Lacking “logical or economic basis” and “counterproductive” – these were just some of the comments industry associations had regarding the potential introduction of progressive penalties for settlement fails. Shared in response to a consultation paper published by ESMA in December last year, the comments – summed up here in an article by The Trade – made clear the industry’s general opposition to the proposed amendments to the CSDR penalty regime.
The suggested amendments came a little over a year after cash penalties for settlement fails were introduced in February 2022. Settlement fail rates were “not immediately impacted” by the initial introduction of the penalties, which has caused many respondents to claim that it is “too soon to take stock” and that there “isn’t enough data and evidence to support increased penalties”. On the other hand, “the drawbacks are many”.
A cause of stress
“Progressive penalties would introduce an unnecessary level of complexity, with the associated cost and resource drain,” wrote The International Capital Market Association (ICMA). It predicted that this would affect not just CSDs, CCPs and custodians, but also market participants who need to reconcile penalty credits and debits, and the clients who might get hit with a pass-on effect. “Furthermore, this would put additional stress on an already dysfunctional claims process that has been born out of the EU’s CSDR penalty mechanism.”
ICMA has also expressed concerns that the amendments could backfire. “Progressive penalty rates would not provide an additional motivation to settling trades, but rather an incentive to avoiding trades, thereby becoming counterproductive. Increasing the cost of failing will not make an illiquid security any less illiquid…this will only make illiquid securities more illiquid.”
Aim for solution
The International Securities Lending Association (ISLA) noted that “an overhaul to the penalty regime would take considerable resource away from a focus on T+1, although it is acknowledged by the industry that in order to be successful in accelerating the settlement cycle, there must also be high settlement rates across the EU.”
ESMA has acknowledged that the penalties should be “unequivocally more expensive than remedial action, like borrowing the securities or funding the cash” and “certain in terms of calculation and forecasting, to facilitate cost/benefit calculations in terms of remedial investments”.