SECURITIES SETTLEMENT DISCIPLINE – SDR REGULATIONS – PART II

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Kattintson ide a magyar verzióért.

In the first part of our series, we reviewed the factors that brought SDR regulations to life and presented its key points. In this article, we look at how the necessary implementation takes place in Hungary, what role the European Securities and Markets Authority plays in this process, and what kind of IT challenges arise when implementing the regulations.

In Hungary, similarly to other EU countries, the local clearing house, KELER Group, and the close cooperation of its members KELER Zrt. and KELER CCP, is essential in terms of developments, as several points of the regulations also affect KELER CCP. Compliance of KELER with SDR is essential for full and automated compliance.

What are the areas of SDR which concern the CCPs (central counterparty clearing houses)?

For CCPs, the key issues of SDR compliance are:

  • introduction of a settlement grace period (minimum 4 days);
  • handling settlement orders after failure (technical regulations);
  • the process of buy-ins, its participants and the related cash flows;
  • method of cash penalties;
  • Collection and redistribution of fines under SDRs;
  • participating in the sanctioning of consistent and systematic non-settlement.

In Hungary, the necessary implementation takes place within the framework of the KELER CCP’s Service Development Program:

  • Beyond SDR regulation, renewal of the securities settlement system
  • Along the principle of gradation, the individual functional elements are designed in a modular way
  • Purpose: to create automated processes

What is ESMA’s role in relation to SDRs?

The main role of the European Securities and Markets Authority (ESMA) in the field of securities clearing is to provide secondary supervision in relation to EU regulations on central clearing houses (CSDR) and to provide information on the Settlement Finality Directive (SFD) and coordinate the work of the authorities responsible for supervising T2S (Target2-Securities).

Why are SDRs sensitive to market participants?

SDRs are sensitive to market participants who, although not capable of SWIFT communication, have tried to bring automation into their day-to-day securities settlement practice. So far, mostly .txt files have been used and submitted in the local market as securities settlements. Unfortunately, T2S harmonization efforts no longer make this possible, as Clearing Houses connected to the T2S clearing system can only communicate with the new ISO standard 20022 XML-based messages on a SWIFT network, so STP (straight-through-processing) processes are essential. Local market players therefore also need to create .xml files to adapt to IT requirements, which is the basis of ISO 20022. It makes life harder that the matching criteria required for settlement have been supplemented with optional matching fields, so if both settlement partners do not fill in the same fields properly, the settlement may be failed. The settlement amount deviation tolerance has been reduced to a minimum, which further complicates positive matching and adherence to the agreed settlement date.

The procedure related to the discipline of settlement is binding on all market participants, the penalty items for non-compliance are uniform and their payment is also subject to rules.

Penalty rates applicable to the calculation of fines

Liquid shares1,00 bp
Illiquid shares0,50 bp
Government securities0,10 bp
Corporate bonds0,20 bp
Financial instruments other than bonds traded on the SME equity market0,25 bp
Bonds traded on the SME equity market0,15 bp
Other financial assets0,50 bp
In case of cash shortage (RVP and PFOD transactions)Official interest rate charged by the central bank issuing the settlement currency in exchange for a daily credit, which may not be less than 0

Without a proper IT background, tracking unpaired, pending, or failed items, receiving and processing a clearing house report, forwarding your own Client report, calculating potential penalty items, and reporting can involve significant manual labour.

It is essential to update existing BO systems or to integrate modular solutions between the clearing house and investment and securities service providers, to create automated – or complete STP processes, to make quick decisions, to be properly informed about settlement statuses, priorities, unmatched trades, and for immediate processing of reports.

The modules of Dorsum Securities services (MT-MX manager, Settlement Clearing and Reconciliation), support compliance with the SDR requirement, which is still preceded by the KELER Service Development Program in Hungary (it is expected to be activated by the week of December 2021). In this relation, the so-called connectivity tests are currently underway with the participation of KELER and market participants, investment service providers and custodian banks. After that, the market tests (MAT) will start at the beginning of the summer, which means a complete test for each KELER business process after the launch.

KELER CCP:

Within the framework of the KELER CCP – in several project phases, building on each other, the individual functional and service elements are developed along the principle of gradation.

The first phase of the Program focuses on the renewal of the securities settlement system. In the framework of this, KELER will maintain a new settlement platform, create an automatic settlement interface, establish an automatic interface between KELER and T2S, and implement the services and mechanisms required primarily by CSDR1 and the related settlement discipline regulations and by the European Union Regulation (SDR).

Simultaneously with the new settlement platform, the foundations of KELER’s new master data management and fee calculation systems will be created, based on which the statements and reports prepared for the Clients will be completely renewed.

Within the framework of the CCP, changes are expected in the following areas:

  • Master data
  • General characteristics of securities settlement
  • Transaction types
  • Discipline regime
  • Reports, queries
  • Fee calculation, invoicing

Lobbying and fears of market participants:

The SDR has been postponed for a second time thanks to a lobby submitted to ESMA, the European Securities and Markets Authority. In this letter, market participants outlined their comments and the problems and dilemmas that the capital markets will face from February 1, 2022:

  • Mandatory buy-ins be deferred as this will impact the liquidity of the market. When implemented they should be made optional for the “failed to” receiving party – not mandatory.
  • There is an anomaly in the nature of the SDR buy-in that can result in financial penalties to one of the parties. The aim of buy-ins was not to be a financial penalty but a mechanism to allow settlement. There is an asymmetrical nature to the SDR buy-ins that can cause parties to be at a financial loss. The letter asks for this to be corrected.
  • The letter accepts that the cash penalties will help improve settlement rates but asks for a delay to help all parties get ready in regard to the technical builds that are required.
  • A live testing period has been requested where the penalties are reported but not imposed to allow all parties to prove their systems.
  • Mechanisms to measure the success rate of the penalties should be created to assist in the assessment of the measure before moving on to impose the buy-ins.

Connection of SDR regulations:

The provisions of the SDR Regulation are closely interlinked, as they deal with measures to prevent and address settlement failures by monitoring settlement failures and to encourage settlement discipline, and by collecting and allocating fines in the event of settlement failure, and by defining the operational details of the mandatory buy-ins procedure.

In order to ensure coherence between those provisions and to enable those required to comply with them to view them comprehensively and to have easy access to them, it was appropriate to consolidate those provisions in a single regulation.

Related IT solutions:

Investment and custodian service providers can now feel free to decide whether to use IT solutions, respond to market challenges, and, by supplementing and modularly updating their existing back-office systems, they can bring automation into securities transaction settlements, status tracking, and thereafter to the stock and reconciliation processes.

It is very important to identify these affected areas at an early stage and to rationalize and automate in a timely manner the clearing steps that facilitate 100% intraday settlement, minimize “failures”, thus reducing the financial penalty and the associated reporting and information obligations, reducing the already huge administration tasks and costs. Among other things, Dorsum can help market players with this, thanks to its more than 20 years of experience. If you are interested in our solutions, contact us via the form on the right.

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If you are interested in our solutions, contact us via the form below.