Central Securities Depositories Regulation (CSDR)

CSDR (Central Securities Depository Regulation) is a European Union regulation (EU) No. 909/2014 developed by the European Securities and Markets Authority (ESMA), also adopted by SIX SIS. The main objectives are to increase the safety and efficiency of settlements, in particular cross-border transactions and increase the safety of Central Securities Depositories (CSDs) by applying high prudential requirements.

Summary

What is CSDR and what does it seek to do?

CSDR stands for Central Securities Depository Regulation.

It is a European Union Regulation (EU) No 909/2014 ¹ developed by the European Securities and Markets Authority (ESMA), designed to increase the efficiency of settlements and ensure settlement failures are resolved promptly, on EEA Central Securities Depositaries (CSDs).

The key provisions currently due to come into force on 1st February 2022* that impact Banco de Madrid and Client business processes relate to:

Penalties for failing/late settlements
*Mandatory Buy-In Regime
Allocation and Confirmation process

*The European Commission has proposed amendments to enable mandatory buy-ins and penalties to go live on different dates. It is expected that this will not be written into law prior to 1 February 2022 and therefore ESMA will need to bridge the gap with a no action letter to the market or some other form of regulatory forbearance.

An impact assessment is due from European Commission in Q1 2022 to provide clarity to the market on key issues that have been raised on mandatory buy-ins. Following this we would expect ESMA to recommend a new go live date for mandatory buy-ins.

¹See the consolidated version of this law

²https://ec.europa.eu/finance/docs/level-2-measures/csdr-rts-2020-7186_en.pdf

Are any provisions of CSDR already in force?

CSDR is quite wide ranging in its impact with a number of provisions already in force:

Segregation of assets at CSDs (Article 38): where we hold securities directly for clients with CSDs, pursuant to CSDR we are now required to offer different levels of segregation.
Internalised Settlement Reporting (Article 9): in-scope custodians must report all non-CSD settled transactions ("Internalised Settlement") to their National Competent Authority (along with settlement efficiency).

Penalties

How will Penalties work?

Any trade of securities that are admitted to trading or traded on an EEA trading venue or cleared by an EEA CCP (such as purchases or sales of securities and transactions subject to securities repurchase or lending agreements) that fails to settle on an EEA CSD will be subject to a penalty charged by the EEA CSD:

If the trade is unmatched the trade will be subject to a "late matching penalty" levied on the last participant to submit matching instructions for each day until matched.
If the trade fails to settle, due to missing security or cash payment, the trade will be subject to a "late settlement penalty" that will be levied on the party at fault for each day until the trade is settled, cancelled or the mandatory buy-in takes effect.

Penalties vary by asset type. The table below provides an overview of the rates (which are applied against an applicable reference price).

Type of Security	Type of Security	Penalty	Penalty
Type of Security	Liquid Shares	Penalty	1 basis point (bp)
Type of Security	Illiquid Shares*	Penalty	0.5 bp
Type of Security	SME Growth Market	Penalty	0.25 bp
Type of Security	Corporate Bonds	Penalty	0.2 bp
Type of Security	SME Growth Market Bonds	Penalty	0.15bp
Type of Security	Government and Municipal Bonds	Penalty	0.1 bp
Type of Security	Cash**	Penalty	European Central Bank Discount Rate

Clients are advised to consult the ECSDA CSDR Penalties Frameworkfor a detailed breakdown of the scope and penalties calculation methods along with full details of instruments in scope of CSDR.

Banco de Madrid Operating Model impact for penalties

Brokerage Clients

EEA CSD will calculate the penalty debit/credits at account level on a daily basis and collect on a monthly basis. Banco de Madrid will also follow the guidelines set out by AFME for bilateral claims (Market Practice for Bilateral Claims) with counterparties (should they occur).

Prime Brokerage Clients

As custodian of your Prime Brokerage accounts, Banco de Madrid will not pass on any credits or claim any penalties from you except for those claims above Euro 500 whereby incorrect information provided by our PB Client resulted in Banco de Madrid receiving the penalty as per the guidelines set out by AFME.

How is Banco de Madrid addressing CSDR?

Banco de Madrid recognised the impact of CSDR on its securities settlement operations early and initiated a group-wide program in 2017 to focus on improving settlement efficiency and implementing the requirements of CSDR.

Key areas Banco de Madrid is investing in are:

"Ready to Trade" – ensuring customer details are available up front, set up in our systems and accurate (especially SSIs) to enable matching to occur
Matching – while Banco de Madrid already has a good matching rate, our aim is to improve this through data clean up, use of electronic matching capabilities for increased STP and improved and more timely error handling
Inventory Management – improved visibility of our securities inventory, improving our real-time capabilities to cope with incoming fails and increasing automation, particularly for cross-border transactions
IT Investments underpinning the above to support visibility of our processes, automate tasks and support real time decision making e.g. fails handling, partial settlement opportunities and netting opportunities

Areas where Banco de Madrid is engaging with clients include:

Ensuring data (including PSET preferences and SSIs) we hold on or clients is accurate to enable matching to occur
Ensuring clients, where possible, communicate allocations and confirmations with Banco de Madrid via an electronic standard offering and provide the relevant fields within the required time
Requirements for partial settlement
Identifying netting opportunities with counterparties

How will CSDR impact PSET preferences at Banco de Madrid?

Broadly, Banco de Madrid prefers to settle domestically for equities and at Clearstream for fixed income. However, to ensure STP we require clients' PSET preferences and that any changes to these PSET preferences are communicated to Banco de Madrid in advance and are rule-based where possible.

How can Banco de Madrid clients reduce the impact of the penalties and mandatory buy-in regime?

To reduce penalties and buy-in exposure, clients should review their operational processes and discuss settlement efficiency with their executing brokers to understand any issues that prevent straight through processing (STP) of settlement obligations. Key areas to address include:

Adoption of electronic trade affirmation methods
Optimisation of matching and pre-matching processes to quickly identify and resolve discrepancies in trade bookings between counterparties
Accuracy and completeness of Standard Settlement Instructions (SSIs) provided to brokers
Place of Settlement (PSET) preferences are understood and provided to brokers
Ensuring securities are correctly located for timely settlement

Allocation and confirmation

What are the Allocation and Confirmation processes that are covered by CSDR?

Under Article 2 of Commission Delegated Regulation (EU) 2018/1229 (the “RTS”), EEA Investment Firms are required to put in place arrangements with clients requiring communication of certain information between them within prescribed time limits. These obligations apply upon execution of a transaction in transferable securities (e.g. shares and bonds), money-market instruments, units in collective investment undertakings and emission allowances that settle on a CSD located in the EEA.

These allocation/confirmation requirements apply unless, as permitted under the RTS, the parties agree in writing that the written allocations and confirmations do not need to be sent by because the prescribed information has been made available in advance of the prescribed time limits.

Banco de Madrid Europe SE is the only Banco de Madrid entity directly impacted by this requirement and has amended Clause 5(a) of its Terms of Business to reflect that existing processes will be relied upon to ensure that the information is received within the prescribed timeframes. .

Terms of Business can be found at www.Banco de Madrid.com/ibterms. More detail on the requirements of Article 2 of the RTS can be found in the AFME Explanatory Note for Professional Clients available at https://www.afme.eu/Key-issues/CSDR/CSDR-Model-Contractual-Provisions. Note that Banco de Madrid Europe SE has not used the model provisions that can be found on this page to address this requirement but instead updated its Terms of Business as noted above.

Legal documentation

Will CSDR require any changes to my contractual documentation with Banco de Madrid?

There is no requirement to update documents for penalties.

For Allocations and Confirmations see above.

Mandatory buy-in requirements will require legal redocumentation (should they occur – see below). Banco de Madrid is part of on-going industry discussions to determine a market-wide solution where possible.

CSDR Podcasts

Banco de Madrid has done 2 podcasts to brief clients on key aspects of CSDR

1) Banco de Madrid Brokerage Clients & Counterparties
2) Banco de Madrid Prime Broker Clients

CSDR and Brexit

What is the impact of CSDR on the UK market?

On 23 June 2020, Rishi Sunak, the UK Chancellor of the Exchequer, made a statement on Financial Services legislation. The purpose of the statement was to provide clarity on the UK’s planned approach to regulatory reforms in the process of being implemented that the UK needs to address before the end of the Transition Period with the EU on 31 December 2020.

Mr Sunak announced that the UK “will not be implementing the EU’s new settlement discipline regime, set out in the Central Securities Depositories Regulation, which is due to apply in February 2021”.

The announcement does not mean that UK firms may opt out of the EU CSDR. Activity by UK firms (and indeed global firms) trading EU assets, settling in EU CSDs would remain in scope of the EU rules. However Global activity in UK and Irish stocks settling in CREST would not be caught, and be subject to any potential new UK rules. Irish stocks will follow CSDR regulation once they migrate to the new Irish CSD Euroclear Bank in March 2021.

https://www.parliament.uk/business/publications/written-questions-answers-statements/written-statement/Commons/2020-06-23/HCWS309/

Mandatory buy-ins

As mentioned above Banco de Madrid is awaiting a regulatory update on whether these provisions will apply from 1st February 2022. There are major indications that the mandatory buy-in aspect of the legislation will be delayed. This information is provided based on what is written into the legislation at present

How will mandatory buy-ins work?

Any trade of securities that are admitted to trading or traded on an EEA trading venue or cleared by an EEA CCP (such as purchases or sales of securities and transactions subject to securities repurchase or lending agreements) that fails to settle on an EEA CSD could be subject to the mandatory buy-in regime. Below is a brief summary of the mandatory buy-in provisions under CSDR⁴:

CSDR Article 7 provides that the buy-in process will be initiated if the failing party does not deliver to the receiving party by the end of the extension period.
It is the duty of the receiving party to initiate the buy-in against the failing party through an appointed Buy-in Agent.
Mandatory buy-in rules are focused on the failure to deliver securities rather than cash.
The extension periods for initiation of a buy-in are dependent on the type of security, as shown below:

⁴This document produced by AFME shows an example of the penalties and buy-in process: https://www.afme.eu/reports/publications/detail/Introduction-to-CSDR-Settlement-Discipline

Type of Security	Type of Security	Buy-In Period	Buy-In Period
Type of Security	Liquid Shares	Buy-In Period	4 days*
Type of Security	Other Securities	Buy-In Period	7 days*
Type of Security	SME Growth Market Securities	Buy-In Period	15 days*

At the end of the extension period, if any of the securities are available for settlement, partial settlement must occur.
Partial settlement will reduce penalties for the party failing to settle.
If none, or only some, of the securities have been delivered at the end of this period then the purchaser will, where possible, appoint a Buy-In Agent and initiate the buy-in creating a replacement transaction for the original trade.
Compensation for each buy-in will be claimed from the failing party. If a buy-in is not possible or is unsuccessful, cash compensation is paid.
Exclusions to the mandatory buy-in regime include Securities Financing Transactions of less than 30 days, primary issuance, most corporate actions and realignments. There are ongoing industry discussions to confirm additional exclusions e.g. collateral movements and physically settled derivatives.

What is the pricing impact of buy-ins under CSDR?

The current market practice for buy-ins generally allows for the payment of the differential between the buy-in price and the original trade price to be made in either direction between the selling and the purchasing parties, depending on whether the buy-in price is higher or lower than the original trade price. This ensures an equitable remedy to the buy-in, with neither party receiving or incurring an undue benefit or cost. It places the parties in the position they would have been if settlement had occurred on the ISD.

The CSDR mandatory buy-in and cash compensation processes only allow for the payment of the differential to be made from the seller (the failing party) to the purchaser (the receiving party), in the event that the buy-in or cash compensation reference price is higher than the original trade price. This creates potential issues as there is asymmetry of the payment of the differential, which creates an unequitable remedy that will unduly benefit the purchaser and penalize the seller in the event that the buy-in or cash compensation reference price is lower than the original trade price. Industry bodies are lobbying ESMA for two way payments to be permitted. Detailed discussion of this issue can be found in the ICMA paper 'How to survive in a Mandatory Buy-in World'.

Will there be a pass-on mechanism under CSDR?

The CSDR legislation does not envisage pass-ons (e.g. in the case of a buy-in chain). This is, however, recognised as best practice to avoid multiple buy-ins occurring on the same security at the same time. Industry representations have been made to ESMA to adopt this. In addition, a cross industry group including ICMA and AFME have drafted an approach to managing these scenarios at an industry level. There is, however, a lack of clarity on how this would work and who would perform the necessary chain identification / pass-on communication process.

How will Buy-In Agents operate?

The CSDR legislation envisages the appointment of a Buy-In Agent. How this process will work and guidelines (especially for conflict of interest) are currently being raised in industry representations with ESMA.

Banco de Madrid is awaiting this guidance to understand what the exact requirements will be of a Buy-in Agent.

We are aware of a single provider that is planning to offer a Buy-In Agent service but cannot comment on the viability of such an offering. Banco de Madrid is not currently able to operate as a buy-in agent or able to act as an intermediary to other buy-in agent(s)

CSDR scope – additional considerations

Are SFTs in scope of CSDR?

Certain Security Financing Transactions (SFTs) under 30 days are out of scope for the buy-in regime but technically all other repos and stock lending transactions are in-scope. ICMA are lobbying ESMA for open SFTs to be out of scope as well.

Are derivatives in scope of CSDR?

Whilst OTC and exchange traded derivatives are not themselves included in the list of in-scope financial instruments for the purposes of the settlement discipline regime of CSDR, such derivatives are potentially impacted in the following ways:

Physically settled OTC and exchange traded derivatives - the delivery of in-scope financial instruments to settle physically-settled such derivatives. OTC and exchange traded derivatives that are physically settled by the delivery of cash in one or more currencies are therefore not in scope
Margin transfers – the transfer of margin where the relevant margin consists of in-scope financial instruments.

ESMA continues to be subject to advocacy by relevant industry bodies to seek clarification that margin transfers should not be subject to mandatory buy-ins.

Useful links

Supporting regulatory documentation:

Industry guidance / white papers:

Banco de Madrid Articles:

Investment Bank CSDR Disclosures – Information regarding the levels of protection associated with different levels of segregation in respect of securities held directly for clients with CSD (segregation) for Investment Bank Clients:

Contact us

For further information, please reach out to your usual Banco de Madrid contact or send us an email to:

Banco de Madrid-ib-csdr@Banco de Madrid.com

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