With just over six months to go before the implementation of the Settlement Discipline Regime (SDR) market participants need to have advanced their preparations for the regulation in time for implementation in February 2022. Here, Matt Johnson, DTCC Director, ITP Product Management, covers some key points on SDR preparation, including where market participants should be in their preparations and how automating post trade processes pre-settlement can assist with timely settlement.
The Settlement Discipline Regime is the component of the Central Securities Depository Regulation (CSDR) that aims to improve settlement efficiency in Europe with a view to reducing risk. Under SDR, market participants will be liable to pay penalties or charges against each transaction which fails to settle under the mandated T+2 timeframe. A penalty will be charged daily based on the asset class/security type and notional value of the transaction up until the buy-in process is initiated.
Further, a mandatory buy-in process will take place for any financial instrument which has not been delivered within a specified period of the intended settlement date to fulfil settlement. Illiquid securities will be required to be bought-in within seven business days of the intended settlement date while liquid equities will be required to be delivered within four days.
The industry has made significant progress in their preparations in that most firms understand what SDR is and have a good understanding of how it will likely impact them. But there is a large gap in preparedness between the sell-side and buy-side.
What stage in their SDR preparations should market participants currently be?
By now, with eight months to go before the implementation of SDR, the majority of market participants should understand where there are automation gaps in their post trade processes. Firms should have analysed their current level of failed transactions and understand the volume of failed transactions, how long they are failing for, and why.
The amount of time that a trade fails for is critical, as the longer the fail lasts, the higher the risk of a buy-in. This is a highly significant issue for small asset managers as many claim to have a much lower rate of fails than larger firms. However, a recent piece of analysis by a large custodian found that while smaller asset managers do have a lower rate of fails, the fails tend to drag on for longer than for bigger firms that have more resource to chase custodians or have budget/resource to rectify failed trades. The longer the trade fails for, the higher the chance of a larger fine or a buy-in.
And do you think most market participants are at that point?
The industry has made significant progress in their preparations in that most firms understand what SDR is and have a good understanding of how it will likely impact them. But there is a large gap in preparedness between the sell-side and buy-side.
Generally speaking, the sell-side is very well prepared. Many of them have spent a significant amount of time with trade associations to get a thorough understanding of what SDR will mean for from a resource and budget perspective. They have also have very established SDR strategies and a dedicated CSDR team.
While buy-side firms have also engaged closely with trade associations, from a practical perspective they don’t have comparable resources to be able to spend on SDR preparations. Smaller buy-side firms need to stay engaged with their broker and custodian communities who can provide support and help them to navigate the regulation. At DTCC, we advise clients on how best to streamline their post trade processes which can assist in timely settlement.
Also critical to successful SDR preparation is that firms need inter-company engagement between front, middle and back-office functions. They all need to be aware of their respective roles and how they will interact daily to ensure they operate seamlessly when SDR goes live.
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How does the level of awareness and preparation for SDR vary between in-scope market participants in different regions?
Given this is a European regulation, unsurprisingly, awareness of it is highest in this region. However, this tends to vary according to the size of the market participant - the larger the firm, the more aware and hence the better prepared they tend to be.
In the U.S., CSDR awareness is high. Despite being a European regulation, it will have a significant impact on US firms, particularly those with European investment strategies.
In the Asia-Pacific region, we haven’t seen the same level of interest in SDR as in the US and as a result, awareness of the regulation isn’t as high there. However, in some Asia markets this is because there are already established strict settlement discipline regimes in place such as in Taiwan and South Korea.
What areas of post trade preparations for SDR are causing market participants the biggest problems?
In some areas of SDR, the market is still waiting for more detailed guidance on the regulation. Trade associations have presented an open list of questions to regulators and in some cases, they are still waiting for feedback. If there is a significant disparity between a firm’s interpretation of regulation and what was intended by regulators, firms may need to make significant changes to their approach.
The buy-in process is also an area which is causing concern. The regulation requires that buy-ins be initiated through a buy-in agent. Firms need to have selected and onboarded a buy-in agent by the time the regulation is implemented. If this is not done, then market participants could fall foul of the regulation.
Also of concern is that there are a small number of firms where there is a persistent lack of post trade automation which will impact timely settlement. When SDR goes live in February 2022, the firms still using manual post trade processes are the ones that will suffer the most.
What are the key post trade processes market participants should implement to avoid CSDR late settlement penalties?
To prepare for the regulation, the post-trade, pre-settlement process needs to be as automated as possible. This means using ALERT, the industry’s largest database of standing settlement instructions (SSIs) so that clients have access to the most up to date information reducing the risk of settlement fails dues to inaccurate or incomplete instructions. Through ALERT Global Custodian Direct, a fully custodian or prime broker managed workflow, clients can ensure that SSIs in the system come directly from and are maintained by source data providers.
By utilizing DTCC’s CTM platform, clients can enrich their trades with SSIs from ALERT automatically through the ALERT Key Auto Select (AKAS) functionality allowing them to agree on the economics and place of settlement on trade date, enabling a timely and accurate trade match. If there are any trade exceptions, DTCC Exception Manager can identify these in real time, enabling clients to quickly resolve them, therefore minimising delays to settlement.
If you could give one piece of advice to market participants preparing for CSDR, what would it be?
Prevention is better than cure. A settled transaction cannot be penalised and can’t be bought in, therefore by automating the post-trade pre-settlement process, you will significantly increase the chances of timely settlement.
This article first appeared in The Network Communication Forum, Issue 7.