Matthew Johnson, Associate Director,
ITP Product Management
The securities industry is still grappling with many aspects of the Settlement Discipline Regime (SDR), and firms are faced with the huge task of automating as much of the post-trade/pre-settlement process, according to Matthew Johnson, associate director, ITP product management at the DTCC.
The announcement by the European Securities and Markets Authority (ESMA) of a delay in SDR implementation to February 2022 was gratefully received. To shed some light on how far industry preparations have progressed in resolving issues related to financial penalties for settlement failure and the buy-in regime under SDR, DTCC recently conducted a survey with over 400 market participants, including broker dealers, buy-side, custodians and outsourcers.
A key requirement of SDR is that the buy-side maintain a solid understanding of the status of financial penalties due to be debited or credited from their custodian accounts on a monthly basis by the CSDs. When asked, however, 43% of buy-side clients had no indication of how the level of penalties would be communicated. From an operational perspective, it appears that market participants will be receiving datasets from multiple sources in multiple formats.
When it comes to the monthly net credits, debits and allocation of financial penalties levied by the CSDs, nearly half of survey respondents still have no information from their custodians, prime brokers or settlement agents as to how this will be carried out. This raises the issue that market participants will need to conduct daily reconciliation of failed trade penalties and credits to ensure the accuracy of the monthly debits/credits.
SDR requires mandatory buy-ins should trades fail to settle beyond a certain time period. If a buy-in is unsuccessful after two attempts, the transaction is resolved via cash compensation. For equities, calculating the cash compensation is a straightforward process as historic pricing data is available; however, for illiquid bonds it is far more challenging. Our survey found that 88% of market participants do not know how the cash compensation price amount for illiquid bonds will be sourced.
Over 50% of buy-side firms surveyed stated their intention to send post buy-in notifications to the counterparty failing into them versus 74% of the sell-side. Of concern is that most respondents said they intend to communicate these notifications via email, which is vulnerable to human error.
One of the most interesting findings of the survey was that the majority of respondents expect the buy-in process to be initiated by the middle/back-office rather than the front-office as had been thought previously. The buy-side currently issues on average one or two buy-ins per quarter. Under SDR, this could rise to as many as 20 a day. Firms will thus need to set up and resource a separate middle-office process to execute and administer buy-ins.
Taking into account all of the requirements above, it is essential that firms work with a solutions provider who is able to facilitate these processes. Automating as much of the post-trade/pre-settlement process as possible will help buy-side and sell-side firms achieve timely settlement and minimize the chances of financial penalties and potentially expensive buy-ins.
DTCC’s CTMTM service has been helping clients achieve full confirmation and affirmation automation for many years, mitigating settlement risk through robust straight through processing capabilities to get trades agreed and pre-matched for settlement as close to execution as possible. Clients also understand the importance of highlighting and rectifying all trade exceptions as quickly as possible to achieve timely settlement. As testament to this, we have seen an increased uptake in our DTCC Exception Manager service, which enables clients to manage all their trade processing needs in one place with 14 custodians, three brokers, and four prime brokers all actively submitting data into the platform and 41 buy-side clients consuming this data.
SDR’s implementation requires a best practice approach to post-trade processing. While the extra time granted for SDR implementation has provided market participants with some reprieve, our research report shows that there are significant operational challenges yet to be resolved. These issues will need to be addressed sooner rather than later.
This article first appeared in Global Custodian on January 11, 2021.