The European Securities and Markets Authority (ESMA) has released a consultation paper on the penalty mechanism for settlement fails under the Central Securities Depositories Regulation (CSDR). Among a number of preliminary proposals to address three main topics is one for alternative methods to calculate cash penalties. For this, ESMA has a suggestion – introducing a progressive penalty rate.

According to the paper, the progressive penalty would come in the form of a daily penalty charged for each business day that a transaction fails to settle after the intended settlement date. ESMA wrote that “cash penalties should not only deter participants from causing settlement fails, but also incentivise the failing party to rapidly resolve the settlement fail”.

Another consideration for the penalty mechanism is the changing interest rate environment and illiquid financial instruments. For the former, ESMA was required by the European Commission to consider how events such as negative interest rates could affect a participant’s incentive to fail and how this could be mitigated. For the latter, a level of flexibility in imposing penalties might be necessary.

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Other matters of concern

The other two topics concern alternative parameters for when the official interest rate for overnight credit charged by the central bank issuing the settlement currency is not available and the treatment of historical reference data for the calculation of late matching fail penalties.

The deadline for comments is 29 February 2024. ESMA will publish a final report and submit its technical advice to the European Commission by 30 September 2024.