the night time technical netting settlement procedures are rather minimised (as compared to day time RTGS settlement). Page 5 of 9

6 4.3.2 Securities Lending Facilities CSD managed securities lending facilities exist in many EU markets. In most CSDs, participation in these procedures is optional. In a few CSDs participation is mandatory. T2S platform will not operate a central functionality for securities lending in Europe. CSDs will continue operating lending facilities in their legacy systems. A question has been raised on how (securities) borrowers will find lenders in foreign securities (via links). The challenge would be there for CSDs in their function as Investor CSDs to offer such services to their participants. Investor CSDs could alternatively make use of local custodian services if at the start of T2S they are not able to provide foreign securities loans to their participants. There is a legal question of identifying the borrower (account holder) in an omnibus account link environment. Is it the Investor CSD or its ultimate participant? (The question remains even if securities lending mechanisms are harmonised in Europe). T2S can not coordinate harmonisation in this areas since securities lending facilities is outside its scope of operations. It would be beneficial though for the future post-trade environment that regulators consider harmonisation in this area, including the question of the identification of the account holder in a crossborder securities loan. AG could consider notifying CESR and CESAME2 on these points Harmonisation of securities lending facilities and further analysis on the identification of account holder in cross-border securities loan. AG to notify CESR and CESAME2 for possible harmonisation initiatives Buy-in on ISD Although there are a few markets (ES, GR, PL and SI) where buying-in is performed on ISD and managed by the CSD, procedures are not harmonised. For example in some of these markets, the buyingin takes place on ISD whereas the settlement of the fail is processed on ISD+1. The ECSDA report does not make any proposals for the wider European introduction of buying-in procedures on ISD. This seems in line with previous discussion held with T2S stakeholders on the enforced settlement where the majority of T2S stakeholder was against it. No further actions are identified by the industry at this stage. Page 6 of 9

7 4.4 Settlement of fails after ISD ECSDA recommends that CSDs have measures in place for promoting settlement of fails as early as possible after the ISD. ESSF is already working on harmonisation proposals in this direction Penalties after ISD Today CSDs calculate (and sometimes collect) penalties on fails after ISD. Schemes and prices vary between CSD schemes. ECSDA raises the question of which scheme is applicable in a cross-csd fail (settlement fail between two Investor CSDs). The T2S Team assumption is that the Investor CSD, in its role as participant in the Issuer CSD, will be liable to the penalty scheme of the Issuer CSD. The Investor CSD, being an Issuer CSD participant, should conform to the Issuer CSD settlement discipline regime. The Issuer CSD would calculate the penalty attached to the Investor CSD fail and the Issuer CSD would collect (if applicable) the penalty from the Investor CSD. The Issuer CSD parties that receive parts or all of the collected penalty will be defined by the rules of the Issuer CSD. Obviously harmonisation in Issuer CSD schemes would smoothen cross-border operations management for Investor CSDs and ultimately for their participants. A more critical issue raised by the ECSDA report pertains to the regulatory arbitrage potential in differing penalty regimes. The issue is already present in Europe and raises concerns as to the existence of a race to softer discipline measures in order for a CSD/market to attract volumes. European regulators may want to further examine the criticality of this point and possible embark on a harmonisation initiative. Harmonisation of fails penalty regimes in Europe CESR, CESAME2. ESSF planned work may cover this area Buy-in after ISD The ECSDA report raises similar report for the buy-in procedures after ISD as for the penalties after ISD. Who defines, who executes and who bears the cost of an Issuer CSD buy-in procedure. The T2S Team assumption is that the Investor CSD, being an Issuer CSD participant, would have to comply with the Issuer CSD discipline regime. As with penalties, the European regulators may consider the benefits of an initiative on harmonising European harmonisation buy-in mechanism (including optional/mandatory status participation) in order to avoid regulatory arbitrage. Page 7 of 9

8 Harmonisation buy-in rules in Europe CESR, CESAME2. ESSF planned work may cover this area Recycling period Recycling of fails after ISD exists in almost all EU CSDs, with a few exceptions. ESSF has worked on a proposal for a maximum recycling period during which a failed transaction could remain unsettled: 10 or 11 business days (depending on T+3/T+2 settlement cycle). T2S is neutral as to this standard. No recycling period of fails is administered at T2S platform. 4 CESAME2 and ESSF will continue monitoring the harmonisation proposal. Harmonisation of CSDs recycling periods. CESAME2 and ESSF to monitor. Could be also Part of T2S List C for monitoring purposes Suspension sanctions Many CSDs have in the rules provisions on the ultimate sanction on the breach of their discipline regimes: suspension from CSD participation. Barely applied, as moral suasion and penalties should avoid such extreme events, they set an upper limit of discipline in a settlement operational environment. As above, the Investor CSD should ensure compliance with the Issuer CSD discipline regime. Being a rare event, ECSDA did not consider this as urgent for identifying any further action. 4 According to AG decision, there is an unlimited for recycling (matched) fails in T2S. There is only a cap on un-matched instructions which are only recycled for 20 business days in T2S platform. Page 8 of 9

9 5 Summary Table Goal Measure Actors Early Efficient Monitoring of CSDs compliance CESAME2 and AG (regarding Matching matching with ESSF/ECSDA standards. CSDs compliance for T2S testing processes and operations) Early Continuous (de facto introduced via Settlement settlement connection to T2S Promotion of Harmonisation proposal on clear AG to invite CESR and early and quantified promotion measures CESAME2 to consider settlement for early settlement (including harmonised measures for early during the night-time settlement settlement. ESSF future work period) may cover this topic too. Prevention of Monitoring settlement Fails fails Securities Harmonisation of securities AG to notify CESR and Lending lending facilities and further CESAME2 for possible Facilities analysis on the identification of harmonisation initiatives account holder in cross-border securities loan. Buy-in on ISD Settlement of Penalties Harmonisation of fails penalty CESR, CESAME2. ESSF fails after after ISD regimes in Europe planned work may cover this ISD area. Buy-in after Harmonisation buy-in rules in CESR, CESAME2. ESSF ISD Europe planned work may cover this area. Recycling Period Suspension sanctions Harmonisation of CSDs recycling periods. CESAME2 and ESSF to monitor. Could be also Part of T2S List C for monitoring purposes. Page 9 of 9

The Depository Trust & Clearing Corporation. Euro CCP Ltd. Contact person: Andrew Douglas Head of Public Affairs, Europe

Central Securities Depositories (CSDs) and the harmonisation of certain aspects of securities settlement in the European Union Consultation 1st March 2011 Response from The Depository Trust & Clearing